Rupee caught in perfect storm

The rupee has suffered the worst among all major currencies, dipping to an all-time low of Rs 68.85 to the dollar on August 28 2013, a decline of 25 per cent from the high of Rs 51.62 on October 5, 2012, seen in the past year. In the meteorological sense, a “perfect storm” is an expression that describes the coming together of a rare combination of phenomena — warm air from a low-pressure system and cool and dry air from a high-pressure system, with a heavy dose of moisture that produces intense rain and winds, leading to severe damage. Even though the rupee seems to have stabilised around Rs 62, it is in the throes of such a perfect storm, a situation aggravated by an unusual combination of variables.

The common discourse in media is that the devaluation is mostly due to the high imports of oil and gold. While such imports are indeed high, they only account for one-third of the problem, with two-thirds of the problem emanating elsewhere. When we look for underlying causes, it is best to examine the problem from a time perspective. Hence, imports and exports data, and trends in the current account deficit (CAD) and forex reserves and other related variables, have been viewed over a 10-year horizon.

A confluence of factors

Here’s a summary of factors pulling down the rupee:

— Oil and gold imports are high. The value of imports has gone up because of a major increase in prices of both commodities, as well as increase in the quantum of imports. However, the consumption and price trends have been known for a long time. Oil and gold cannot be blamed entirely for the situation.

— Merchandise imports, excluding oil and gold, have been dramatically opened up due to so-called reforms and lowering of import duties across the board, causing a major drain. The impact of this is hardly talked about.

— Growth in merchandise exports is not commensurate with imports.

— External borrowings have been freed up. Short-term borrowings are way too high, and their upcoming repayments are causing downward pressure on the rupee.

— Outflow from the country due to investments has gone up manifold. This is also not talked about.

As these factors have come into play, simultaneously two external developments have taken place. These are: one, the threat of withdrawal of quantitative easing by the Federal Reserve in the US, which will pull capital out of markets like India, and two, ongoing development of the non-deliverable forwards (NDF) market in places such as Singapore and London that is causing volatility in the value of the rupee. More on this later.

Beyond an understanding of the causes for the crash of the rupee, we will look at what can be done to address the issue, and regain the initiative in managing the value of the rupee.

Look beyond oil and gold

Table 1 shows the 10-year trend in imports and exports. Exports are up 5.7 times, with a quantum increase of $253 billion. Imports are up 7.8 times with a quantum increase of $438 billion.

Table 2 shows the decadal trend in oil imports. While looking at this, it is important to net off exports of petroleum products which India does in substantial measure. Oil imports are up 7.2 times with a quantum increase of $94 billion. This is 21 per cent of the increase in the value of imports over this period.

Table 3 shows the trend in value of gold imports. The quantum of increase is $50 billion which is 11 per cent of the increase in the value of imports over this period. It should be noted that the value increase is more due to a four-fold increase in gold prices — from $350 an ounce ten years ago to around $1,300 an ounce in recent times. The volume of gold demand has only doubled from around 500 tonnes ten years ago, a compounded growth rate of 7-8 per cent only. The argument that Indians are suddenly loading up on gold hardly holds true.

Increase in oil and gold imports accounts for only about 33 per cent of the incremental value of imports over the 10 years. The balance 67 per cent increase in imports is due to the opening up of imports of all kinds of capital goods and consumption goods, which are not supported by a commensurate increase in exports.

In effect, the country is on an import binge aided by policy and so-called reforms which resulted in a $195-billion deficit in merchandise trade last year. Even if we eliminate oil and gold imports, the country will still have a merchandise trade deficit of over $50 billion! Exports of services (mostly IT), remittances from Indians abroad, and inward capital flows through FDI and FII, are simply inadequate to bridge the import deficit. How can the rupee hold up against this?

Narrative is not working

The globalisation and liberalisation narrative, also known as ‘reforms’, is as follows: Open up the market to trade in merchandise (but not labour). Free up capital controls to enable its flow across borders. Make the environment attractive for global investors. The markets know what is best. Competition will enhance efficiency and competitiveness. As imports increase, so will exports, as the country gets more and more integrated into the global economy. This is the Western Anglo-Saxon narrative that the policymakers running the country have been tutored in, on with their American and British Ph.Ds. At the core of this is an expectation that capital inflows from overseas can be counted on to maintain the balance of the rupee. Well, what if this does not happen?

Parts of this narrative can work. But there are accompanying pre-conditions that must be met, the most important being export competitiveness. If this is not there, the narrative not merely fails but causes havoc. This is why the ‘reforms’ process in India has benefited but a small minority while the vast majority is paying the price for it. The rupee decline is a striking example of this.

(Part 2 of this analysis will look at other issues adversely affecting the rupee. Part 3 will offer practical suggestions to address the issue.)

(The author is Group CEO, R. K. Swamy Hansa and Visiting Faculty, Northwestern University, US. Views are personal.)

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