Where is a cheaper rupee taking us?

All is not well with the Indian economy. Growth has slowed. In the April-June quarter of 2013-14, growth slid to 4.4 per cent. India’s economy grew at 5 per cent in 2012-13, against 6.2 per cent in 2011-12.
Current account deficit (CAD) widened from 4.2 per cent of GDP in 2011-12 to 4.8 per cent in 2012-13.
There has been a fall in both public and private sector investment.
Contraction in the manufacturing sector widened to 1.2 per cent, from one per cent a year earlier. Virtually everyday, news of the falling rupee is splashed across the front pages of newspapers.
There are two aspects to this story: why the rupee is falling, and whether the fall benefits our exports and CAD. But let us take the second point – of whether the rupee fall helps us—first.
EXPORTS MAY NOT BENEFIT
Some optimists hold the view that rupee depreciation is good for our exports. Here, data suggest otherwise.
A look at our major export items suggests there is a change in its composition from price-sensitive items such as leather footwear, dairy products, beverages, textiles and apparel, to less price-sensitive items such as refined petroleum products, chemicals, mineral products (especially, mineral fuels, bituminous substances, etc.), and machinery and transport equipment (engineering goods).
The share of petroleum products in India’s export basket increased dramatically from around 2 per cent in 1993 to around 20 per cent in 2012. The surge in exports in the case of petroleum items is because of India’s potential in oil refining activities.
On contrary, India’s CAD is likely to increase further as oil and precious metals still contribute to bulk of our imports. Controlling CAD is an important factor from the perspective of sovereign rating.
Countries with higher CAD generally lose out in terms of investor attractiveness. Therefore, the merits of a falling rupee are not really clear.
Now, to why the rupee is falling. In order to explain this story, we will have to connect a few dots – exchange rate, inflation rate, fiscal deficit, CAD, exports, imports, and the US economy.
Under a floating exchange rate regime, the market determines exchange rate. In economics, there are two ways to determine the correct value of exchange rate.
First, is the goods market approach where an attempt to find the correct value of exchange rate is based on the assumption of ‘law of one price’ (LOOP), using the concept of purchasing power parity (PPP). LOOP states that in the absence of transport and other costs such as tariffs, identical (similar) goods will sell for the same price. Because of the combined activities of arbitrageurs, identical goods, primarily financial assets, cannot sell at different prices for long.
The prices of homogenous goods, once converted to common currency, should be same in spatially separated markets. In fact, the magazine, The Economist, publishes the Big Mac Index, which serves as an informal way of measuring PPP between two currencies. The index takes its name from the Big Mac, a hamburger sold at McDonald’s restaurant in various countries.
If LOOP, or the Big Mac principle, holds true, then real exchange rate is one. Therefore, if domestic inflation is higher than the US inflation, the rupee is expected to depreciate against the US dollar ($).
Second, is the asset market approach, where the value of exchange rate is conditional upon the inflow and outflow of capital into and from the domestic economy.
What determines these inflows and outflows? In foreign exchange markets, expectation plays a crucial role. High fiscal deficits and higher inflationary expectations, makes domestic assets (government bonds) less attractive.
Currency depreciates (following asset market approach), as foreigners pull out money from the domestic capital market. Stock market tanking every other day is an indication of this trend. And, countries with higher CAD lose investors. Therefore, whichever way we approach the issue, understanding the drivers of inflation is crucial to understanding exchange rate movements.
INFLATION DRIVERS
How does one explain inflation in India? One school of thought holds the view that inflation in India is because of factors such as increased transfers through MGNREGA, higher minimum support price for farmers, and now, the government committing to spend around Rs 1.3 lakh crore per annum on account of food security Bill. Money spent without increase in storage capacity in the case of food security Bill, or without infrastructure projects being completed in the case of MGNREGA, is bound to cause inflation.
Questions were raised about the effective usage of government money on health and education. To take the case of Sarva Shiksha Yojana, there has been a rise in literacy and gross enrolment ratios (at the primary level), which has been attributed to the programme. But these achievements do not tell us whether the quality of education has improved.
Critics argue that although development indicators have improved, money is not being well spent, as quality of service has not improved. Add to this, corruption and one finds perfect recipe for inflation.
Fiscal deficit, and with it, inflation, is likely to increase further with the formation of new states such as Telangana, with more resources being used to spend to set up adequate administrative infrastructures (secretariat, police, revenue department, etc.). Adding to these domestic factors is the US economy showing sign of revival.
There is indication of quantitative tightening where the Federal Reserve is likely to reduce government bond purchase by $10 billion per month (from $ 85 billion to $ 75 billion).
This has further strengthened the US dollar against most Asian currencies. The likely attack by US on Syria has already pushed up the crude price to $113 per barrel. In fact, gold in international markets is now trading at $1400 per ounce (around 28.3 gram). In India, gold is trading at Rs 34000 per 10 gram, whereas it should have traded at Rs 24,000, with Rs 50 to $1 as exchange rate.
VALUE FOR RUPEE

How does one arrest this fall? First, create an environment for long-term capital investment. Capital-surplus countries such as Japan are keen about investing in our infrastructure. This is, however, conditional upon creating the necessary environment for investment. Second, we should build better trade relations with Iran.
This will allow India to import oil in rupees and not use up precious dollars. This is not happening for fear of US sanctions.
Third, proper monitoring and implementation of government-funded programmes is important. A reforms push such as direct cash transfer is a welcome move and is expected to plug leakages in the system.
Likewise, money sanctioned under any particular scheme, say, under SSA to build schools, should be allowed to be used for next best alternatives, say, building hospitals, if the village already has a school. This will ease inflation and may arrest a fall in rupee.

India, and the art of driving away FDI

BYE BYE FDI

Foreign investors want consistency in policy, not big bang announcements.
We did, perhaps, need this crisis to remind ourselves how globally connected we all are. There was a time when our experts were talking about “de-coupling” and how our financial systems were stronger, and the post-Lehman global financial crisis did not hit us hard. We also patted ourselves on the back, saying that because our growth was driven by domestic exigencies, we were relatively protected from global swings.
I am referring to the rupee’s current rocky relationship with the dollar. All it took was the suggestion that the US might start reducing its bond purchases to make foreign investors run back to mama. And our rupee to plunge.
There is no comfort in being told that Indonesia and Brazil are also facing similar pressures. It is time to look at what we can learn from the situation so we recognise that there are some things within our control.
FAIR-WEATHER FRIENDS
Foreign Institutional Investors (FII) are known to be fair-weather friends. They can and do move money by the click of a mouse and place very low weight on loyalty and the long term. It is good to invite them for some fun times in the evening but we all know they leave when the party is over. What have we done to those who moved into the flat next door because they wanted to be with us? I refer to Foreign Direct Investment (FDI).
We don’t particularly shine in taking care of them. Nokia, the mobile phone manufacturer, has been struggling in the global marketplace. It faces challenges in developed markets from competing suppliers; their speed with high-end and innovative products has left Nokia holding on to what it has in the developing world, while it recoups. At such a time, it would like to be focused on product development while also aiming for manufacturing efficiencies to help improve margins. In other words, it does not want an adverse signal from the Tamil Nadu government.
UNKEPT PROMISE
I’m referring to the recent report that the mobile phone-maker, with a manufacturing plant on the outskirts of Chennai, apparently was not getting the tax refunds it had been promised for a period of 10 years, as incentive for setting up the plant. The company has also been subjected to tax raids; the matter could, perhaps, have been discussed and sorted out across the table.
Companies constantly worry about the vagaries of the marketplace and how to deal with fickle customers. However, they like certainty when it comes to government policies and regulatory matters.
Now, there are reports that Nokia may shift its base to China.
The Chinese government understands better the notions of stability and certainty. You make a deal and parties honour it.
Speaking of deals, the Tamil Nadu government was reportedly not paying its wind power producers on time. In a State that is chronically short on power, you would think better sense would prevail to encourage more investment, domestic or foreign.
SAME STORY
Ironically, that was also true of Gujarat, often touted as an economic policy exemplar. The government apparently decided to reduce the price to be paid per unit of power to solar energy producers. The argument was that the cost of production had fallen. Fortunately, the State regulatory commission intervened to remind the government that a contract was a contract and the terms of the power purchase agreements have to be adhered to.
There is nothing wrong in being savvy negotiators, but a contract is meant to make transaction costs predictable. If governments are going to acquire a reputation of considering a contract as the starting point of negotiation (and not the conclusion), it introduces one more element of uncertainty. Businesses would prefer not to deal with such a situation, particularly if they have alternatives -- such as China.

The Vodafone tax case continues to be an example of policy changes that appear to be politically motivated, and create an impression of a banana republic-style of governance. When the Government changes rules in the middle of the game, and applies them retroactively, how do you plan? Our policies on mining licences and telecommunication spectrums must have, by now, made it into the text-books as examples of bad governance, keeping company with the late Hugo Chavez of Venezuela. Need one be reminded of the decision-making mess we made in trying to permit FDI in multi-brand retail? Even knowledgeable observers of the Indian economy are now confused: Is it allowed or is it not?
FIIs are expert at studying and measuring risk; political risk plays a big part in their calculations. But those who are in the FDI game are more busy making and selling their products or services, and do not want to be constantly thinking about and calculating for political risk. Foreign direct investors are here for the long haul. If we don’t take care of them, they leave, and they tell their friends.
Sure, fixing the problems of the sort mentioned above is not going to result in a rush of FDI inflow and stabilise the rupee exchange rate. That is the point: A big bang does not result in FDI inflow. Our ministers thought it did when they recently revised the foreign investment percentages allowed in different sectors, thinking there was a queue waiting at the borders. FDI needs to be courted over a long period through stable and rational behaviour. What we have done is chase them away with a thousand cuts.

Land and Food Bills: Sonia takes forward 'Garibi hatao' plank

With Lok Sabha polls just eight months away, Congress plans to go to town on the Food Security and Land Acquisition bills with the message that Sonia Gandhi is taking forward the "Garibi hatao" plank championed by Indira Gandhi.
As part of preparations for a massive propaganda drive on the key measures, Congress is organising a workshop for its spokespersons and TV panelists on the Land Acquisition bill to explain the benefits of the proposed legislation. Similar exercise on the Food Security bill was undertaken recently by the AICC.
The two bills, passed by Lok Sabha and are expected to get the approval of Rajya Sabha this week, are seen by the ruling party as a "game changer" in the general elections.
A Congress Chief Minister remarked that Sonia Gandhi is trying to fulfil the unfinished task of "Garibi Hatao" undertaken by Indira Gandhi by working for ending the hunger and malnutrition among the poor and downtrodden.
Rural Development Minister Jairam Ramesh will be explaining the benefits of the proposed legislation at the workshop on Monday organised by party General Secretary Ajay Maken who heads the AICC Communication Department.
Maken said the idea behind the workshop was to propagate the "good work" done by UPA and take the "positive work" of the government to people. After the workshop, plans are afoot to send the spokespersons to various states to apprise PCC office-bearers about the proposed legislation and also address media conferences.
The earlier workshop on the Food bill had seen food and consumer affairs minister K V Thomas explaining to the spokespersons the nuances of the much-touted legislation to educate them on the right-based scheme. A booklet with ready talking points has also been brought out to propagate the measure.
The refrain of party leaders like Information and Broadcasting Minister Manish Tewari is that the Food Security and Land Acquisition bills are two landmark initiatives taken by the UPA government, and have no parallels in history.
They insist that it is for the first time in country's history that the poor will enjoy the right to highly subsidised food, and nobody will sleep hungry any more.

Congress leaders have also been critical of the Opposition parties for "trying their best to scuttle these bills as they thought the Congress will gain from them."

Banks approving loans on condition borrowers don't buy gold

With a view to curb appetite for gold, banks are sanctioning advances, including personal loans, only if borrowers agree not to use the proceeds to buy the metal beyond permitted levels.

Banks have placed the condition that borrowers should not use even personal loans to buy gold, a senior official of a private sector bank said.

The measures follow directions from the Reserve Bank of India to banks and NBFCs that are aimed at reining in demand for the yellow metal. The RBI and the government have taken steps to curb demand for gold after imports of the metal widened the current account deficit.

As per existing guidelines, no advances can be granted by banks for the purchase of gold in any form, including primary gold, gold bullion, gold jewellery, gold coins, units of gold exchange traded funds and units of gold mutual funds.

For advances against the security of specially minted gold coins sold by banks, the RBI has directed that the weight of the coins should not exceed 50 grams per customer, according to a senior public bank official.

In June, the RBI restricted the import of gold on consignment basis by banks only to meet the needs of exporters of gold jewellery. Last month, the central bank prohibited the import of gold coins and medallions without licence.

It further stipulated that nominated banks, agencies and other entities should make gold available for domestic use only to entities engaged in the jewellery business, bullion dealers and banks authorised to administer the gold deposit scheme against whole upfront payment.

Steps taken by the government to curb inbound shipments include raising import duty on the metal to 10 per cent.

After a dip in June, gold imports surged in July to 47 tonnes compared with 31 tonnes in the previous month. Import of gold in April-July rose 87 per cent to 383 tonnes

India pushes for joint FX intervention

India is seeking support from other emerging market countries for coordinated intervention in offshore foreign exchange markets after a currency rout the past three months, but at least one critical partner, Brazil, said it is not involved in such planning at this time.
Mexico and Russia, two other key developing nations, had no comment on such a plan.
Concern about the end of cheap dollars from the U.S. Federal Reserve's stimulus programme has prompted a massive capital flight toward dollar-denominated assets. The rout has been compounded by short-seller attacks in offshore trading centres.
"It is now time to stop," Dipak Dasgupta, the Indian finance ministry's principal economic adviser, told Reuters on Friday, referring to speculative behaviour in offshore markets he said was damaging the stability of the world economy.
"It is going to happen in a matter of days rather than weeks," he said. "Brazil and India can start the move."
Other major emerging market economies have either rejected outright involvement in any intervention, or declined comment. Brazil's central bank and its finance minister Guido Mantega said the government was not currently participating in any planning for co-ordinated intervention in offshore markets.
Mantega said the leading emerging market nations that form the BRICS group - including Brazil, Russia, India, China and South Africa - are planning coordinated actions to create a joint bank and a joint reserve fund.
The Indian rupee is the worst performing major currency in recent months, having lost about 20 percent against the dollar since May to hit an all-time low. Other hard-hit emerging market currencies include the Brazilian real, which has fallen more than 14 percent and the Indonesian rupiah, which has slid nearly 12 percent in 2013.
The idea of intervention did not come up at a Kremlin briefing earlier on Friday looking ahead to the annual Group of 20 summit in St Petersburg on September 5-6.
A meeting of BRICS finance ministers on the fringes of a G20 gathering in Moscow in July made no progress on setting up a joint currency fighting fund, sources said at the time.
Russian officials have not shown any great concern over recent declines in the rouble to four-year lows, describing them as normal fluctuations. They have argued that a weaker currency will boost the export competitiveness of Russia's flagging economy.
Coordinated action among major emerging economies to support their depreciating currencies against a buoyant dollar had been mentioned in June by Brazilian President Dilma Rousseff in a phone call to her Chinese counterpart.
The BRICS nations fretted about the global turbulence at a July G20 summit in Moscow, but no action materialised. G20 leaders are due to meet in St Petersburg next week.
India's Dasgupta said there had been correspondence among several countries on the plans in the last few weeks and predicted that action would now come quickly, but he declined to share specific details of the discussions.
He said the conversations were not limited to BRICS nations. It was not immediately clear how many takers there were for such a proposal from other major emerging economies.
RUPEE GETS REPRIEVE
Comments from the Indian official extended the rupee's gains on Friday to 65.72 per dollar from 65.85 after the currency slumped to a record low earlier this week. The government in New Delhi is struggling with the weakest economic growth in years and a yawning current account deficit.
"Any steps in this direction will not lead to more than short term 2-3 percent gains - which will be quite difficult to trade anyway - and may lead to more long term damage," said Bhanu Baweja, head of EM FX and debt strategy, at UBS in London.
When the idea for coordinated action surfaced earlier, analysts said that - unlike their wealthier counterparts at the G7 group - the BRICS were still far from either coordinating monetary policy or jointly intervening in forex markets.
Separately, the BRICS countries have been working during the past year on a $100 billion reserve fund and a joint development bank to reshape the global financial architecture long dominated by rich nations. These new institutions are expected to take some time to materialise.
"NO FORCE CAN STOP THEM"
Offshore markets developed to allow foreign investors to hedge or speculate on emerging-market currencies when exchange controls in those countries made it difficult to trade directly in the domestic spot market.
Dasgupta said such markets had exerted pressure on 12 of the main emerging market currencies, including Brazil, China, India, Russia, South Africa, Turkey and Malaysia.
He said that, acting together, even four or five members would have estimated international reserves of $1.2 trillion. With China, the total reserves exceed $6 trillion, he said.
"Once they decide they will move to intervene to mutually support each other to put a floor, there is no force that can stop the impact," he said.
Non-deliverable forward (NDF) markets operating mainly from Singapore, Hong Kong, New York and London allow trade in several Asian currencies, including the rupee. They allow investors to bet without ever having to physically exchange the currency involved.
A report by the Indian central bank in August said NDFs were affecting the rupee's value. Indian central bank Governor Duvvuri Subbarao in July said he would rather there were no NDF markets.
One Indian government estimate puts global trading of the rupee at $60-$70 billion per day.