Vivek Kaul
The trade deficit or the difference between imports and exports, in August 2013 was at $10.9 billion. This was a significant improvement over August 2012, when it was at $14.17 billion. The deficit was $12.27 billion in July, 2013.
This fall in trade deficit, as I pointed out a couple of days back, was largely on account of lower gold imports. The gold imports stood at 2.5 tonnes, almost down to zero. These imports cost around $650 million. Now compare this to 47.5 tonnes imported in July, 31.5 tonnes in June, 162 tonnes in May and 142.5 tonnes in April of this year.
In April 2013, the 142.5 tonne of imported gold had cost $7.5 billion, and the trade deficit was at $17.8 billion. In May 2013, the 162 tonnes of imported gold had cost $8.4 billion, and the trade deficit was at $20.1 billion.
Hence, its safe to say that the major reason for the fall in trade deficit has been a fall in gold imports. As the Indian Express reported a few days back “Gold imports stopped after July 22 due to confusion over a rule issued by the Reserve Bank of India, which required importers to re-export at least 20% of all the purchases from overseas.”
Dan Smith and Anubhuti Sahay of Standard Chartered offer a similar reason in their September 12, 2013, report titled “Gold – India’s government gets tough.”As they write “Recent weeks and months have seen aggressive government action to dampen gold demand, owing to its heavy impact on the current account deficit…the…initial lack of clarity on these measures resulted in a dramatic slump in imports in August.”
This confusion has now been sorted out, and gold imports are going to surge in the months to come. “Local traders and sources estimate that we might see an upswing in bullion imports to 35 tonnes in September. This is still modest compared with the official average import level of 59 tonnes/month last year. October is also likely to see relatively firm imports,” write Smith and Sahay.
The Indian demand for gold is seasonal and tends to pick up around the festival time and wedding season. The festival season has started and the wedding season will soon start. As Smith and Sahay point out “Over the past five years, August, September and October have been the strongest months for India‟s gold imports, accounting for 30% of the annual total as the country restocks ahead of a pick-up in demand. Key reasons for buying gold include the marriage season, which normally starts after the monsoon season in mid-September, and Diwali, which is on 3 November this year.”
What will also drive the demand for gold is a good monsoon which is likely to lead to a higher agricultural growth. As the Economic Outlook 2013-14 released today, by the Economic Advisory Council to the Prime Minister, points out “Agriculture projected to grow at 4.8% in 2013-14 as against 1.9% in 2012-13. The early and good monsoon had a huge positive impact on sowing activity.”
This is likely to lead to a higher demand for gold during the current month and the following few months. “This year the monsoon season was good and farmers planted 7% more crops, according to the Agriculture Ministry. This should feed through into higher incomes and gold demand in the weeks ahead,” write Smith and Sahay.
In a country as underbanked as India is, any increase in income ends up being invested in gold, especially in rural areas. As the Economic Survey released before the budget pointed out “Gold has been a combination of investment tool and status symbol in India. With limited access to financial instruments, especially in the rural areas, gold and silver are popular savings instruments.”
It also needs to be mentioned here that even though “official” gold imports have fallen close to zero, gold continues to come into the country through other routes. This is not surprising given that the import duty on gold bullion currently stands at 10%. Hence, for anyone who manages to get gold into the country without paying the duty on it, there is a huge arbitrage opportunity.
Smith and Sahay provide several examples of gold coming into the country through unofficial routes. As they write “There is much anecdotal evidence suggesting that increased amounts of gold are entering India through unofficial channels, which makes the official figures an understatement. Pakistan temporarily suspended a duty-free gold import arrangement in August, when gold imports doubled. According to media reports, much of this was crossing the border into India. Dubai has seen a steady pick-up in the number of passengers being arrested at airports for smuggling.”
Gold is also coming in from Nepal. “Nepal has seen an eight-fold rise in smuggling – 69kg of smuggled gold was seized by customs in the first half of this year, versus 18kg for the whole of 2012.”
Higher gold imports will obviously cancel out the recovery on the export front. Exports for August 2013, went up by nearly 13% to $26.4 billion, in comparison to August 2012. In July, exports were at $25.83 billion. Even if gold imports come in at $2-3 billion on an average, they will cancel out the bounce in exports. Given this, the trade deficit is likely to go up in the months to come.
The article originally appeared on www.firstpost.com on September 14, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
trade deficit
With gold imports almost zero, trade deficit unlikely to fall further
Vivek Kaul
The trouble with being a one trick pony is that the trick stops yielding dividends after sometime. Something similar seems to have happened to the efforts of the government of India to control the huge trade deficit. Trade deficit is the difference between imports and exports.”
Trade deficit for August 2013 was at $10.9 billion. This is a major improvement in comparison to the trade deficit of $14.17 billion in August 2012. The deficit was $12.27 billion in July, 2013.
This fall in trade deficit has come through the efforts of the government to bring down gold imports by increasing the import duty on it. India imported just 2.5 tonnes of gold in August and this cost $650 million. Now compare this to 47.5 tonnes imported in July, 31.5 tonnes in June, 162 tonnes in May and 142.5 tonnes in April of this year.
In April 2013, the 142.5 tonne of imported gold had cost $7.5 billion and the trade deficit was at $17.8 billion. If there had been no gold imports, then the trade deficit for April would have stood at $10.3billion($17.8 billion – $7.5 billion). If the gold imports had been at $650 million (or $0.65 billion) as has been the case in August 2013, then the trade deficit would have stood at $10.95 billion ($17.8 billion – $7.5 billion + $0.65 billion). This number is very close to the trade deficit of $10.9 billion that the country saw in August 2013.
So the point is that the government has been able to control the trade deficit by ensuring that the gold imports are down to almost zero. As the Indian Express reports “Gold imports stopped after July 22 due to confusion over a rule issued by the Reserve Bank of India, which required importers to re-export at least 20% of all the purchases from overseas.”
The confusion has now been cleared. Also, with Diwali in early November and the marriage season starting from October, gold imports are likely to pick up in September and October. Even if it doesn’t, the imports are already close to zero. So, any more gains on the trade deficit front by limiting gold imports, is no longer possible. The Indian Express report cited earlier quotes a senior executive of the Bombay Bullion Association as saying “Imports may again rise to around 30 tonne in September, as jewellers usually start building inventory to cater to the requirement during the festival and marriage season.”
At the same time, the government hasn’t been able to do much about oil, which is India’s biggest import. In August 2013, oil imports stood at $15.1 billion, up by 17.9% in comparison to the same period last year. Oil imports formed nearly 40.8% of the total imports of $37.05 billion. There isn’t much the government can do on this front, other than raising prices majorly to cut under-recoveries of oil marketing companies and limit demand for oil products at the same time.
But that may not be a politically prudent thing to do. The commerce minister, Anand Sharma, warned that with the international prices of crude oil rising over the past 10 days, the oil import bill may go up in the months to come. And this may lead to a higher trade deficit.
As Sonal Varma of Nomura Securities wrote in a report dated September 10, 2013, “Looking ahead, a seasonal rise in imports during the festive season and higher oil prices should result in a slightly higher trade deficit in Q4 2013(the period between Oct and Dec 2013), relative to Q3 (the period between July and Sep 2013).”
But imports form just one part of the trade deficit equation. Exports are the other part. Exports for August 2013, went up by nearly 13% to $26.4 billion, in comparison to August 2012. In July, exports were at $25.83 billion.
While exports may have gone up by in August due to a significantly weaker rupee, whether they will continue to go up in the months to come is a big question. As Ruchir Sharma, Head of Global Macro and Emerging Markets at Morgan Stanley, and the author of Breakout Nations, told me in a recent interview I did for Forbes India “Exports are dependent on multiple factors, exchange rate being only one of them. Global demand which is another major factor influencing exports, has been weak. If just changing the nominal exchange rate was the game, then it would be such an easy recipe for every country to follow. You could just devalue your way to prosperity. But in the real world you need other supporting factors to come through. You need a manufacturing sector which can respond to a cheap currency. Our manufacturing sector, as has been well documented, has been throttled by all sorts of local problems which exist.”
This something that another international fund manager reiterated when I met him recently. As he said “A part of the problem that India has is that the economic model has been based more on the service sector rather than manufacturing. The amount of manufactured products that become cheaper immediately and everyone says that I need more Indian products rather than Chinese products or Vietnamese products, is probably insufficient in number to give a sharp rebound immediately.”
The other big problem with Indian exports is that they are heavily dependent on imports. As commerce minister Anand Sharma admitted to “45% of exports have imported contents. I don’t think weak rupee has any impact on positive export results.”
In fact The Economic Times had quoted Anup Pujari, director general of foreign trade(DGFT) on this subject a few months back. As he said “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.”
Also, the moment the rupee falls against the dollar, the foreign buyers try to renegotiate earlier deals, Pujari had said. “As most exporters give in to the pressure and split the benefits, the advantages of a weak rupee disappear.”
What all these points tell us is the simple fact that the trade deficit will be higher in the months to come. And given, this the market, like is the case usually, is probably overreacting.
The article originally appeared on www.firstpost.com on September 11, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Why govt's surprise theory on rupee collapse doesn't hold
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)
Why rupee might even touch 65-70 to a dollar
Vivek Kaul
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)
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 www.firstpost.com on June 25, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)