Chidamabaram didn’t start the rupee fire, but India is burning because of it

Vivek Kaul
P Chidambaram, the finance minister, made the routine let’s not get worried statement, over the rupee’s recent fall against the dollar.“We are watching the situation. RBI will take whatever action it has to take. We will (do) whatever has to be done…My request is you should not react in panic. It’s happening around the world,” he said.
This was something that was reiterated by 
Arvind Mayaram, secretary of the department of economic affairs, in the ministry of finance. “No, I don’t think the government needs to take any measures…We are watching the situation closely…If you see weakening of all currencies vis-a-vis the dollar, the rupee is also not unaffected in that sense…this panic in the market is unwarranted.”
A finance minister and his bureaucrat are expected to defend a falling currency. And yes, it’s true a lot of currencies have lost value against the dollar recently. But does that make the pain any lesser for India? Are there no reasons to worry as Mayaram wants us to believe?
Chidambaram’s “it is happening around the world” argument can be tackled with a simple analogy. Let’s say one of your neighbours starts a fire by mistake, which eventually spreads to your house. What do you do in such a situation? You try and stop the fire from spreading further, rather than sitting and blaming your neighbour for it or saying that I should not panic because I did not start the fire. Irrespective of where the fire started, the damage is yours, if you do not work towards putting it off.
Even though the rupee is falling against the dollar because of 
certain actions taken by the Federal Reserve of United States, it is clearly damaging India.
A depreciating rupee means that India has to pay more in rupee terms, for its oil imports. The price of the Indian basket of crude oil was at around $98 per barrel at the beginning of June.
It rose to $104 per barrel on June 19, 2013. On June 20, 2013, it fell to $101.8 per barrel. The rupee during the same period has fallen to Rs 60 to a dollar(Rs 59.75 as I write this) from around Rs 56.5 at the beginning of .
What this means is that India’s oil import bill has gone up in rupee terms. If the government decides to pass on this increase to the final consumer in the form of an increase in the price of diesel, petrol and kerosene, then it will lead to inflation or higher prices.
In fact CNG prices have already been hiked in Delhi by Rs 2, because of a weaker rupee.
If it decides to take on a part of the increase then it means greater expenditure for the government. A greater expenditure in turn means a higher fiscal deficit for the government. Fiscal deficit is the difference between what a government earns and what it spends. A higher fiscal deficit means that the government has to borrow more to finance its expenditure and this leads to higher interest rates, which holds back economic growth.
Coal is another big import item. With the rupee losing value against the dollar the cost of importing coal is going up. Coal in India is imported typically by private power companies to produce power. The government owned Coal India Ltd, does not produce enough coal to meet the needs. The Cabinet Committee on Economic Affairs recently 
decided to allow private power companies to pass on the rising cost of imported coal to consumers.
This will lead to a higher cost of power, which will add to inflation. 
As Anand Tandon writes in The Economic Times “Inflation at the consumer level will start hotting up in the third quarter of the fiscal year as increases in power and fuel cost work their way through the system.”
A depreciating rupee will benefit Indian exporters, or so goes the argument. As rupee loses value against the dollar, an exporter who gets paid in dollars, gets more rupees, when he converts those dollars into rupees, thus boosting his profits.
This argument doesn’t really hold. 
The Economic Times quotes Anup Pujari, director general of foreign trade (DGFT), on this issue. “It is a myth that the depreciation of the rupee necessarily results in massive gains for Indian exporters. India’s top five exports — petroleum products, gems and jewellery, organic chemicals, vehicles and machinery — are so much import-dependent that the currency fluctuation in favour of exporters gets neutralised. In other words, exporters spend more in importing raw materials, which in turn erodes their profitability.”
The other thing that seems to be happening is that in a tough global economic environment, buyers are renegotiating contracts with Indian exports as the rupee loses value against the dollar.”The moment the rupee falls sharply against the dollar foreign buyers try to renegotiate their earlier deals. As most exporters give in to the pressure and split the benefits, the advantages of a weak rupee disappear,” Pujari told 
The Economic Times.
What this means is that a weaker rupee is unlikely to lead to higher exports. This means that the trade deficit or the difference between imports and exports will continue to remain high, which can weaken the rupee further against the dollar.
In fact, a depreciating rupee has rendered 
nearly 25,000 diamond workers in Surat jobless, reports The Times of India. “The depreciating rupee has resulted in nearly 1,200 small and medium diamond unit owners in shutting shops as they are unable to purchase rough stones whose prices have touched an all-time high. This has led to at least 25,000 workers being rendered jobless since last Thursday,” the report points out.
The rupee could have fallen to a much lower level against the dollar, but it did not. This is primarily because the Reserve Bank of India(RBI) has been defending the rupee, by selling dollars from its foreign exchange reserves, and buying rupees.
But the question is till when can the RBI keep selling dollars? “Foreign exchange reserves are barely sufficient to cover seven months of imports — the lowest it has been in the last 15 years. As a comparison, the other Bric members have 19-21 months of import cover,” writes Tandon. 
According Bank of America-Merril Lynch, the RBI can sell up to $30 billion to support the rupee.
The RBI cannot create dollars out of thin air, only the Federal Reserve of United States can do that.
Given this, there are reasons to worry. And yes, the Chidambaram’s UPA government did not start this rupee fire, but that does not mean that India is not burning because of it.

The article originally appeared on on June 25, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)