The fall of the rupee
Source: by Sucha Singh Gill: The Tribune
THE nation has been watching with great anxiety the sharp fall in the external value of the rupee. There is a genuine worry that the falling value of the rupee will lead to increased inflation due to the rising prices of imported fuel, both petroleum and coal, and other essential inputs.
This would start a cost-price spiral, making exports less competitive due to the rising costs of inputs and infrastructure. This is further compounded by the falling growth rate of the economy from 9.3 per cent in 2010-11 to 6.7 per cent in 2011-12 to 5 per cent in 2013. This is expected to fall to 4 per cent for the current year, raising fears of a fall in employment.
In a simple language the tumbling of the rupee is due to the widening gap between the growing demand and the shrinking supply of dollars in India. India’s current account deficit has always been there since 1990-91 but it was compensated by greater foreign capital inflows. This led to the building of foreign exchange reserves from $15.0 billion in 1993-94 to $51.0 billion in 2001-02 and further to $299.2 billion in 2012-13. This has now fallen to $277.72 billion by July 31.
Since the total inflow of dollars in the economy was greater than the total outflow on account of trade and capital movements, there was no pressure on the rupee to depreciate. In fact, due to the high rate of inflation in India, especially since 2008 compared to stable prices in the world economy, the rupee’s value was little inflated. Since May 2013 pressure on the rupee began to build and the trigger came from the indication of the Federal Reserve Bank (US) that it would unwind part of the monetary stimulus earlier than anticipated and this has led to the tightening of the financial conditions globally.
This resulted in the outflow of capital from the emerging economies, including India. After the comments of the Federal Reserve Chairman in May, there was an outflow of $10.4 billion ($8.3 billion bond portfolio and $2.1 billion equity portfolio in cash market) from India between May 22 and July 25, 2013. According to the estimates of the RBI, India lost $14.6 billion through FII outflows from May 27 to August9, 2013. This has put a strong pressure on the value of the rupee to fall.
The speculative flows through the “hawala” trading of foreign exchange, import of gold and forward trading of dollars have added fuel to the fire, making the rupee fall at a fast speed. The limited unloading of dollars by the RBI accumulated from reserves proved insufficient to meet the growing demand for the dollar. The greater integration of the Indian economy with the global economy with the removal of insulators under the policy of liberalisation, privatisation and globalisation has made the economy vulnerable to volatilities of the global market.
The sudden trigger of the US Federal bank’s move has initiated a speculative process, leading to the reverse movement of foreign capital, undermining the confidence of Indian policymakers and investors. This is further compounded by the international agencies’ threat to downgrade the rating of the Indian economy. The volatility of the international market does greater harm to the economies which are fragile in terms of their own earning of foreign exchange. Unlike China, India did not build foreign exchange reserves through a surplus balance of payments (when exports are in excess of imports) but through a greater import of capital. This is the reason that the Chinese currency is not tumbling like the Indian rupee.
The real cause of India’s trouble lies in its current account deficit (CAD). India’s CAD was just $2.5 billion in 2004-05, which increased $87.4 billion in 2012-13. CAD as a ratio of GDP was 0.15 per cent in 2004-05 and it increased to 4.2 per cent in 2001-12 and further to 4.8 per cent in 2012-13. Some of the observers have considered the high import bill of petrol and petroleum products and along with gold as the main cause of the burgeoning CAD.
Actually, there are two big holes which have caused this deficit to grow. One hole has been caused by the mining sector. India is having one of the largest reserves of coal which are not being properly used. The policy to involve private players in coal mining led to the allocation of 195 coal blocks as captive blocks for private players who did not start mining of the coal which is being imported from abroad. The coal demand in the country in 2012-13 was 696 million tonnes while domestic production was 558 million tones, leading to the import of 138 million tonnes.
India has the largest reserves of iron ore in the world and was exporting iron ore to China and Japan. Due to the misappropriation of this national wealth by greedy private players the Supreme Court imposed a ban on mining in Goa and a cap in Karnataka. This has made India as a net importer of a huge quantity of iron ore. India imported 3.05 million tonnes of iron ore in 2012-13. Mishandling of the mining sector has created a huge hole in the foreign exchange of the country which has contributed in a big way to CAD.
The second hole in the foreign exchange (demand for dollar) has emerged from speculative activities. In speculative activities portfolio investment by Foreign Institutional Investors has initiated the outflow process: encouraging speculative demand for dollars in the forward trading market and a high demand for gold, stimulating outflows through “hawala” channels. These three sources of the outflow of the dollar have created a second big hole in the foreign exchange or a large demand.
Thus, these two holes are draining away a huge quantity of dollars from the country, creating shortage of the dollar or a big gap between the demand and its supply. India has already lost $22 billion by the end of August 2013.
The recession in the global market has decelerated the demand for Indian exports. The global trade was expanding at an annual rate of 12.5 per cent in 2010-11, which became 6.0 per cent in 2011-12 and 2.5 per cent in 2012-13. In the recessionary situation of the world market, Indian exports cannot achieve a major breakthrough to add to the earning of the dollars. Nor can India attract foreign capital to cover up the huge CAD due to the reverse flows from India.
The contention of the government that the depreciation of the rupee will help in achieving a better performance in exports is faulty on the ground that the combined elasticity of imports and exports is not high enough to give India this benefit. Mining needs an immediate correction to start production to meet domestic needs of the economy and save precious foreign exchange.
Secondly, speculative drainage by various ways needs to be stopped. Foreign exchange reserves can be released in larger doses. In the medium and long term India will have to relook at its policy and change it towards inward orientation. The revival of the manufacturing sector, which has decelerated to just 1 per cent annual growth rate, is the urgent need for generating employment and income. Equally important is to revive agriculture and rural non-farm activities and strengthen the rural economy. The whole development process must generate equitable wealth and income distribution and ensure participative and shared fruits of the growth.
Courtesy: http://www.ksgindia.com/study-material/today-s-editorial/9094-10-sept-2013.html
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