Nose-diving economy

Faced with a 17 per cent depreciation of the rupee in six weeks, the Reserve Bank governor D Subbarao, sought to allay panic by asserting  that ‘India’s growth story is still credible’. If its growth had slackened, he said, it was only because of the global financial crisis. His explanation is less than credible. The rupee has plunged inspite of 18 months of rising interest rates. In open, or largely open economies rising  interest rates normally make  the exchange rate go the other way.  

What is more, money that is in search of safer havens is fleeing the euro but is not going into the dollar, for the dollar has fallen by 8 per cent against the euro since July. Instead it has rushed into the Japanese yen, Swiss francs, Brazilian escudos, and even the Thai baht despite its political woes. Why is not even a trickle coming to India? And why is the money being pulled out of the stock markets?

The inescapable truth is that investors are pulling out of India because they have lost confidence in India’s immediate future. They know that its fundamentals are still strong: that it has enjoyed a more than 8 per cent rate of growth for the past decade; that the global recession caused barely a hiccup in its growth; that its inflation is driven not by internal mismanagement but  by global price increases, and that its balance of payments deficit is barely 1.6 per cent of its GDP. They know that its foreign exchange exceed $ 300 billion and that it has one of the better regulated stock markets of the world. What has evaporated is   their confidence in the capacity of the Manmohan Singh government to manage the Indian economy. 

The onset of doubt has been relatively sudden. Murmurs that India’s growth story was coming to an end began to be heard only last summer, but the seeds of doubt had been sown by the RBI in April 2010 when it decided to fight a resurgence of inflation caused by rising food, oil and commodity prices in the international economy, by raising interest rates to restrict the growth of money supply in the domestic economy.

 The slackening of industrial growth that followed the interest rate hikes did not immediately affect the stock market because companies kept declaring high profits and dividends -- a product of high growth in  2009-10. The sensex therefore kept rising till it briefly crossed the 20,000 mark in December 2010.

But underneath the fizz, as industrial growth began to slip, investors became more and more nervous. When another unexpected spurt in food prices at the end of the year made yet another rise in interest rates inevitable, foreign investors decided that it was time to book profits. The resulting outflow from the stock market in early January caused the sensex to drop by 7 per cent – over 1400 points-- in five days. Since then the outflow has, if anything, gained speed because, far from admitting that it had been trying to do the impossible – tame cost push inflation by reducing money supply-- the Reserve Bank again signalled its unshaken faith in monetary instruments  with another increase in interest rates in October. 

Loss of confidence

The investors’ loss of confidence, is precisely reflected in the depreciation of the rupee against the dollar. The rupee gradually appreciated against the (admittedly depreciating) dollar till April this year, hovered indecisively for the next three months and started depreciating again at an accelerating pace from August.

In October the outflow became a flood. Had the RBI released some of its $300 billion-plus of reserves and brought down repo rates in October, at the beginning of the slide, it would not have become self –reinforcing. But doing that would have required it to admit the enormity of the mistake it had made. So, instead, it made a virtue of the devaluation and left it to the market to bring it to a halt before it went too far, pinned its hopes on the market correcting itself and did nothing till it was almost too late. As a result $5.7 billion of foreign currency reserves slipped out of the country in the single week from November 11 to 18 – more than a billion dollars per working day.

In the past few weeks the pigeons have begun to come home to roost. When the RBI jacked up interest rates mercilessly in 2007-8 while the rest of the industrialised world was bringing them closer to zero, large Indian corporates went out in droves to borrow abroad. They did so again when the RBI began raising interest rates in 2010. Indeed private borrowing abroad doubled between August 2010 and July  2011.

Today Indian corporates are in debt abroad to the tune of several hundred  crores. All but a small portion of this has gone into infrastructure projects – airlines, oil and gas exploration and production, steel, and power. Most of them borrowed when the rupee was appreciating, and thought that the appreciation and low interest rates abroad would give them virtually free capital for their projects.

But they hadn’t reckoned with the RBI. All of them have seen their annual debt servicing obligation go up by 17 per cent in six weeks. That is the main  reason why the airline industry has lost Rs 3,500 crore in the last year and is set to lose more next year. Today it is not only Kingfisher but even Jet airways, whose future is threatened. Before prime minister Manmohan Singh is persuaded by his officials about all the things he cannot do for the industry, such as lower taxes on fuel and allow it to sell some of its equity abroad, he would do well to acknowledge the government’s share of the responsibility for putting them in such dire peril. 

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