Vivek Kaul
‘Comatose’ is a word that can be used to best describe the nine year rule of the Congress led United Progressive Alliance (UPA) government, when it comes to economic reforms.
The only exception to this is the period of the last two months in which the government has taken some measures to open up the Indian economy a little more to the outsiders. At the same time steps have also been taken to allow Indian companies to borrow more freely abroad.
Today’s edition of the Business Standard reports that the finance ministry might “ease norms for (companies) raising funds through an external commercial borrowing(ECB)”. In early July, the Reserve Bank of India had allowed the non banking finance companies(NBFCs) to borrow money through ECBs under the automatic route to finance the import of infrastructure equipment which would be leased to infrastructure projects. Earlier this could happen only through the approval route.
On July 16, the government had announced that it would allow more foreign direct investment (FDI) into 13 sectors of the Indian economy. This included 100% FDI being allowed in the telecom sector.
All this so called ‘reform’ is being sold under the garb of the government having been unprepared for the crash of the rupee against the dollar. As finance minister P Chidambaram said on August 1, 2013 “the rupee depreciation of June, July was quite unexpected.”
Between January and May 2013, the rupee moved in the range of 54-55 against the dollar. After that it started dramatically losing value and currently stands at close to 61 to a dollar. To ensure that the rupee doesn’t fall any further against the dollar, the government has been taking steps to ensure that more dollars come into India and thus boost the value of the rupee against the dollar.
The depreciation of the rupee had caught the government by surprise but now its doing everything it can to arrest its fall. Or so we are being told.
But the surprise theory doesn’t really hold. Anand Tandon, the CEO of JRG Securities makes a very interesting point in the Wealth Insight magazine for August 2013. “In 2010, the ministry of commerce put out a strategy plan and a paper. The paper was titled “Strategy for doubling exports in the next three years”. In it, the ministry assumed that near term trend growth of exports and imports would continue. Based on this, it forecast that India would have a negative merchandise trade balance of $210 billion by 2013. This proved remarkably accurate (the actual figure is $196 billion).”
What Tandon is saying here is that in 2010 a paper was put out by the ministry of commerce which estimated that in three years time by 2013, the trade deficit (i.e. the difference between imports and exports) would be at $210 billion (actually $210.5 billion to be very precise).
When the imports are significantly greater than the exports, what it means is that the country is not earning enough dollars through exports to pay for the imports. In this situation the demand for dollars is greater than the supply, and hence the dollar gains in value against the local currency, which happened to be the rupee in this case.
Also the method used to make this forecast wasn’t rocket science at all. As the report points out “An attempt has been made to forecast the merchandise trade; trends over the next three years, based on the Compound Annual Average Growth Rate (CAGR) during 2002-03 to 2009-10.”
Basically, the authors of the report looked at the average growth rate during the eight year period between 2002 and 2010, and used that to make projections (projections were based on a CAGR of 19.05% for exports and 24.63% for imports) of imports and exports in the years to come.
Given that the report was put out in 2010, so the entire theory about the government being ‘surprised’ and being caught on the wrong foot doesn’t really hold. The high trade deficit is the basic reason behind the rupee losing value rapidly against the dollar.
As Tandon puts it “It is noteworthy that the likely pressure on the rupee was identified as a problem over three years ago, and the current blame attributed to the US Fed action is only perhaps a trigger for the inevitable.”
The question that crops up here is why did the rupee start losing value rapidly against the dollar towards the end of May 2013, and not any time before it? As far as the trade deficit goes, the situation was not very different in January 2013, than it was in May 2013.
While India was not earning enough dollars through exports, dollars kept coming in through other routes. Foreign investors brought money into India to invest in stocks and bonds. Indian companies borrowed abroad in dollars and brought that money back into India. Non Resident Indians(NRIs) also deposited money with Indian banks to at significantly higher interest rates than what they could earn in Western countries.
Things started to change on May 22, 2013, when Ben Bernanke, the Chairman of the Federal Reserve of United States, the American central bank, made a testimony before the Joint Economic Committee, of the US Congress. In this testimony Bernanke said that “a long period of low interest rates has costs and risks. For example, even as low interest rates have helped create jobs and supported the prices of homes and other assets, savers who rely on interest income from savings accounts or government bonds are receiving very low returns. Another cost, one that we take very seriously, is the possibility that very low interest rates, if maintained too long, could undermine financial stability.”
This was interpreted by the market as a hint from Bernanke that the days of the Federal Reserve maintaining low interest rates in order to ensure that people borrowed and spent, would soon be over. Bernanke made the same point in a more direct manner when he addressed the press after the Federal Open Market Committee (FOMC) meeting on June 19, 2013.
International investors had borrowed money at low interest rates prevailing in the United States, and invested that money all over the world, including in Indian bonds, where they could earn higher returns. But after Bernanke’s clarification came in, the return on Indian bonds wasn’t good enough to compensate for the higher interest rate in the United States.
So investors started selling out of Indian bonds in late May 2013. When they sold these bonds they were paid in rupees. They sold these rupees to buy dollars and this led to a rapid depreciation of the rupee.
As mentioned earlier since India’s imports are significantly higher than its exports, there was a shortage of dollars. And once foreign investors started selling out, it only added to that shortage. Hence, the American Federal Reserve just provided the trigger for the rupee crash. It could have very well been something else.
What has added to the pain is the fact 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 further pressure on the rupee. Nearly $21 billion of ECBs raised by companies need to be repaid before March 31, 2014. So NRI deposits and ECBs which were a source of dollars earlier will now add to the dollar drain from India.
The solution to India’s dollar problem has been encouraging companies to borrow abroad and opening up or allowing higher FDI in various sectors. The trouble with encouraging companies to borrow abroad is that someday the loan will have to be returned and it would mean a demand for dollars shooting up at that point of time. So in that way, it just postpones the problem rather than solving it.
Allowing FDI in more and more sectors has been the government big mantra in trying to shore up the rupee against the dollar. As Tandon puts it “Of late, it is rare to hear any pronouncements from the finance ministry without it being focussed on foreign direct investment(FDI). Ignoring the findings of the commerce ministry…North Block(where the finance ministry is based) continues to believe that is needed is to remove the pressure on the rupee is to raise FDI limits across various sectors.”
The trouble here is that the foreigners will come with their dollars into India when they want to, not when we want them to. In this situation, the long term solution to India’s dollar problem is to encourage exports. And for that to happen, the ‘weak’ physical infrastructure first needs to be set right.
As the commerce ministry 2010 report pointed out “Infrastructure bottlenecks remain the single most important constraint for achieving accelerated growth of Indian exports.”
The report made estimates of India’s infrastructure gaps on the transport front. For ports it estimated that “in 2014 there will be a shortage of 598 million metric tonnes of cargo handling.”
As far as roads are concerned it estimated that in order to adequately handle export-import cargo, “the ideal length of 4 lanes highway should be 112635 kms and that of 6 lanes 6758 kms by 2014.” This implies a projected gap of “4437 kms for 6 lanes and 66320 kms for 4 lanes highways.”
For Railways “there would be a gap in railway infrastructure of 746 million tons of cargo handling in the year 2014.” And as far as airports are concerned, “poor infrastructure to handle cargo at the airports needs to be addressed to reduce the dwell time of cargo handling and to increase the overall handling of exports cargo,” the report said. “As per the international benchmarks, dwell time for exports is 12 hours, while for imports it is 24 hours as against 3-5 days at Indian airports.”
This is what is required to set the rupee right. Of course, all this is not going to happen anytime soon. And hence, more pain lies ahead.
The article originally appeared on www.firstpost.com on August 5, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)