Vivek Kaul
The Reserve Bank of India(RBI) painted a very worrying picture of India’s external debt scenario in a report released late last week. The total external debt of the country stood at US$ 390 billion as on March 31,2013. This was an increase of US$ 44.6 billion or 12.9 per cent in comparison to March 31, 2012.
Even on a quarterly basis the increase is substantial. As on December 31, 2012, the total external debt had stood at $376.3 billion. This implies an increase of 3.6% of the three month period between December, 2012 and March, 2013.
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. What is worrying here is that nearly 44.2% or $172.4 billion of the outstanding external debt matures on or before March 31, 2014.
The borrower will have to sell rupees and buy dollars in order to repay this maturing foreign debt. When this happens, it might lead to a surfeit of rupees and a shortage of dollars in the foreign exchange market, leading to a further fall in value of the rupee against the dollar.
The foreign investors pulled out investments worth more than Rs 44,000 crore from the Indian debt and equity markets during the month of June, 2013. During the process of conversion of these rupees into $7.53 billion, the demand for dollars went up, and pushed the value of one dollar beyond sixty rupees. The rupee has since recovered a little, and as I write this one dollar is worth around Rs 59.24.
The broader point is that if the demand for $7.53 billion can cause a massacre of the Indian rupee against the dollar, $172.4 billion of debt which needs to be repaid before March 31, 2014, can create a bigger havoc.
The ratio of debt that needs to be paid before March 31, 2014, to the foreign exchange reserves of India is around 59%. This was at 17% as on March 31, 2008. This is another number that tells us very clearly the precarious position India is in as far as its external debt is concerned.
One factor that needs to be considered here is that all the maturing debt may not need to be repaid. Take the case of 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 more likely to repatriate their maturing deposits, rather than renew them, and this will put pressure on the rupee dollar exchange rate. Data from the RBI suggests that NRI deposits worth nearly $49 billion mature on or before March 31, 2014.
External commercial borrowings worth $21 billion need to be repaid before March 31, 2014. Companies can pay off these loans by raising fresh loans. But in the aftermath of the Federal Reserve of United States, the American central bank, deciding to “taper” or go slow on the money printing, fresh loans may not be so easy to come by. Also, businesses may want to pay up as quickly as possible given that more the rupee depreciates against the dollar, the greater is the amount in rupees they would need to buy dollars needed to repay there loans.
Interestingly, nearly $43.3 billion of external commercial borrowings are set to mature between April 1, 2014 and March 31, 2016.
So to cut a long story shot, much of the external debt maturing before March 31, 2014 will have to repaid and this will put further pressure on the rupee vis a vis the dollar.
India’s burgeoning external debt is only a recent phenomenon. As on March 31, 2007, the total external debt had stood at $169.7 billion. Since then it has jumped by a massive 129.8% to $390 billion. There are basically two reasons for the same.
The first reason is the burgeoning fiscal deficit of the Congress led United Progressive Alliance(UPA) government. Fiscal deficit is the difference between what a government earns and what it spends. For 2007-2008(i.e. the period between April 1, 2007 and March 31, 2008), the fiscal deficit had stood at Rs 1,26,912 crore. For the year 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014) it is projected to be at Rs 5,42,599 crore or nearly 327.5% higher.
The higher fiscal deficit has been financed through greater borrowings made by the government. In order to borrow money the government had to offer better terms than available elsewhere, and thus managed to push up interest rates. This encouraged NRIs to invest their money in India. NRI deposits have increased from $41.24 billion as on March 31, 2007, to $70.82 billion as on March 31, 2013.
Higher interest rates also led to businesses looking at cheaper options abroad. External commercial borrowings went up from $41.44 billion as on March 31, 2007 to $120.89 billion as on March 31, 2013. Interest rates were lower abroad primarily because the Western central banks had unleashed a huge money printing effort in the aftermath of the financial crisis that started in late 2008 to get their respective economies up and running again. And this is the second reason behind India’s burgeoning foreign debt.
To conclude, tough times lie ahead for the rupee. The recent Financial Stability Report released by the RBI points out that “rise in India’s overall external debt is an added source of concern.” But that is a very mild “British” sort of way of putting it. What we need here is a classic American expression. When it comes to the rupee “you ain’t seen nothin’ yet”.
The article originally appeared on www.firstpost.com on July 1, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
rupee
This economic number shows all that is wrong with Indian economy
Vivek Kaul
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)
Rupee fall: Why India's struggle for dollars will continue
Vivek Kaul
The question being asked yesterday was “why is the rupee falling against the dollar”. The answer is very simple. The demand for American dollars was more than that of the Indian rupee leading to the rupee rapidly losing value against the dollar.
This situation is likely to continue in the days to come with the demand for dollars in India being more than their supply. And this will have a huge impact on the dollar-rupee exchange rate, which crossed 60 rupees to a dollar for the first time yesterday.
Here are a few reasons why the demand for dollars will continue to be more than their supply in the days to come.
a) 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. When dollars come into India through the foreign direct investment(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.
In 2012, the FDI coming into India fell dramatically. The situation is likely to continue in the days to come. The corruption sagas unleashed in the 2G and the coalgate scam hasn’t done India’s image abroad any good. In fact in the 2G scam telecom licenses have been cancelled and the message that was sent to the foreign investors was that India as a country can go back on policy decisions. This is something that no big investor who is willing to put a lot of money at stake, likes to hear.
Opening up multi-brand retailing was government’s other big plan for getting FDI into the country. In September 2012, the government had allowed foreign investors to invest upto 51% in multi-brand retailing. But between then and now not a single global retailing company has filed an application with the Foreign Investment Promotion Board (FIPB), which looks at FDI proposals.
This scenario doesn’t look like changing as likely foreign investors struggle to make sense of the regulations as they stand today. Dollars that come in through the FDI route come in for the long run as they are used to set up new industries and factories or pick up a stake in existing companies. This money cannot be withdrawn overnight like the money invested in the stock market and the bond market.
b) There has been a lot of talk about the Reserve Bank of India(RBI) selling bonds to Non Resident Indians (NRIs) and thus getting precious dollars into the country. The trouble here is that any NRI who invests in these bonds will carry a huge amount of currency risk, given the rapid rate at which the rupee has lost value against the dollar.
Lets understand this through a simple example. An NRI invests $100,000 in India. At the point he gets money into India $1 is worth Rs 55. So $100,000 when converted into rupees, amounts to Rs 55 lakh. This money lets assume is invested at an interest rate of 10%. A year later Rs 55 lakh has grown to Rs 60.5 lakh (Rs 55 lakh + 10% interest on Rs 55 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 $100,800 or more or less the same amount of money that he had invested. His return in dollar terms is 0.8%. The real return would be much lower given that this calculation doesn’t take the cost of conversion into account.
Hence, the NRI would have been simply better off by letting his money stay invested in dollars. This is the currency risk. To make it attractive for NRI investors to invest money in any such RBI bond, the interest on offer will have to be very high.
c) While the supply of dollars will continue to be a problem, the demand for them will continue to remain high. A major demand for dollars will come from companies which have raised loans in dollars over the last few years and now need to repay them. 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. Much of this ECB will come up for repayment this financial year, putting further pressure on the rupee.”
A lot of companies have raised foreign loans over the last few years simply because the interest rates have been lower outside India than in India. These companies will need dollars to repay their foreign loans as they mature.
The other thing that might happen is that 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 the dollar and thus put further pressure on the rupee.
d) India’s love for gold has been one reason behind significant demand for the dollar. Gold is bought and sold internationally in dollars. India produces very little gold of its own and hence has to import almost all the gold that is consumed in the country. When gold is imported into the country, it needs to be paid for in dollars, thus pushing up the demand for dollars. As this writer has argued in the past there is some logic for the fascination that Indians have had for gold. A major reason behind Indians hoarding to gold is high inflation. Consumer price inflation continues to remain high. Also, with the marriage season set to start over the next few months, the demand for gold is likely to go up. What can also add to the demand is the fall in price of gold, which will get those buyers who have not been buying gold because of the high price, back into the market. All this means a greater demand for dollars.
e) India has been importing a huge amount of coal lately to run its power plants. Indian coal imports shot up by 43% to 16.77 million tonnes in the month of May 2013, in comparison to the same period last year. Importing coal again means a greater demand for dollars.
The irony is that India has huge coal reserves which are not being mined. The common logic here is to blame Coal India Ltd, which more or less has had a monopoly to produce coal in India. The government has tried to encourage private sector investment in the sector but that has been done in a haphazard manner leading to the coalgate scam. This has delayed the bigger role that the private sector could have played in the mining of coal and thus led to lower coal imports.
The situation cannot be set right overnight. The major reason for this is the fact that the expertise to get a coal mine up and running in India has been limited to Coal India till now. To develop the same expertise in the private sector will take time and till then India will have to import coal, which will need dollars.
f) The government’s social sector policies may also add to a huge demand for dollars in the time to come. The procurement of wheat by the government this year has fallen by 33% to 25.08 million tonnes. This will not have any immediate impact given the huge amount of grain reserves that India currently has. But as and when right to food security becomes a legal right any fall in procurement will mean that the government will have to import food grains like wheat and rice, and this will again mean a demand for dollars. While this is a little far fetched as of now, but is a likely possibility and hence cannot be ignored.
These are fundamental issues which will continue to influence the dollar-rupee exchange rate in the days to come and do not have easy overnight kind of solutions. Of course, if the Ben Bernanke led Federal Reserve of United States, decides to go back to printing as many dollars as it is right now, then a lot of dollars could flow into India, looking for a higher return. But then, that is something not under the control of Indian government or its policy makers.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
India is screwed, no matter what RBI does on rupee
Vivek Kaul
The Reserve Bank of India(RBI) finally threw in the towel today. Over the past several days it had been selling dollars in the foreign exchange market and had thus managed to hold back the rupee to under 60 to a dollar.
The RBI tried halting the fall of the rupee by selling dollars today as well. A report on www.livemint.com points out that “The Indian central bank(i.e. the RBI) intervened by selling the dollar at 59.98, earlier in the day, according to currency dealers, who added that a foreign bank had aided RBI by selling dollars in the market.”
This helped the rupee to recover to around 59.93 to a dollar. But it soon crossed 60 to a dollar. At the end of trading today, one dollar was worth Rs 60.73.
The question being asked is could the RBI have continued to sell dollars and help stem the fall? As on June 14, 2013, India had foreign exchange reserves of $290.66 billion. This is tenth largest in the world.
So it seems that the RBI has enough dollars that it can sell to halt the rupee’s fall against the dollar. But things are not as simple as that. Indian imports during the month of May 2013, stood at $44.65 billion. This basically means that the current foreign exchange reserves are good enough to cover around six and a half months of imports ($290.66 billion of foreign exchange reserves divided by $44.65 billion of monthly imports).
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. What does not help is the huge difference between Indian exports and imports. In May 2013, Indian exports fell by 1.1% to $24.51 billion. This meant that India had a trade deficit (or the difference between imports and exports) of more than $20 billion. The broader point is that India is not exporting enough to earn a sufficient amount of dollars to pay for its imports.
In this scenario the RBI can use only a limited portion of its foreign exchange reserves to defend the dollar. An estimate made by Bank of America- Merrill Lynch suggests that the RBI can use upto $30 billion to defend the rupee. If it chooses to do that the foreign exchange reserves will come down to around $260 billion, which would mean an import cover of around 5.8 months ($260billion divided by $44.65 billion of imports). This will be a very precarious situation and was last seen in the early 1990s, when India had just started the liberalisation programme.
This is one reason behind why the RBI cannot stop the rupee from falling beyond a point. More than that it does not make sense for any central bank (unless we are talking about the People’s Bank of China) to obsess with a certain currency target against the dollar. This was the learning that came out from the South East Asian crisis of the late 1990s.
Various South East Asian currencies were pegged to the dollar. The Thai baht, was pegged to the US dollar with one dollar being equal to 25 Thai baht. The Philippines peso was pegged at 25 pesos to the dollar. The Malaysian ringgit was pegged at 2.5 ringgits per dollar and so was the Indonesian rupiah, which was pegged at 2030 rupiah to a dollar.
The central banks of these countries ensured that there currencies continued to remain pegged. In case the market suddenly had a surfeit of baht, and the baht started to lose value against the dollar, the Thai central bank started to buy baht and sell dollars. In a situation where the market had a surfeit of dollars and the baht started to appreciate against the dollar, the Thai central bank intervened and started to buy dollars and sell baht. This ensured that the value of the baht against the dollar remained fixed.
But when the South East Asian crisis started, investors started to exit these countries lock, stock and barrel. So if an investor sold out of the Thai stock exchange he was paid in Thai baht. When he had to repatriate this money abroad he needed to convert these baht to dollars. So suddenly the foreign exchange market had a surfeit of Thai baht. In the normal scheme of things, the value of the baht would have fallen against the dollar. But the baht was pegged to the dollar. So as a logical step the Thai central bank started to sell dollars and buy baht, in order to ensure that one dollar continued to be worth 25 Thai baht.
In May 1997, the finance minister of Thailand was fired. The new finance minister made a secret visit to the central bank and realised that the country had more or less run out of dollars trying to defend the dollar-baht exchange rate. The bank had run through nearly $33billion of foreign exchange reserves trying to defend the exchange rate.
On July 2, 1997, Thailand decided to stop supporting the baht and let it fall. It was estimated that the baht would fall by around 15%, but instead by the end of July it had already fallen by 20% to 30 baht a dollar. A year later the exchange rate was down to 41 baht to a dollar. And within two weeks of Thailand setting the baht free, others followed. The Philippines peso’s peg with the dollar broke on July 14. The peg of the Indonesian rupiah and the Malaysian ringgit also broke the same day.
A year later the Indonesian rupiah was at 14,150 to a dollar. It had been at 2380 to a dollar. The Malaysian ringgit was at 4.1 to a dollar, down from 2.5. And Philippines peso was at 42 to a dollar against 26.3 a year earlier
That is the problem with trying to defend the exchange rate. It needs an unlimited amount of dollars, which no country in the world other than the United States (and to a certain extent China which has nearly $3.3 trillion foreign exchange reserves) has. And only the Federal Reserve of United States, the American central bank can print dollars. No other central bank can do that.
A similar situation is playing out in India right now. Foreign investors are looking to exit the country. They have sold off more than $5 billion worth of bonds since late May. They have also sold off stocks worth $1.39 billion in June, after buying stocks worth $4 billion in May. These investors are now trying to convert there rupees into dollars, and that has led to the rupee rapidly depreciating against the dollar.
The RBI tried to halt this fall by intervening in the foreign exchange market and selling dollars. But as the South East Asian experience tells us, obsessing with a certain target against the dollar is not a great idea.
So given that the RBI has got it right by not obsessing with the target of Rs 60 to a dollar. But the trouble is that a weaker rupee will have several negative consequences in the days to come (This is discussed in detail here).
First and foremost will be higher inflation as India will pay more for imported products. Oil will become expensive in rupee terms. If the government passes on the increase in price to the end consumer, then it will lead to higher prices or inflation. If it does not pass on the increase in prices to the end consumer then the government will run a higher fiscal deficit as its expenditure will go up. Fiscal deficit is the difference between what a government earns and what it spends. It will also mean that the government will have to borrow more to finance its expenditure and that in turn will mean that the high interest rate scenario will continue.
India imports a lot of coal which is used for the production of power. With the rupee losing value against the dollar the cost of importing coal will go 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 again will add to inflation.
Companies which had borrowed in dollars and have not insured themselves against the fall of the rupee, will have to pay more. Economist Arvind Subramanian points out in the Business Standard that there will be “a decline in the profitability of all those enterprises that have borrowed heavily in foreign currency and have not insured themselves against a rupee decline (“unhedged borrowing”).”
This cost “will manifest itself in reduced investment by these companies and hence lower aggregate growth; it will also manifest itself (eventually) in a worsened fiscal situation because the government will have to support these companies directly or the banks that have lent to them,” writes Subramanian.
The broader point is that India is screwed both ways irrespective of whether RBI defends the rupee or not.
The article originally appeared on www.firstpost.com on June 26, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Why FM is tickling the markets: it’s his only chance
Vivek Kaul
So P Chidambaram’s at it again, trying to bully the Reserve Bank of India (RBI) to cut interest rates. “In our view, the government and monetary authority must point in the same direction and walk in the same direction. As we take steps on the fiscal side, RBI should take steps on the monetary side,” the Union Finance Minister told the Economic Times.
Economic theory suggests that when interest rates are low, consumers and businesses tend to borrow more. When consumers borrow and spend money businesses benefit. When businesses benefit they tend to expand their operations by borrowing money. And this benefits the entire economy and it grows at a much faster rate.
But then economics is no science and so theory and practice do not always go together. If they did the world we live would be a much better place. As John Kenneth Galbraith points out in The Economics of Innocent Fraud: “If in recession the interest rate is lowered by the central bank, the member banks are counted on to pass the lower rate along to their customers, thus encouraging them to borrow. Producers will thus produce goods and services, buy the plant and machinery they can afford now and from which they can make money, and consumption paid for by cheaper loans will expand..The difficulty is that this highly plausible, wholly agreeable process exists only in well-established economic belief and not in real life… Business firms borrow when they can make money and not because interest rates are low.”
While India is not in a recession exactly, economic growth has slowed down considerably this year. And this has led to businesses not borrowing. As a story in theBusiness Standard points out “At a recent meeting with the Reserve Bank of India (RBI), 10 of the country’s top bankers said companies were still keeping expansion plans on hold, as business growth continued to be slow in an uncertain economic environment. Nine of 10 bankers who attended the meeting admitted their sanctioned loan pipeline was shrinking fast due to tepid demand.”
This is borne out even by RBI data. The incremental credit deposit ratio for scheduled commercial banks between March 30, 2012 and September7, 2012, stood at 14.4%. This meant that for every Rs 100 that bank raised as deposits during this period they only lent out Rs 14.4 as loans. Hence, businesses are not borrowing to expand neither are consumers borrowing to buy flats, cars, motorcycles and consumer durables.
One reason for this lack of borrowing is high interest rates. But just cutting interest rates won’t ensure that the borrowing will pick up. As Galbraith aptly puts it business firms borrow when they can make money. But that doesn’t seem to be the case right now. Take the case of the infrastructure sector which was one of the most hyped sectors in 2007. As Swaminathan Aiyar points out in the Times of India “The government claims India is a global leader in public-private partnerships in infrastructure. The private sector financed 36% of infrastructure in the 11th Plan (2007-12 ),and is expected to finance fully 50% in the 12th Plan. This is now a pie in the sky. Corporations that charged into this sector have suffered heavy losses. They expected a gold mine, but found only quicksand. They have been hit by financially disastrous time and cost overruns.”
Clearly these firms are not in a state to borrow. Several other business sectors are in a mess. Airlines are not going anywhere. The big Indian companies that got into organised retail have lost a lot of money. The telecom sector is bleeding. So just because interest rates are low it doesn’t automatically follow that businesses will borrow money.
“If you take a poll of the top 100 companies in the country, you will find them saying nothing has changed despite the reforms. Confidence will return only if things start happening on the ground,” a Chief Executive of a leading foreign bank in India was quoted as saying in the Business Standard.
Confidence on the ground can only come back once businesses start feeling that this business is committed to genuine economic reform, there is lesser corruption, more transparency, so and so forth. These things cannot happen overnight.
Consumers are also feeling the heat with salary increments having been low this year and the consumer price inflation remaining higher than 10%. Borrowing doesn’t exactly make sense in an environment like this, when just trying to make ends meet has become more and more difficult.
Given these reasons why has Chidambaram been after the RBI to try and get it to cut interest rates? The thing is that the finance minister is not so concerned about consumers and businesses, but what he is concerned about is the stock market.
With interest rates on fixed income investments like bank fixed deposits, corporate fixed deposits, debentures, etc, being close to 10%, there is very little incentive for the Indian investor to channelise his money into the stock market.
Since the beginning of the year the domestic institutional investors have taken out Rs 38,000.5 crore from the stock market. If the RBI does cut interest rates as Chidambaram wants it to, then investing in fixed income investments will become less lucrative and this might just get Indian investors interested in the stock market.
The lucky thing is that even though Indian investors have been selling out of the stock market, the foreign investors have been buying. Since the beginning of the year the foreign institutional investors have bought stocks worth Rs 72,065.2 crore. This has ensured that stock market has not fallen despite the Indian investors selling out.
If the RBI does cut interest rates and that leads Indian investors getting back into the stock market there might be several other positive things that can happen. If Indian investors turn net buyers and the stock market goes up, more foreign money will come in. This will push up the stock market even further up.
The other thing that will happen with the foreign money coming in is that the rupee will appreciate against the dollar. When foreigners bring dollars into India they have to sell those dollars and buy rupees. This increases the demand for the rupee and it gains value against the dollar.
An appreciating rupee will also spruce up returns for foreign investors. Let us say a foreign investor gets $1million to invest in Indian stocks when one dollar is worth Rs 55. He converts the dollars into rupees and invests Rs 5.5 crore ($1million x Rs 55) into the Indian market. He invests for a period of one year and makes a return of 10%. His investment is now worth Rs 6.05 crore. One dollar is now worth Rs 50. When he converts the investors ends up with $1.21million or a return of 21% in dollar terms. An appreciating rupee thus spruces up his returns. This prospect of making more money in dollar terms is likely to get more and more foreign investors into India, which will lead to the rupee appreciating further. So the cycle will feeds on itself.
In the month of September 2012, foreign investors have bought stocks worth Rs 20,807.8 crore. Correspondingly, the rupee has gained in value against the dollar. On September 1, 2012, one dollar was worth Rs 55.42. Currently it quotes at around Rs 52.8. This means that the rupee has appreciated against the dollar by 4.72%.
An immediate impact of the appreciating rupee is that it brings down the oil bill. Oil is sold internationally in dollars. Let us say the Indian basket of crude oil is selling at $108 per barrel (one barrel equals 159 litres). If one dollar is worth Rs 55.4 then India has to pay Rs 5983.2 for a barrel of oil. If one dollar is worth Rs 52.8, then India has to pay Rs 5702.4 per barrel. So as the rupee appreciates the oil bill comes down.
The oil marketing companies (OMCs) sell diesel, kerosene and cooking gas at a price which is lower than the cost price and thus incur huge losses. The government compensates the OMCs for these losses to prevent them from going bankrupt. This money is provided out of the annual budget of the government under the oil subsidy account. But as the rupee appreciates and the losses come down, the oil subsidy also comes down. This means that the expenditure of the government comes down as well, thus lowering the fiscal deficit. Fiscal deficit is the difference between what the government earns and what it spends.
This is how a rising stock market may lead to a lower fiscal deficit. But that’s just one part of the argument. A rising stock market will also allow the government to sell some of the shares that it owns in public sector enterprises to the general public. The targeted disinvestment for the year is Rs 30,000 crore. While that can be easily met the government has to exceed this target given that the government is unlikely to meet the fiscal deficit target of 5.1% of GDP as its subsidy bill keeps going up. The Kelkar Committee recently estimated that the fiscal deficit level can even reach 6.1% of the GDP.
For the government to exceed this target the stock markets need to continue to do well. It is a well known fact people buy stocks only when the stock markets have rallied for a while. As Akash Prakash writes in the Business Standard “The finance minister will have to do a lot more than raise Rs 40,000 crore from spectrum and Rs 30,000 crore from divestment. We will need to see movement on selling the SUUTI (Specified Undertaking of UTI) stakes, strategic assets like Hindustan Zinc, land with companies like VSNL, coal block auctions, etc. To enable the government to raise resources of the required magnitude, the capital markets have to remain healthy, both to absorb equity issuance and to enable companies to raise enough debt resources to participate in these asset auctions.”
Given this the stock market has a very important role to play in the scheme of things. Controlling the burgeoning fiscal deficit remains the top priority for the government. But it is easier said than done. “Given the difficulty in getting the coalition to accept the diesel hike and LPG-targeting measures, there are limitations as to how much the current subsidies and revenue expenditure can be compressed. We can see some further measures on fuel price hikes and maybe some movement on a nutrient-based subsidy on urea; but with elections only 15-18 months away, there are serious political costs to any subsidy cuts,” points out Prakash.
Over and above this with elections around the corner the government is also likely to announce more freebies. Money to finance this also needs to come from somewhere. As Prakash writes “There is also intense pressure on the government to roll out more freebies through the right to food, free medicines and so on. If expenditure compression is intensely difficult in the run-up to an election cycle, higher revenue is the only way to control the fiscal deficit.”
For the government to raise a higher revenue it is very important that more and more money keeps coming into the stock market. For this to happen interest rates need to fall. And that is something that D Subbarao the governor of RBI controls and not Chidambaram.
The article originally appeared on www.firstpost.com on October 1, 2012. http://www.firstpost.com/economy/why-fm-is-tickling-the-markets-its-his-only-chance-474908.html
Vivek Kaul is a writer. He can be reached at [email protected]