It is a question bothering everyone – why is India unable to defend the rupee despite having $400 billion in foreign exchange reserves? More than that, to alleviate the crisis, why have government measures – a poor mish-mash incidentally – failed to attract capital flows? Simply, because they have been under-whelming and middling. The absence of a meaningful plan or intervention seems to have spooked not just the currency market, but created mayhem in the equity and bond market as well. What is perhaps most galling is the ineffectual handling of the currency tumult, showing complete inability and grasp of tactical and strategic intent to shore up the rupee. Feeble attempts to talk up the rupee by the finance ministry mandarins were dismissed in the ensuing rout. Gross mismanagement has only aggravated the uptrend in the economy, acting as a decelerator and deterrent to growth. Demoralisation has set in just when the economy was taking off again. For there is no cogent recourse.
Conversely, the continuing plunge in the rupee, coupled with the rising crude prices, will give the states a windfall in tax revenues to the tune of Rs 22,700 crore over and above the budget estimates for the current financial year. Some time ago, the State Bank of India (SBI) in its regular Ecowrap had prognosticated the problems with the tanking rupee and how it would act as a destabilising agent on the economy. It is clear that nobody paid attention to this report. For the ferocity of the run on the rupee has unnerved one and all. SBI said: The depreciation of the rupee is set to inflict multiple costs on the economy. On two fronts alone – crude cost and debt servicing – the additional burden could be at least Rs 1 lakh crore.
There could be other worries as well. For instance, the Reserve Bank of India (RBI) may be forced to raise rates, which will have an adverse impact on consumption and investment expenditure. Fu?r?ther, with gilt yields crossing the 8 per cent mark, the government will be staring at higher fiscal costs. Inflation, which appears benign currently, will see a spike going forward on higher fuel costs and increased minimum su?pport price (MSP), adding to the woes of policy planners.
On Wednesday, the rupee did stabilise somewhat, rebounding by 61 paise closing at 72.37, its best single-day gain since March 14, 2017, but this was primarily due to heavy dollar selling by exporters in conjunction with the government ba?nks, arg?u?ably at the behest of RBI to boost the sagging currency. Equally, the greenback slip?ped to a near seven-week low against a basket of currencies
Govt caught off guard?
Why has the worm turned so suddenly and was the government caught unawares is the moot point? The domestic currency has depreciated around 13 per cent this calendar year, accompanied by rising crude oil prices. With India importing around 80 per cent of its crude oil requirements, the rising prices along with the depreciation would inflate the country’s oil import bill. Ecowrap, the SBI research report, forecast that the crude import bill will come to $57 billion in the current financial year, assuming that the country imports 0.76 billion barrels during the rest of the year. The estimate is based on an average oil price of $74.24 per barrel for the remaining half. “If the average exchange rate remained at Rs 65.1 per dollar, the crude oil import bill would have been Rs 3,64,300 crore. However, with the rupee depreciating to an average of Rs 71.4 per dollar in the second half of 2018, the import bill will increase to Rs 4,03,600 crore, implying an extra cost of around Rs 39,300 crore,” the report added.
If the average exchange rate of the rupee falls to 73 to the greenback, the extra cost will rise to Rs 45,700 crore. Well, we are almost there, flirting with Rs 73 daily and in any case the non-deliverable forward market is seeing the rupee closer to Rs75 per dollar as speculators shorted the rupee once Saudis announced that they were comfortable seeing crude at $80 per barrel – at least in the short-term, as the global market adjusts to the loss of Iranian supply due to the US sanctions.
Depreciation & appreciation
SBI added that the rupee’s depreciation can also have an impact on short-term external debt repayment of corporate India. While India’s short-term debt obligations as on December 2017 were $217.6 billion, the SBI said if half of this amount has either been paid in the first half of 2018 or is rolled over to 2019, the remaining repayment amount in rupee terms would be Rs 7.1 lakh crore at an average 2017 exchange rate of Rs 65.1 per dollar. However, for the second half, assuming that the rupee depreciates to an average value of Rs 71.4 per dollar, the debt repayment amount would be Rs 7.8 lakh crore, implying an additional cost of Rs 67,000 crore. However, the report forecast that the domestic unit will bounce back. The SBI, which is tracking the rupee movement against the dollar since the global financial crisis, said the depreciation was always followed by appreciation. “There were two insta?nces where the depreciation lengthened for more than three quarters, but once the currency settled at a lower level, the appreciation pick?ed up at a dramatic pace,” the report said. “We believe, this time will be no different as currency will start appreciating once the dust settles for the currency to settle at a lower level”, it added.
As part of a larger emerging market currency debilitation, which began with the run on the Turkish lira, the Indian rupee has been pounded for the widening trade gap and swept into the broader emerging market maelstrom caused by the rising US interest rates and an escalating US-China trade conflict. It has Asia’s worst performing currency tag this year. Investors preferred safe havens such as the US dollar and the yen after a plunge in the Turkish lira sent all emerging market currencies scurrying for cover. The lira has fallen over 45 per cent against the constantly stronger US dollar this year on worries over Turkish president Recep Tayyip Erdogan’s increasing control of the economy and a deepening diplomatic rift with the US.
RBI fails to stem the slide
Back home, the RBI has tried desperately to sterlise buying dollars to stem the slide, but this hasn’t worked. Moreover, the government measures have been met with disdain as the rupee selling continues unabated. Empirically, the RBI spent $6.2 billion defending the rupee in June. This eased to $1.8 billion in July when markets stabilised somewhat, and is estimated to have remained around $2 billion in August despite renewed market volatility. Since April, the RBI is believed to have spent $20-25 billion to defend the rupee, yet the currency has continued to slump. Disappointing investors was the absence of an announcement about non-resident India (NRI) bonds, which would tap into the savings of the wealthy Indian Diaspora, a measure taken during currency crises in 1998, 2000 and 2013 with good results. In December 2013, as the rupee headed southwards, going on a bungee jump, the RBI’s dramatic out-of-the-box move to woo dollar deposits by protecting banks from currency risks saw a huge demand. Bringing capital inflows was crucial and banks managed to mobilise $34 billion in foreign currency deposits since the special swap scheme was flagged off in September. This was much higher than the sums raised by the Resurgent India Bonds (RIBs) of 1998 ($4.2 billion) and the India Millennium Bonds ($5.5 billion). The inflows acted as a booster shot for the beleaguered rupee, stabilising it and helping it recover from its steady slide right through the year. The paucity of intellectual capital on display this time has only added to the rupee rout with punters in Dubai and Singapore aggressively shorting the rupee. To calm the currency market, policy mavens only came up with half-baked steps and nothing as unconventional as 2013.
Historically, the rupee has often depreciated against the dollar in a period of 12 months prior to the general elections. Since 1984, Lok Sabha elections were held 9 times. Of these, the rupee weakened on 8 occasions and the fall was in double-digits 5 times. In 2004, it bucked the trend and appreciated by 6.4 per cent.
While the RBI mobilised $34 billion through the swap windows for FCNR-B funds and banks overseas borrowing as of November 30, 2013, the swap window was opened in September 2013 to attract the dollar flows into the country at a time when the rupee touched record low levels of around Rs 68 to the dollar. As a consequence the rupee strengthened by around 8 per cent since the opening of the swap window. The rupee was bolstered over a three-month period due to the US Federal Reserve postponing the tapering of $85 billion a month asset purchase programme, resulting in India’s current account deficit for the second quarter of 2013-14 falling to $5.6 billion from $21.8 billion seen in the first quarter of 2013-14 and the increase in foreign exchange reserves of the country from $274 billion to $286 billion since September 2013. The swap window pumped up the rupee and India's foreign exchange reserve position. It must be mentioned here that the cost of opening the swap window is definitely high. The RBI allowed banks to swap three-year and above maturity FCNR-B deposits at a fixed cost of 3.5 per cent per year. Despite that it brought all round stability in the currency market and bumped up our forex reserves. The trajectory was upwards, by mid-April this year, it had touched a lifetime high of $426 billion. Imagine the pace of accretion as we added $24.34 billion to $424.55 billion as of end March 2018 from $400.21 billion as of end September 2017. And since then slip sliding away to just under $400 billion.
The concert playing in unison of rising crude oil prices, a strengthening dollar and dramatically diving rupee is now running on surround sound and the pain on the economy is showing. But for this devastating concerto, the economy appears to be in fine fettle with consumption having perked up. The RBI has said investment activity too has picked up, in the main in the politically sensitive job generating medium and small industries segment. Promisingly, the RBI in statement to the parliamentary standing committee on finance also communicated that slowing of credit to medium enterprises ebbed at 1.1 per cent in 2017-18 and turned positive by May 2018, a big change from the huge contraction of 8.7 per cent a year ago. Furthermore, credit to medium enterprises turned positive, while credit to large enterprises improved at 0.8 per cent from minus 1.7 per cent in 2016-17. Among the rapidly improving economic metrics, capacity utilisation improved from 71 per cent in the third quarter of 2016-17 to 74 per cent in the third quarter of 2017-18 while financial resource mobilisation after declining to Rs 155 billion rose to Rs 438 billion in 2017-18.
Most importantly, on the vital issue of India’s twin balance sheet problem, the RBI was happy to state that early indications of the progress of these non-performing assets (NPAs) seem encouraging. Some of these accounts have already rea?ched resolution stage or appear close to resolution, recoveries out of resolution will be net gains for banks (despite huge haircuts in many cases). Finally, the RBI said credit growth has revitalised in food processing, automobiles, cement, construction and engineering. The biggest catalyst of course remains the consumption in India’s economic calculus. Market research company Nielsen recently stated that FMCG sector’s sales grew 10.9 per cent in the June quarter. This was better than the high single-digit growth the agency had projected in end-May, when it had released the March quarter figures (sales grew by 11.3 per cent). That growth surpassed its expectations is a bit surprising. The agency has revised its growth estimate for 2018 as well, to 12-13 per cent or nearly as much as it grew in 2017. Earlier, it expected growth to be a bit lower than 2017. Nielsen also highlighted that sales growth in rural markets has recovered. The rural-to-urban sales growth ratio is at 1.28 times, slightly higher than the 1.26 times of the March quarter. This means not only was the overall growth higher, but rural markets did better. The industry’s growth momentum is supported by the 8.6 per cent growth in private final consumption expenditure – what households spend – in the June quarter. While the Kharif crop is a bit below last year, the government’s MSP incentives in the run-up to the general election should keep farm income in animal spirits.