Austerity and the rupee

The Finance Minister, Mr Pranab Mukherjee's statement on Wednesday calling for “some austerity” and “little bit of unpopular steps” is perhaps the first admission by this Government that the current woes of the economy go beyond just Greece or the Euro Zone. These remarks came on a day when the rupee slid to a fresh low of Rs 54.5-to-the-dollar. Since February-end, when its second phase of weakening began after an earlier one from August to December, the rupee has shed 9.9 per cent against the dollar. But it has also lost 10 per cent against the pound, 9.8 per cent against the yen and 4.3 per cent against even the euro. The rupee's fall, thus, is not simply about a strengthening dollar, linked to the latter's safe haven status in these times of global economic uncertainty. It is an independent phenomenon reflective of India's, and not Europe's, problems. Mr Mukherjee seems to have at least partially acknowledged this fact by making a case for belt-tightening, that too in Parliament. What he needs to do next is walk the talk and take the decisive steps that would ultimately also help fix the rupee.

The rupee's problems are largely structural, having to do with a current account deficit (CAD) that has grown almost five-folds from less than $ 16 billion to roughly $ 75 billion between 2007-08 and 2011-12. There are limits to financing these through capital inflows, which average $ 50-60 billion in a normal year (2007-08 was exceptional, when they touched $ 107 billion, just as they plunged to $ 7.4 billion in the following crisis year). One cannot expect this year to be a normal one for capital flows, when most global investors are primarily concerned about not losing their shirts. Nor can measures such as what the Reserve Bank of India did last week — forcing exporters to convert half of their dollar remittances immediately to rupees or raising interest rates on foreign currency-denominated non-resident Indian deposits — be a durable cure for a structural problem that is bound to assert itself after brief moments of respite.

The only real solution, then, is to cut the CAD. But that cannot happen without restraints on high-value imports, particularly oil, fertilisers and gold. In the case of the first two, domestic prices are mainly set by the Government. Not raising them has led to an artificial demand and growing imports of these commodities, even in the face of spiralling international prices. Deregulation, especially of diesel and urea, will bring down not only the CAD, but even the Government's subsidy burden, enabling a redirection of its expenditures to more productive, growth-promoting investments. Such positive austerity measures would, in turn, inspire investor confidence and bring back capital flows that can fund CADs on a sustainable basis. They would also contribute to a structurally strong rupee, as was the case over much of the last decade.

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