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Here, Arvind Chari, Fund Manager – Debt, Quantum Mutual Fund shares his insights on the rupee's fall and outlines measures the government should undertake to help the currency.
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The Indian rupee is at an all-time lows, struggling on the back of global negative sentiment and continued pressure on the current account with capital flows just not matching up to import and portfolio outflows.
Although, we believe that the Reserve Bank of India has a lot more up its sleeve to protect the currency, the communication from policymakers in this regard continues to remain poor and is thus impacting sentiment. Policymakers need to realize that global investors most fear an unchartered currency trajectory.
We believe that Indian policymakers should admit that the current phase is tough and challenging but that they are in control of the situation and would respond with appropriate policy responses.
A bad growth mix
We are facing the consequences of a bad growth policy mix of trying to achieve '9%' growth in a weak global economy with domestic supply constraints.
The government has used fiscal measures to boost consumption but the result has been persistent inflation and an extended current account deficit. With the government asleep; growth has slumped and investment sentiment is at its lowest.
A current account deficit of 4% of GDP, indicating domestic demand and high oil/gold imports; has been difficult to fund and has resulted in the rupee depreciating.
Currency flexibility important
Although from a foreign investor's perspective, a depreciating currency is an irritant leading to fall in their overall returns; but from a macroeconomic perspective, India needed the depreciation to rebalance the external account.
High domestic inflation has eroded competitiveness impacting exports and government apathy has resulted in little fresh capacities increasing import dependence. Thus, the rupee needed to depreciate to address this imbalance.
Source: Bloomberg
In both charts, the orange line is India. So the REER is now at the lowest among Asian countries indexed since the Lehman crisis. This should improve competitiveness and boost exports.
Also, seen from the right chart, Indian exports have held up well as compared to other Asian economies despite the global slowdown and overvalued rupee. With the depreciation now, exports should get further boost.
On the other hand, imports for elastic commodities would become uncompetitive and boost domestic sourcing. Since this works with a lag, we believe the impact on the current account would be visible over time. The key however is to moderate demand for inelastic goods like oil and gold.
What government can do
We think policymakers need to proactively move towards increasing elasticity by increasing domestic fuel oil prices and thus moderating demand for oil consumption. Managing domestic inflation expectations would also help further reduce the already lower gold import remand.
We believe that a country possessing the flexibility to address its external imbalance by adjusting its currency is in good stead and the initial depreciation that we saw in September to December was beneficial in that regard.
But now, as mentioned earlier, the pace and trajectory of the depreciation has resulted in the perception of a currency out of bound and beyond control. This we believe is not the case and the RBI can turn around the situation by initiating a few more policy steps.
- More and aggressive intervention: we have the FX reserves and it needs to be used at such times to avoid a disorderly outcome. Although, the total amount that we can use needs to be calibrated.
- Paying oil companies directly from reserves and taking them off the daily spot market. RBI can initiate an initial USD 10 billion window; which should keep the oil companies out of the spot market for one month. This is more effective than ad-hoc intervention.
- FII bond limit increase of another USD 5 - 10 billion.
- Non Resident Indian deposit/bond issue (like the India Millennium Deposit and Resurgent India Bonds of the 90s): this is the most likely avenue and can raise USD 5 – 10 billion of long-term debt flow.
- A sovereign bond issue: unlikely at the moment; but can be thought of as pressure intensifies and equity flows remain weak.
- Banning gold imports: can be used as a short term measure although not advisable from a long term perspective
Road to be tricky
The Indian government needs to start admitting its domestic problems and stop blaming global reasons for its current ills.
Despite all the measures discussed above, further deterioration in the Euro area sentiment can lead to a broad based USD rally and impact the INR/USD rate.
Today, we have seen currencies of many other countries--even with current account surpluses--also depreciate more than the rupee. So a global contagion can lead to further pair weakness. The Indian currency can benefit on a dollar rally only on a sharp fall in oil prices.
Also, the rupee adjustment would take time and the government, in the meantime, would need to ensure that economic momentum is revived else investor sentiment would remain negative on India.
We need the government to wake up and initiate some structural reforms required for reversing the current bad growth mix and revive and improve the investment sentiment by committing to control inflation and reduce the fiscal deficit.