Why rupee is on a freefall …

Vivek Kaul
Free Fallin!” is an old American country song sung by Tom Petty and the Heartbreakers. The rupee surely is now on a free “heartbreaking” fall. The last that I looked at the numbers, the dollar was worth around Rs 54.7, the lowest level ever for it has ever reached against the dollar. It is well on its way to touching Rs 55 against the dollar. Some analysts have even predicted that it will soon touch Rs 60 against the dollar.
So what is making the rupee fall? There are several interlinked reasons for the same. Let me offer a few here.
Trade deficit
India ran a trade deficit of nearly $185billion in the financial year 2011-2012 (i.e. between April 1, 2011 and March 31,2012). Trade deficit refers to a situation where a country imports more than it exports. So in the last financial year India’s import of goods and services was $185billion more than its exports.
This trend has continued in the current financial year as well. The Indian imports for the month of April 2012 were at $37.9billion, almost 55% more than its exports at $24.5bilion.
Imports have to be paid for in dollars because that is the international currency that everybody accepts. They cannot be paid for in rupees. Now when payments have to be made in dollars, the importers sell rupees and buy dollars. When this happens the foreign exchange market suddenly has an excess supply of rupees and a short fall of dollars. This leads to rupee losing value against the dollar. This is the basic reason why rupee has been losing value against the dollar because we have been importing much more than we have been exporting. In case our exports matched our imports, then exporters who brought in dollars would be converting them into rupees, and thus there would be a balance in the market. Importers would be buying dollars and selling rupees. And exporters would be selling dollars and buying rupees. But that isn’t happening in a balanced way.
The RBI intervention
The Reserve Bank of India (RBI) tries to stem the fall of the rupee at times. It does this by selling dollars and buying rupees to ensure that there is an adequate supply of dollars in the market and at the same time any excess supply of rupees is sucked out. This is done in order to ensure that the rupee either maintains or gains value against the dollar. But the RBI cannot do this indefinitely for the simple reason that it has a limited amount of dollars. The RBI can print rupees and create them out of thin air, but it cannot do the same with the dollar.
But that still doesn’t answer the basic question of why does India import more than it exports.
Why does India run a trade deficit?
India runs a trade deficit on two accounts. One is that it has to import oil to meet a major portion of its domestic needs. And the second is the fact that Indians have a huge fascination for gold. Last year India imported around 1000 tonnes of gold. So we do not produce enough of the oil that we use and the gold that we buy. This in turn means that we have to import this from abroad. Both oil and gold are internationally sold in dollars. The price of both oil and gold has been going up for a while (though very recently it has been falling). This means more and more dollars have to be paid for importing them. This, as explained above, leads to a glut of rupees and an increased demand for the dollars, thus pushing down the value of the rupee against the dollar.
On April 1, 2011, one dollar was worth Rs 44.44. Between then and March 31, 2012, India ran a trade deficit of $185billion. And it has continued that in the month of April 2012 as well. This has led to one dollar being currently worth Rs 54.7.
What has also happened is that the government of India has not allowed the oil companies to pass on the increased cost of oil to the end consumer. Hence products like kerosene, diesel and LPG continued to be subsidized. The government in turn pays the oil companies for the losses leading to an increased fiscal deficit. But more than that with prices not rising as much as they should people have not adjusted their consumption accordingly. An increase in price typically leads to a fall in demand. If the increased price of oil had been passed onto the end consumer, the demand for oil would have come down. This would have meant that a fewer number of dollars would have been required to pay for the oil being imported, in turn leading to a lower trade deficit and hence lesser pressure on the rupee-dollar rate.
To conclude
When imports are more than exports what it means is that the country is paying more dollars for the imports than it is earning from the exports. This difference obviously comes from the foreign exchange reserves that India has accumulated over the years. But that clearly isn’t healthy given our imports are more than 50% of our exports and there is a limited supply of foreign exchange reserves.
So the market is now worried about this and is further pushing down the value of the rupee. The only way to control the fall of the rupee for the government is show the market that it serious about cutting down the trade deficit. And this can only be done by pricing the various oil products like diesel and kerosene, correctly. This in turn will lead to a lower demand for these products and help bring down the trade deficit. It will also push down the fiscal deficit, given that the subsidy burden of the government will be eliminated or come down. On the flip side an increase in the price of oil products will lead to increased inflation, at least in the short term.
In the end the only way to stem the fall of the rupee against the dollar is to eliminate and if not that, at least bring down, oil subsidy. Will that happen? Will the allies of the Congress led United Progressive Alliance government allow that to happen?
I remain pessimistic.
(This post originally appeared on Rediff.com on May 18,2012. http://www.rediff.com/business/slide-show/slide-show-1-column-why-the-rupee-is-on-a-freefall/20120518.htm)
(Vivek Kaul is a writer and can be reached at [email protected])

What the UPA government can learn from B.E.S.T

Vivek Kaul
Ek bandra station,” I told the conductor of the B.E.S.T (BrihanMumbai Electric Supply and Transport) bus number 83, handing over a ten rupee note.
Do rupiya aur,” he replied.
12 rupiya ka ticket hai?” I asked him.
Ji sir,” he replied.
I was travelling from Century Bazar in Worli to Bandra. The ticket till very recently used to cost eight rupees. It has now been increased to Rs 12, a rather steep 50% increase. The prices of tickets of lower denominations haven’t been increased so much. A four rupee ticket is now five rupees. But at the same time a ten rupee ticket now costs fifteen rupees and a twelve rupee ticket costs eighteen rupees.
This got me thinking. Why had the B.E.S.T increased prices? Well for the simple reason that they had to match their income with their expenditure, which is the most basic thing that needs to be done for successfully operating any institution. The fact that it is not allowed to raise prices as often as it probably wants to has led to this very high increase.
While the B.E.S.T believes in at least trying to ensure that its income meets its expenditure, the United Progressive AllianceUPA) which runs the government of India, doesn’t. And this is neither good for the UPA nor for you and me, the citizens of India.
In the year 2007-2008 (i.e. between April 1, 2007 and March 31,2008) the fiscal deficit of the government of India stood at Rs 1,26,912 crore. Fiscal deficit is the difference between what the government earns and what it spends. For the year 2011-2012 (i.e. between April 1, 2011 and March 31, 2012) the fiscal deficit is expected to be Rs 5,21,980 crore.
Hence the fiscal deficit has increased by a whopping 312% between 2007 and 2012. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore.
Things cannot be quite right when your expenditure is expanding nine times as fast as your income. As Franklin Roosevelt, who was the President of America for a record four times, between 1933 and 1945 famously said “Any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.”
So why is the UPA led Indian government headed to the poorhouse? For that we have to dig a little deep and look into this document known as the annual financial statement of the government of India. In this document the government gives out numbers for the amount it had assumed initially as the oil subsidy for the year, and the final oil subsidy it gave.
The data for the last three years has been very interesting. The subsidy assumed at the time of the finance minister presenting the budget has always been much lower than the final subsidy bill. Take the case for the year 2009-2010(i.e. between April 1, 2009 and March 31,2010) the oil subsidy assumed was Rs 3109 crore. The final bill came to Rs 25,257 crore (direct subsidies + oil bonds issued to the oil companies), around eight times more.
The next year (i.e. between April 1, 2010 and March 31, 2011) the oil subsidy assumed was Rs 3108 crore. The actual bill was nearly 20 times more at Rs 62,301 crore. For the year 2011-2012(i.e. between April 1,2011 and March 31,2012) the subsidy assumed was Rs 23,640 crore. The actual subsidy bill came to Rs 68,481 crore.
So in each of the last three years the oil subsidy bill has come out to be greater than what was assumed. For the current financial year (i.e. April 1, 2012 to March 31,2013) the oil subsidy bill has been assumed to be at Rs 43,580 crore. While this is greater than the assumption made over the last three years, it is highly likely that the oil subsidy bill will come to amount greater than this.
There are two reasons for the same. The first reason is that the rupee has been rapidly depreciating against the dollar and since oil is sold in dollars that means that the Indian companies are paying up more in rupees to buy the same volume of oil. Currently oil is priced at around $115 per barrel (around 159litres) of oil. This means that Indian companies pay around Rs 6141 per barrel of oil.
If the rupee falls further and one dollar equals Rs 60 (as has been written about on this website), the Indian companies will be paying Rs 6900 or 12.4% more per barrel of oil. In the normal scheme of things this cost would have been passed onto the customer and everybody would have lived happily ever after.
But that is not the case. Various products coming out of oil like kerosene, diesel etc, are heavily subsidized in India. Hence even with higher prices of oil internationally the Indian oil companies will have to keep selling their products at lower prices and suffer losses. These companies are then compensated for the losses they face by the government of India.
The second reason is that the price of oil is unlikely to go down in dollar terms as well. As governments and central banks around the world run close to zero interest rates and print more and more money (and are likely to continue to do so) in order to revive economic growth in their respective countries, oil has become a favourite commodity to buy among the speculators.
While central banks and governments can print all the money they want, they can’t dictate where it goes. As Ruchir Sharma writes in Breakout Nations – In Pursuit of the Next Economic Miracles “When money is loose, investors borrow to buy hard assets, which is why the prices of oil, copper, and other commodities have become disconnected from actual demand.”
This means that oil will either continue at its current price level or even go up for that matter. And with the rupee likely to depreciate further this means that India’s oil import bill is likely go up even further.
It is highly unlikely that this increase in price will be passed onto the end customer. This means that the government will have to bear the losses incurred by the oil companies, pushing up the oil subsidy, which has been assumed to be at Rs 43,580 crore.
A higher oil subsidy bill means the government expenditure going up and this in turn means a higher fiscal deficit. Typically, the government finances this deficit by borrowing money. With the government needing to borrow more money it would have to offer a higher rate of interest. At the same time a higher government borrowing will crowd out private borrowing, meaning that the private borrowers like banks and other finance companies will have to offer a higher rate of interest on their deposits because there would be lesser amount of money to borrow. A higher rate of interest on deposits would obviously mean charging a higher rate of interest on loans.
All this can be avoided if the government follows what B.E.S.T did recently i.e. allow oil companies to raise prices of its products. Why can’t a free market operate when it comes to oil products? If the price of oil products changes on a daily basis depending on its international price, like the price of vegetables, people will gradually get used to the idea of a changing price for products like diesel and kerosene.
And of course chances are that with the government borrowing coming down, interest rates might also fall. In 2007, when the government fiscal deficit was low, a 20 year home loan could be got at an interest rate of 8%. A loan of Rs 25 lakh would mean an EMI(equated monthly installment) of around Rs 25,093. A lot of banks are now charging their existing consumers around 13% on their home loans. This means an EMI of around Rs 35,147 or almost 40% more.
The huge subsidy on oil prices has had a role to play in this increasing EMI. Bad economics does not always mean good politics. Its time UPA woke up to that.
(The article was originally published on May 9, 2012,at http://www.rediff.com/business/slide-show/slide-show-1-special-what-the-upa-govt-can-learn-from-best/20120509.htm. Vivek Kaul is a writer and can be reached at [email protected])