The Hindu Business Line : Why the falling dollar is `our problem'

Apart from causing a huge dent in the value of India's foreign currency reserves, the falling dollar also has implications for competitiveness. Moving reserves to other currencies, however, could end up depreciating the dollar further, as demand for it falls even more. The RBI should come out with a plan of what it will do to protect industry against the sliding greenback, says S. VENKITARAMANAN.

While the financial newspapers have highlighted the sad fact that Indian investors in the stock market are poorer by nearly Rs 100,000 crore after the fall in the Sensex, they have not quantified the impact of the US dollar's fall on the value of India's foreign currency reserves.

We hold about $160 billion in foreign currency reserves. Most of it is reportedly in US dollar-denominated assets, although the Reserve Bank of India is coy about disclosing its currency composition. The dollar has fallen by 23 per cent in trade-weighted exchange rate items since February 2002. Roughly, this translates into a fall in the value of our currency assets by 23 per cent, calculated against the benchmark currency, the euro.

This means the country has suffered a potential loss of wealth of around $32 billion. In rupee terms — if such a conversion were to be made — this means the country has lost Rs 144,000-160,000 crore. That is not a small sum, by any reckoning. If that amount, or at least a part of it, had been invested in physical infrastructure, we would have been infinitely better off.

There are other ways of using the country's hard-earned forex — be it from current earnings or capital flows — than to invest them in the doubtful debt paper of developed countries, invested in their housing and infrastructure. But this plea falls on deaf ears, for ideological but technically correct reasons.

The plight of the dollar causes us concern for more reasons than the one stated above. Apart from the potential loss of value in assets, this has implications for the country's competitiveness. The fall of the dollar has so far not seen much appreciation of the rupee. It is mostly confined to the euro and the yen. The rupee has held more or less steady, thanks to the RBI's intervention, which incidentally adds to its problems — more forex to deploy abroad.

Unsustainable deficit

Experts have been discussing what is in store for the dollar. They are obviously discouraged by the fact that their earlier predictions about the sharp decline of the dollar were proved wrong on more than one occasion. The fact, however, remains that the US current account deficit is running at nearly 7 per cent of GDP. This is unsustainable.

Worse, the current account deficit is financed by the US accumulating net liabilities to the rest of the world. One analysis has it that US liabilities would probably stabilise at 100 per cent of the GDP. This is, indeed, a very high proportion for a large economy like the US.

How exactly the current imbalances will unravel is difficult to foresee. Unless the dollar depreciates further, a structural change in the US economy, which will enable its exports to grow faster than its imports, is not possible. The US' fiscal deficit, which contributes to its current account deficit, should also fall. Almost all expert opinion is that the dollar has a long way to go before US imbalances begin to set themselves right.

The Economist of December 2 has an instructive analysis of the prospects. It points out that the real trade-weighted exchange rate of the dollar against a broad basket of currencies is still close to its 30-year average.

The Economist concludes that the dollar needs to fall by a lot more to make a significant difference to its external deficit and argues that a falling dollar will not spell doom for the rest of the world. In its view, the world economy would well benefit from a gradual slide of the greenback. It would help to reduce global current account imbalances by shifting production into America's tradable sector. But a weaker dollar would tend to hurt exporters in Europe and Asia.

No wonder, China is strongly contesting the US' plea to revalue its currency as it will spell disaster for a number of businesses, especially in the manufacturing sector. India is in almost the same boat!

Fall in reserves value

I have not mentioned in this context the decline in value of the trillions of dollars the Asian countries hold as reserves. That will be as catastrophic as the result mentioned for India. The nearest precedent to this is the erosion of sterling balances deposited by India and other colonies with Great Britain following the Second World War. When Britain devalued the sterling, the colonies had to lump the consequence — the fall in value of their balances. Are we in for a similar fate?

The US is in a win-win situation, as a result of the strategic bind in which reserve-rich economies find themselves. If the latter — China, India, Japan and Russia, to mention only a few — start shifting their reserves to other currencies, they face the risk that that very act could depreciate the dollar by reducing the demand for it. In consequence, they may find their reserves losing value. This is a Catch-22 situation, indeed!

The reserve-rich economies cannot afford to do anything to hasten the decline of the dollar as it will only hurt their economies more by causing a diminution in the value of their reserves, which may mean a hit on the balance-sheets of their central banks.

The Bank for International Settlements — the central bank's central bank — discloses in its latest news release that oil producing countries have reduced their exposure to the dollar to the lowest level in two years and shifted their income into euros, yen and sterling. Russia and the OPEC members have cut their dollar exposure in the third quarter to 60 per cent from 65 per cent in the second quarter. The difference is relatively small, but in absolute terms, it is significant.

Qatar and Iran, whose foreign exchange policy has sparked widespread market speculation, cut their dollar exposure by $2.4 billion and $4 billion respectively. These are signs of change that may further weaken the dollar. Financial Times comments that the last time oil exporting countries cut their exposure to the dollar in late 2003 was when the euro was pushed to all time high against the dollar, and vice-versa. Will these events repeat themselves?

RBI action

The fate of the US currency is of enormous significance to the Indian economy. To what extent we can mitigate the consequences to India's asset value is not clear. Surely, the RBI must be exercised about this, as has been disclosed by recent speeches of the Governor, Dr Y.V. Reddy.

While much is being talked about alternative modes of deployment of the reserves, the consequence of the US dollar depreciation and its effect on India's export competitiveness is not much discussed.

One would expect that the RBI will, true to its traditions, come out with a discussion paper on what it can do effectively to help Indian industry, including the service exporters, against the consequences of a falling green-back. Obviously, it may need more action on the part of the North Block itself.

One is tempted to recall here what the former US Secretary of the Treasury, John Connally, once famously remarked: "The dollar is our currency, but your problem." He has been proved right again. Lord Keynes had hit the nail on the head when he had suggested the issue of an international currency, Bancor, by the fledgling IMF, of which he was a progenitor. He must have known a thing or two about how far his American friends would go in their erratic behaviour.

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