The rupee crossed 60 to a dollar again and touched 60.06, briefly in early morning trade today. As I write this one dollar is worth around Rs 59.97. This should not be surprising given that the demand for dollars is much more than their supply.
The external debt of India stood at $ 390 billion as on March 31,2013. Nearly 44.2% or $172.4 billion of this debt has a residual maturity of less than one year i.e. it needs to be repaid by March 31, 2014. The external debt typically consists of external commercial borrowings (ECBs) raised by companies, NRI deposits, loans raised from the IMF and other countries, short term trade credit etc.
Every time an Indian borrower repays external debt he needs to sell rupees to buy dollars. When this happens the demand for dollars goes up, and leads to the depreciation of the rupee against the dollar. The demand for dollars for repayment of external debt is likely to remain high all through the year.
Data from the RBI suggests that NRI deposits worth nearly $49 billion mature on or before March 31, 2014. With the rupee depreciating against the dollar, the perception of currency risk is high and thus NRIs are likely to repatriate these deposits rather than renew them. This will mean a demand for dollars and thus pressure on the rupee.
External commercial borrowings of $21 billion raised by companies need to be repaid before March 31, 2014. Companies which have cash, might look to repay their foreign loans sooner rather than later. This is simply because as the rupee depreciates against the dollar, it takes a greater amount of rupees to buy dollars. So if companies have idle cash lying around, it makes tremendous sense for them to prepay dollar loans. The trouble is that if a lot of companies decide to prepay loans then it will add to the demand for dollars and thus put further pressure on the rupee.
Things are not looking good on the trade deficit front as well. Trade deficit is the difference between imports and exports. Indian imports during the month of May 2013, stood at $44.65 billion. Exports fell by 1.1% to $24.51 billion. This meant that India had a trade deficit of more than $20 billion. Trade deficit for the year 2012-2013 (i.e. the period between April 1, 2012 and March 31, 2013) had stood at $191 billion. The broader point is that India is not exporting enough to earn a sufficient amount of dollars to pay for its imports.
The trade deficit for the month of April 2013 had stood at $17.8 billion. If we add this to the trade deficit of $20.1 billion for the month of May 2013, we get a trade deficit of nearly $38 billion for the first two months of the year.
With the way things currently are it is safe to say that the trade deficit for 2013-2014(or the period between April 1, 2013 and March 31, 2014) is likely to be similar to that of last year, if not higher. What will add to the import pressure is a fall in the price of gold.
Hence, if we add the foreign debt of $172 billion that needs to be repaid during 2013-2014, to the likely trade deficit of $191 billion, we get $363 billion. This is going to be the likely demand for dollars for repayment of foreign debt and for payment of excess of imports over exports, during the course of the year.
A further demand for dollars is likely to come from foreign investors pulling money out of the Indian stock and bond market. The foreign investors pulled out investments worth more than Rs 44,000 crore or around $7.53 billion, from the Indian bond and stock markets during the month of June, 2013.
This is likely to continue in the days to come given that the Federal Reserve of United States, the American central bank, has indicated that it will go slow on printing dollars in the days to come. This means that interest rates in the United States are likely to go up, and thus close a cheap source of funding for the foreign investors.
Now lets compare this demand for dollars with India’s foreign exchange reserves. As on June 21, 2013, the foreign exchange reserves of India stood at $287.85 billion. Even if we were to ignore the demand for dollars that will come from foreign investors exiting India, the foreign exchange reserves are significantly lower than the $363 billion that is likely to be required for repayment of foreign debt and for payment of excess of imports over exports.
This clearly tells us that India is in a messy situation on this front. If we were to just look at the ratio of foreign exchange reserves to imports we come to the same conclusion. The current foreign exchange reserves are good enough to cover around six and a half months of imports ($287.85 billion of foreign exchange reserves divided by $44.65 billion of monthly imports). This is a very precarious situation and was last seen in the early 1990s, when India had just started the liberalisation programme. This is a very low number when we compare it to other BRIC economies(i.e. Brazil, Russia and China), which have an import cover of 19 to 21 months.
That’s one side of the equation addressing the demand for dollars. But what about the supply? Dollars can come into India through the foreign direct investment(FDI) route. When dollars come into India through the FDI route they need to be exchanged for rupees. Hence, dollars are sold and rupees are bought. This pushes up the demand for rupees, while increasing the supply of dollars, thus helping the rupee gain value against the dollar or at least hold stable.
The United Nations Conference on Trade and Development (UNCTAD) recently pointed out that the foreign direct investment in India fell by 29% to $26 billion in 2012. So things are not looking good on the FDI front for India. A spate of scams from 2G to coalgate is likely to keep foreign businesses away as well. The recent mess in India’s telecom policy and the Jet-Etihad deal, which would have been the biggest FDI in India’s aviation sector till date, doesn’t help either.
The other big route through which dollars can come is through foreign investors getting in money to invest in the Indian stock and bond market. But as explained above that is likely to be come down this year with the Federal Reserve of United States announcing that it will go slow on its money printing programme in the months to come.
NRI remittances can ease the pressure a bit. India is the world’s largest receiver of remittances. In 2012, it received $69 billion, as per World Bank data. But even this will not help much to plug the gap between the demand for dollars and their supply.
Then come the NRI deposits. As on March 31, 2013, they stood at around $70.8 billion, having gone up nearly 20.8% since March 31, 2012. NRIs typically invest in India because the interest that they earn on deposits is higher in comparison to what they would earn by investing in the countries that they live in.
Interest rates offered on bank deposits continue to remain high in India in comparison to the western countries. So does that mean that NRIs will renew their deposits and not take their money out of India? Interest is not the only thing NRIs need to consider while investing money in India. They also need to take currency risk into account. With the rupee depreciating against the dollar, the ‘perception’ of currency risk has gone up. Lets understand this through an example.
An NRI invests $10,000 in India. At the point he gets money into India $1 is worth Rs 55. So $10,000 when converted into rupees, amounts to Rs 5.5 lakh. This money lets assume is invested at an interest rate of 10%. A year later Rs 5.5 lakh has grown to Rs 6.05 lakh (Rs 5.5 lakh + 10% interest on Rs 5.5 lakh). The NRI now has to repatriate this money back. At this point of time lets say $1 is worth Rs 60. So when the NRI converts rupees into dollars he gets $10,080 or more or less the same amount of money that he had invested.
With the rupee depreciating against the dollar, the ‘perception’ of currency risk has thus gone up. Given this, NRIs are unlikely to bring in as many dollars into the country as they did during the course of the last financial year (i.e. the period between April 1, 2012 and March 31,2013).
In short, the demand for dollars is likely to continue to be more than their supply in the time to come. This will ensure that the rupee will keep depreciating against the dollar. Economist Rajiv Mallik of CLSA summarised the situation best in a recent column “Prepare for the rupee at 65-70 per US dollar next year. That still won’t be the end of the story.”
The article originally appeared on www.firstpost.com on July 3, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
External Commercial Borrowings
This economic number shows all that is wrong with Indian economy
The Reserve Bank of India released the financial stability report on June 27, 2013. The page 14 of the points out “Gross Domestic Saving as a proportion to GDP has fallen from 36.8 per cent in 2007-08 to 30.8 per cent in 2011-12.”
In the year 2004-2005, the total domestic savings had stood at 32.4% of the gross domestic product. Hence, there has been a tremendous drop in savings during the time the Congress led United Progressive Alliance (UPA) has governed this country. And this as we shall see is one number that is a broad representation of all that is wrong with the Indian economy in its current state.
The total amount of money that a country saves essentially comes from three sources: households, the private corporate sector, and the public sector. The worrying thing here is that household savings have fallen dramatically during the last seven years.
As the Economic Survey released in February 2013 pointed out “On average, households accounted for nearly three-fourths of gross domestic savings during the period 1980-81 to 2011-12. The share declined somewhat in recent years, and in the period from 2004-05 to 2011-12, it averaged 70.1 per cent of total savings.”
The other worrying factor is the dramatic fall in financial savings, which have pushed down overall domestic savings as well. As the RBI report points out “A large part of this decline has been due to fall in financial savings of households which have declined from 11.6 per cent of GDP to 8 per cent of GDP over the corresponding period (i.e. between 2007-08 to 2011-12.” Financial savings essentially accounts for savings in the form of bank deposits, life insurance, pension and provision funds, shares and debentures etc. In fact between 2010-2011 and 2011-2012, the household financial savings fell by a massive Rs 90,000 crore.
So the question is why have households savings and within them household financial savings, fallen so dramatically over the last few years? A straight forward answer is high inflation. The high inflation that has plagued the country during the course of UPA’s second term has meant that people have had to spend more money to buy the same basket of goods as they were doing the same. And this has meant lower savings. What this also tells us is that newspaper stories that talk about salaries in India going up in double digit terms, need to be taken with a pinch of salt, given that inflation has also more or less gone up at the same rate.
Also high inflation has meant that the real rate of returns after adjusting for inflation on products like public provident fund, bank deposits and post office deposits, which pay out a fixed rate of interest every year, have gone down. In fact, a fixed deposit paying an interest of 8-9% per year currently has a negative real rate of return in an environment where the consumer price inflation is greater than 9%. “Much of the financial savings of the household sector are in the form of bank deposits (around 30 per cent in the 2000s)..These were also the years when the real rate of interest was generally declining,” the Economic Survey pointed out.
In such an environment a lot of money has gone into gold and real estate which had a prospect of giving higher returns. As the Economic Survey pointed out “The last three years have seen a substantial rise in gold imports (the value of gold imports increased nine times between January 2008 and October 2012)…Gold imports are positively correlated with inflation.” High inflation reduces the ‘real’ return adjusted for inflation on other financial instruments and leads to people buying gold.
Given that a lot of savings have gone into gold and real estate, this has pulled down overall financial savings. As financial savings have fallen dramatically the interest rates on loans has been high for the last few years. In fact this is one reason why Indian businesses have been borrowing a lot of money abroad rather in India over the last few years. As the Business Standard reports “Beginning 2004, the central bank(i.e. RBI) has approved nearly $220 billion worth of external commercial borrowings and foreign currency convertible bonds (FCCB), at the rate of a little over $2 billion a month. Nearly two-thirds of this amount was approved in the past five years.”
Both gold and external borrowings have added to India’s dollar problem. India produces very little gold. Hence, almost all the gold that is consumed in the country is imported. Gold is bought and sold in dollars internationally. And every time an Indian importer buys gold, dollars are needed. This pushes up the demand for dollars in the market and puts pressure on the rupee. Gold imports are one reason why the rupee has lost value against the dollar through much of this year.
The finance minister P Chidambaram has been asking people time and again not to buy gold, without addressing the basic problem of “inflation”. Gold is finally just a symptom of the problem i.e. inflation. “The rising demand for gold is only a “symptom” of more fundamental problems in the economy,” the Economic Survey pointed out.
As far as foreign borrowings by Indian businesses are concerned, they need to repaid. To do this, Indian businesses will have to sell rupees and buy dollars, and this will push up the demand for dollars and put further pressure on the rupee. As the Business Standard points out “Much of this external commercial borrowing will come up for repayment this financial year, putting further pressure on the rupee.”
So financial savings going down due to inflation has created several problems for the country. Another reason for the financial savings being hit is the tremendous mis-selling of insurance by insurance companies. The RBI report says that the “credibility of the financial institutions” has been hit “in the wake of mis-selling of products and financial frauds”. The government hasn’t been able to do much on this front as well.
The article originally appeared on www.firstpost.com on June 28, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)