The Plummeting Rupee and an Economy in Doldrums

In yet another indication of the precarious and deteriorating state of the Indian economy, the rupee breached the “psychological benchmark” of Rs 60 to the dollar on June 26, touching an all-time low of Rs. 60.21 to the dollar on July 8. Over the last one year, while the rupee has depreciated by 29% against the dollar, it has fallen by as much as 23% vis-a-vis the pound and 18% vis-a-vis the troubled euro as well.

A proximate cause was the US Federal Reserve’s hint that it could roll back its easy credit policy. For India the implication was that this would make external commercial borrowings (ECBs) much more costly for the Indian corporate houses and will harm foreign players too. This possibility served to intensify speculative pressure on the rupee. When, on July 11, the US Federal Reserve Chairman Ben Bernanke made a reverse comment to the effect that the state of the US economy won’t allow him to withdraw the easy money policy immediately, the rupee recovered to 59.32 per dollar.

But how does the appreciation and depreciation of the Indian currency relate to the US monetary policy? Actually what has been happening for quite some time, particularly since the abolition of capital gains tax in the 2003-04 budget (which for all practical purposes converted India’s equity market into a tax-free enclave) is this. Foreign Institutional Investors (FIIs) borrowed in dollar markets, where liquidity was in abundance and interest rates very low, and invested in stocks and commodity markets and real estates in developing countries, where returns were high, so as to earn huge profits by borrowing cheap and getting higher returns on these investments.

With enhanced influx of footloose finance capital, the Indian Sensex began to shine brilliantly. Credit became cheaper and financed an automobile (and other consumer durables) boom as well as significantly higher investments in housing and real estate. The rupee began to appreciate, reaching a record high of less than Rs. 40 to the dollar in April 2008. This, of course, made Indian exports dearer in foreign markets, but imports – including oil imports – became cheaper in rupee terms. Apparently the economy was doing quite well, and establishment economists attributed this to deregulation and opening up.

In the wake of the global financial crisis, however, international players found it necessary to book profits by selling their stakes in Indian markets and take the money out of this country to meet other obligations. This led to a drop in Sensex, declining GDP growth rate and a depreciating rupee, which fell to Rs.52 to the dollar in just one year, that is, by March 2009. But with the massive bailout and stimulus packages and the resultant cheap credit in the US and other Western countries, hot money started flowing into developing countries, including ours, once again. The government and the RBI on their parts also took various steps. The former announced stimulus packages like reduction in central excise duties and service tax, additional plan spending, etc. The apex bank took monetary measures like reducing the cash reserve ratio (CRR), repo rate and reverse repo rate, as well as other liquidity injecting measures like refinance facilities for banks.

The combined outcome of all this was that the Sensex and the rupee started soaring again, though not to the extent witnessed before 2008, and GDP growth rate also was restored. This recovery, however was to a large extent externally induced (stimulated by volatile inflows) and artificially generated (with short-term fiscal stimulus packages and monetary measures outlined above, rather than with long-term measures for expanding the home market by augmenting the purchasing power of the labouring millions). No wonder, it could not and did not last long, particularly in the backdrop of global recession. From 2010-2011 all the indices, one after the other, began to give out the wrong signals.

Take the case of GDP growth rate first. The Central Statistical Organisation in its first estimate of 2013 released on 7 February revealed that the Indian economy is expected to grow at its lowest pace in a decade at a mere 5 per cent, with dismal performance in all three sectors including services. According to a report made available by the same organisation on 31 May this year, GDP at 2004-05 prices has decelerated sharply from 9.5% in 2010-11 (second revised estimate) to 6.2% in 2011-12 (first RE), and from this to 5.0% in 2012-13, the fourth quarter figure of which is 4.8%. This was the lowest figure in 10 years.

Inflation remained high and persistent. The rupee was declining steadily, albeit with brief interregnums of appreciation, and is now hovering around the Rs.60 to the dollar benchmark. To make matters worse, Fitch, Moody’s and the other rating agencies have repeatedly threatened to downgrade India’s sovereign credit rating, which currently stands at one notch above junk bond status.

The government, of course, is putting up a brave face. It seeks to hide the fact that the weakness of the Indian currency is not a passing shadow. It is a reflection of the country’s bad economic performance in an overall sense, as expressed in so many indices like the steadily declining GDP growth rate and stubborn inflation. In a more direct or immediate sense, the decline stems from the widening current account deficit (CAD) on India’s balance of payments (BoP) on one hand and the burgeoning external debt on the other, both of which contribute to dwindling international investor confidence and can provoke an exodus of hot money (already in the 2012-13 fiscal year, Foreign Direct Investment (FDI) was off 38 percent from 2011-12.). Now let us take a closer look at these proximate causes.

To start with the BoP problem, we can identify two major areas of concern. First, a near-90 % jump in annual gold imports was one of the main causes for the trade deficit rising to $20.1 billion, from $16.9 billion in May last year. A government worried about rising import bills should normally have imposed physical controls on the import of gold. But the government of the rich, by the rich, for the rich, did the exact opposite in the last budget. It raised the limits of duty-free imports of gold by individuals (especially by ladies – a morbid gesture in gender-sensitive budgeting, just like the empty tokenism of setting up an all-women bank). It was only under tremendous pressure of the growing trade deficit that very recently it increased the import duty on gold marginally from 6% to 8%.

Secondly, with more than 80% of our oil requirements being imported, depreciation of the rupee is putting tremendous pressure on the national exchequer, which is, of course, being transferred to the common man in the form of higher oil and gas prices. Moreover, fuels being a universal intermediate, the higher prices of fuels enter into all other prices directly in production costs and also by affecting transport costs. It not only hits the common person with skyrocketing prices, but raises the prices of Indian exports too. So the expected advantage of a depreciated rupee in terms of export growth did not accrue to India. On the contrary, it registered negative export growth over the first seven months of 2012-13. (This cannot be blamed simply on global slowdown, because certain other emerging Asian countries did achieve positive export growth under the same conditions.)The net result is that India’s CAD increased sharply from less than 1% of GDP in the first half of the 2000s to 2.7% in 2010-11 to 4.2% of GDP in 2011-12, and to 5.1% in 2012-13. This is much higher than the 3% (of GDP) recorded in 1990-91, i.e., at the time of the crisis of 1991.

As regards our external debt (totaling $390 billion as of March 31), the main problem is that nearly half of it consists of short term debt maturing in a year from now. At $172 billion, it is more than twice the amount ($54.7 billion) recorded in March 2008, when the full impact of the global financial crisis had yet to be felt in our country. The main reason behind this surge is a huge amount of external commercial borrowings (ECBs) resorted to by Indian corporates mainly during the boom years of 2003-2008. What the declining rupee means for these corporate borrowers is that they will have to pay back much more in rupee terms for every dollar they had borrowed.

With such dismal situation on the external sector, the free fall of the rupee – it has declined by 9.3% against the dollar since the beginning of this year, making it the worst performer among all Asian currencies – was not unexpected. Naturally it has unnerved both the apex bank and North Block. The former is trying to curb the rupee’s decline by tightening liquidity and making it costlier for banks to access funds from the RBI. But such measures, while having some marginal and temporary effects in checking the downslide of the rupee, is likely to further depress economic growth by forcing banks raise interest rates for borrowers. And depressed growth will mean reduced tax revenue for the government, leading either to further cuts in social sector spending or increased fiscal deficit or maybe both.

In a situation like this, what is the Manmohan-Chidambaram duo doing? The PM is busy managing the infinite series of scams involving himself and his senior ministerial colleagues. The FM is frequently visiting the US and other Western countries begging for foreign investment. The government has also decided to further relax the cap on foreign investment in a whole range of sectors including telecommunications, insurance, public sector banks, commodity and stock exchanges etc. It is ironic that this latest relaxation was immediately greeted by South Korea’s Posco scrapping its $6 billion project in Karnataka and the world’s largest steel maker Arcelor-Mittal withdrawing its $12 billion steel plant project in Orissa.

And there is nothing to be surprised about such developments. Given the fragile state of the Indian economy, it is only normal that profiteers from abroad would not show much interest investing in this country. In fact the actual experience over the last one year (in the case of FDI in retail for example, where their response was less than lukewarm) has been far below the government’s expectation.

As for the Indian people’s response to the government’s policy of wooing big capital, the latest and one of the strongest signals came on July 18 when Vedanta Aluminium’s controversial plan to mine the Niyamgiri hills for bauxite received a major jolt after local tribal people unanimously rejected the proposal, claiming religious and cultural rights over the entire hills. This happened in the first of the 12 pallisabhas or village meetings being held under an April 18 Supreme Court order; the rest of the meetings are expected to follow suit.

A very pertinent question that arises at this point is, even if the government’s frantic efforts lead to a resumption of high foreign capital inflows, will that really solve the problems we are facing? It won’t. Rather, it will lead to increased outflow of dividend on equity and interest on debt, which will, in the given situation of faltering export of goods and services, result in further deterioration of the BoP situation, i.e., increased CAD. And that will further depress the Indian currency. Is this what the government wants? The overall experience of the last two decades also strongly suggests that addiction to global finance capital as a growth steroid can exact very high economic and political costs in the medium to long run.

Clearly, the government is clueless about how to save the situation. What is needed at the moment – rejecting foreign capital fetishism and relying instead on generation of domestic demand and capital formation for augmenting inclusive economic development – is absolutely beyond its policy framework as determined by its class position. Therefore, what it cannot achieve by economic measures, it is trying to accomplish through the political gimmick of the food security ordinance, which it hopes will at least help save the government in the forthcoming parliamentary elections. But the food security project is a product of bad politics and fraudulent economics; and real life lessons have made the people of India wise enough to understand this. With the economic situation all set to deteriorate in the coming months, the UPA government should be prepared to pay a very heavy price for all its misdeeds and anti-people policies.

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