Economists, market analysts, planners and administrators have their own theories, explanations and remedies for the rupee crisis. But one only has to recall the famous words of Sherlock Holmes: “It is simple, my dear Watson!”
The continuous fall of the rupee, despite brave statements and declarations by the country’s central bank and the administrators, is mainly due to the demand-supply gap. It is somewhat akin to what happens to onions and tomatoes seasonally. Historically, the currency markets in India lacked depth and volumes. In addition, currently, the market sentiment, which impacts the market at all times, has weakened beyond a point.
There is no denying the fact that economic fundamentals and policies would determine the value of a country’s currency. But this is valid only in the long run.
The theories and not-so-relevant explanations do not make clear the mechanics of market operations. Only the speculators rely and quote factors such as sentiment, expectations on economic fundamentals and political developments.
One time it is CAD (current account deficit) or fiscal deficit, another time it is Syrian crisis or oil prices. In the short term the demand and supply factors play a crucial role. When there are clear pointers to a brewing crisis, bold, firm and immediate actions are required to stem the rot.
Once the steep slide begins because of temporary mismatches in foreign currency cash flows, it will not be easy to bring back normalcy with only long-term measures.
Feeble attempt
The burgeoning current account deficit has been a clear writing on the wall about the shape of ‘the rupee’ to come. It was wishful thinking that a pep talk or half-hearted and hesitant measures would ward off the crisis. On the other hand, these feeble attempts gave the unintended impression to the markets that the RBI and the Government were indecisive and had no clues to protect the rupee or had run out of ideas. Both the speculators and the panic stricken genuine importers rushed to the markets pushing up the demand.
Thus, the demand, which would have been more evenly spread over a period, came crowding, due to the panic, while even the normal inflows including investments, remittances or export proceeds slowed down because of the uncertainties. From about a 53/54 level which sustained for a while, the rupee plunged to the 67/68 level in a matter of weeks, for the same reason.
For combating a disease a strong medicine needs to be taken for a given period. If taken in small doses and with breaks and gaps, the disease will develop immunity for the usually effective medicine also. The rupee behaviour seems to have developed immunity to the hesitant measures taken by the RBI and the Government in instalments.
Gold imports
The increase in import duty on gold in small steps and stages is a case in point. It was well known that gold accounted for half the current account deficit with a staggering $70 billion spent on imports during last year. Import of gold in July was 47.6 tonnes.
A layman would be tempted to know why straightaway an impost of, say, 15 or 20 per cent was not imposed or imports by only recognised gold jewellery exporters permitted, based on their performance. When the problem was mainly of current deficit, consumption of non-essentials should have been the target. And, certainly, gold was not an essential item. Control over gold imports right in the beginning would have calmed the markets. The fear of smuggling is rather exaggerated as physical security has been upgraded substantially along the borders and the intelligence surveillance over financial transactions is much improved now.
The choices for the RBI are few. Interest rate as a tool to influence the money markets has always been limited with only marginal impact on money supply and markets, more so in a given situation like the present one. The other option of sale of dollars directly to oil companies has been put into effect pretty late in the day. The role of oil companies for the fall is significant.
In the past there used to be a special window of the RBI for banks to cover their large merchant positions in case of need, albeit with wide spreads and worse than the market rates. The kind of panic and volatility seen in the markets today could have been avoided if this standby arrangement was there.
With markets starved of dollars mere symbolic market interventions cannot achieve the same objective. History is replete with examples of strong central banks, either singly or jointly, that went against the market sentiment, failing in a crisis situation.
The other major factor that influenced the markets was the withdrawal of FIIs (foreign institutional investors) from the stock and debt markets. This alone could not have caused the mayhem witnessed. It is true that any knee-jerk reaction or pressing panic buttons would send a wrong signal to international players and FIIs, to whom we look to for sustained inflows to help the rupee and the economy as a whole. While any steps taken to protect the rupee should not give them an impression of weakness or instability of the economy, the continuous rupee fall would discourage investments.
The total of outflows during the last 12 weeks is about $10-12 billion. With reserves of $280 billion, if only the RBI had set apart $8-10 billion as a war chest at the right time and intervened in the market effectively, the rupee fall would have been limited to the 58-60 level and contained the outflows at around $3-4 billion.
More than what is saved on intervention has to be spent on imports now. Trying to improve the inflows through borrowings by pubic sector units or private corporates and liberalising investments by the FIIs in bonds amounts to forgetting the lessons. These opportunistic inflows may upset markets any time.
Non-essential imports
Though the rupee is not fully convertible, imports are completely free. Our exchange reserves are hardly enough to cover 5-6 months of imports. Regulating the import of super luxury goods cannot be seen as a weakness but prudential management of scarce resources. Oil, edible oils, cereals and Defence imports have to compete with the non-essentials. Why gold alone? Are high-end luxury cars, fancy motorbikes, fashion wear and gear, private jets and boats essentials for use of scarce foreign exchange? By resorting to indiscriminate imports we might also be destroying the manufacturing base and putting an end to the meagre research and development (R&D) efforts, innovation and employment.
The reductions in the limits for overseas investments by Indian companies and gift-remittances by individuals are more symbolic, their impact being marginal. In reality, how many average Indians gift NRI relatives? Maybe $10,000 or $25,000? The limit of $75,000 a year too will only help transfer of savings abroad.
(The author is a former Managing Director of State Bank of Mysore.)