The Hindu Business Line : Rupee seen ‘decoupling’ from other Asian currencies

Thiruvananthapuram, Dec. 26 The much bandied ‘decoupling’ theory may have got its comeuppance in the context of the global recessionary contagion having begun to eat into the vitals of the Indian economy.

But a decoupling could be waiting to happen in a sub-sector — the currency market. Only difference is that the canvas is less broad and regional — Asian, that is.

“This could happen in the second half of 2009, or perhaps even earlier,” says Mr Abheek Barua, Chief Economist, HDFC Bank.

In an interview with Business Line, he explained that Asian currencies have moved together in the past few months and it is unlikely to change soon. However, as risk aversion abates and international investors begin to make a distinction between economies that are more and less sensitive to the global downturn, this could change.

“There could be some decoupling in the sense that currencies of economies that are less dependent on external demand could fare better than those that are driven by external demand. Going by this logic, the rupee could stabilise even if other currencies continue to depreciate,” Mr Barua said.

On spending and the stimulus package: I think the biggest risk for government spending is implementation risk. More funds maybe allocated but absorbing these funds by identifying and then implementing projects can be a big problem.

Tax cuts have a more immediate impact and I am not surprised that the government has chosen this option. However, the employment and multiplier effects of stepping up expenditure are known to be stronger than for tax cuts.

Both expenditure and revenue side measures have to be implemented. I think you will have to give the stimulus package some more time before its effect becomes visible. The liquidity infusion measures have incidentally worked rather well in bringing down the cost of short-term funds.

It is important to remember though that neither fiscal nor monetary measures are a magic pill and are unlikely to reverse the business cycle entirely.

On infrastructure spend: I disagree with the contention that that the infrastructure sector has become more capital intensive.

Road and irrigation projects, for instance, are known to be extremely employment intensive and have quick multiplier effects on the economy.

On recession: The classical definition of recession is two consecutive quarters of negative growth in GDP.

We are nowhere close to that. However, given the fact that we were averaging nine per cent growth recently, the situation looks fairly dismal. I wouldn’t deny that.

On options available for banks: I think fiscal expansion and the steps to enhance credit flow are different instruments that the Government is using.

It now seems ready to accept a higher fiscal deficit to accommodate greater expenditure and tax reduction.

There is likely to be more expansion going forward. Of course, the current level of public debt will act as a constraint on how much expansion is feasible.

For banks, the tack seems to provide greater liquidity and combine that with incentives and special schemes to lend to sectors that are short of funds. But I would question the very notion that banks are not lending. The latest credit data for the end of November shows credit growth (YoY) at 29 per cent.

There maybe some sectors where the flow of credit has been impaired because of concerns about credit quality in an economic downturn.

But banks are bound to be a little more cautious about lending to sectors that are most vulnerable to business cycle movements.

On bank capitalisation

Undercapitalisation is not a significant problem for banks in India unlike banks in the G-7 countries.

Indian banks have had negligible exposure to toxic assets. Hence, the value erosion in investment portfolios (that had eroded the capital base in US and Europe) has been relatively minuscule.

The real constraint for lending a couple of months back was an acute shortage of liquidity. That has been addressed by monetary easing.

If there is some problem of credit flow to some sectors, it is perhaps because banks are concerned about credit impairment in an economic slump.

MSS bonds

The MSS bonds were created and issued as a liquidity management device.

The RBI is now unwinding the liquidity embedded in these bonds by buying them back. Every new issue of Government bonds is now matched by a buyback of MSS.

There is certainly a case for making oil-fertiliser-FCI bonds repoable with the RBI particularly since they have the same credit risk as Government securities.

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