Can’t compare this Re shock with 2013

The rupee’s relentless slide in recent weeks has naturally led to comparisons with the situation that prevailed in 2013.

The fact that the RBI remained silent on the currency management issue in the credit policy and focused on inflation exclusively has given a signal that the rupee will have to find its own level.

The currency crisis this time has been caused ostensibly by the oil economics going awry driven largely by the US sanctions on Iran. The escalation in the US-China trade war with the former is calling the shots, and the strengthening dollar has only made matters worse. .

In the previous episode, while oil had sky-rocketed to $140/barrel (it is less than $ 90 today), the price rise was caused by a combination of the US Fed’s ‘taper tantrum’, signalling the winding up of quantitative easing (QE) and hardening of policy rates, as well as severe demand-supply mismatches of oil.

Low investment in the past had reflected in higher prices which were then corrected by US shale oil subsequently. This time it is largely politics that is causing the distortion making it more difficult to find a solution.

How does India stand today? While it sounds tempting to draw parallels with 2013 and also call for similar solutions, the Indian situation is actually quite different in 2018. In fact, interestingly it is stronger than before. The table ( attached ) gives some important macro indicators in these two episodes which are quite conclusive of this belief.

The data reveal that the position in 2018 is far more comfortable in almost all the parameters except foreign portfolio investment (FPI). FPI flows have been negative in both the episodes, and this has got to do more with the Federal Reserve driving such actions.

In 2013, the talk of QE being rolled back had an adverse impact on these funds, as there was a reversal of existing stocks as well as a slowdown in fresh flows as less liquidity was available.

In 2018 too, the continuous increase in interest rates by the Federal Reserve is the main reason for the FPI flows to turn negative. So the RBI was expected to increase rates this time to even out the interest rate differential between the two regimes.

The other parameters like the CAD, import cover, FDI and real sector indices look healthier than before which gives a great deal of confidence to the policy makers.

A critical point for India would be November when the oil story will play out and the direction of the currency will be known.

The political element

In the present environment it is hard to speculate on how the politics will play out and whether India will be able to strike a deal with Iran within the US overall framework of sanctions. This combined with the OPEC reaction to lesser oil from Iran will determine the direction of oil prices.

If the political temperatures cool down then oil prices should return to less than $80/barrel. However, if there is a stalemate and the US is not able to supplement supplies with its own shale reserves, then the price could go up further, which will call for some solutions from the government. The US-China trade war will continue to keep the dollar stronger and make the rupee wobbly. But the primary factor of oil would be addressed by this point of time.

If the rupee continues to fall, it would be tricky for the government. The government has announced measures to make ECBs easier and FPIs more attractive. At the same time import tariffs on several goods have been increased to lower the growth in imports. The measures, which have been tried out already, have not had much of an impact on capital flows or containing imports, though these measures could take at least six months to work out. Given that the quota system went out of vogue after the WTO was set up, there aren’t too many other steps that can be taken to improve the CAD. The last option would be to go in for sovereign bonds.

Reserves cover

Currently with forex reserves at around $400 billion, import cover is comfortable. In fact the decline in reserves of around $25 billion this year can be attributed mainly to the RBI selling dollars of around $15-16 billion to stem the rupee’s fall. It is here that it is necessary to distinguish between the fundamentals that are driving the rupee and the extraneous factors over which we have no control — trade wars, Federal Reserve actions and the oil conundrum.

The RBI and the government have worked well to address the fundamentals including getting the oil marketing companies (OMCs) to raise foreign funds of up to $10 billion to ease pressure in the forex market.

A sovereign bond or NRI bond or a swap would be the last resort. While it would be prudent to have such a scheme as a standby, the government needs to work out critical triggers which would lead to exercising this option. Such bonds are expensive and given that the ECBs and OMC borrowings are now being allowed without hedging requirements, the future risk also needs to be weighed appropriately.

The writer is Chief Economist, CARE Ratings

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