Rupee heading for 60? It is difficult to stop the slide

The Indian rupee is making headlines today, but mostly for the wrong reasons. Its value has been falling against the US dollar steadily and since the beginning of 2012, it has fallen 23 per cent, closing at a record low of Rs 55.39 on Tuesday. 

 
The worrisome fact, however, is that no one has any inkling, the government and the Finance Ministry the least, as to how deep the rupee will fall and how long will the downturn last? Research units of some banks have already predicted that the rupee may soon touch 60  to a dollar.

About a month ago when the rupee was at 48, such predictions would have looked preposterous, but not anymore. Worst, neither the Finance Ministry nor the Reserve Bank of India (RBI) can do much to stop the fall.

There are several reasons behind this pessimistic view. The most important factor is that India’s deficit in foreign trade – excess of imports against exports – has ballooned to an all time high of $185 billion in 2011-12, a whopping 56 per cent more than $119 in 2010-11.

The culprit is the import of crude oil, petroleum products, gold, coal, fetiliser etc. Oil imports at $152 billion, for instance, accounted for 31 per cent of the total import bill.

Similarly, the import bill for gold and silver was at $60 billion, the second largest item in the basket.     

Our imports went up by 32 per cent in 2011-12 to Rs 489 crore, our exports at Rs 304 crore were higher by 21 per cent. Since the financial turmoil in Europe has resulted in severe demand contractions in many European countries, a major destination for Indian exports, India’s total export earnings, experts believe, are likely to stagnate or marginally go up in the current year.

Imports, on the other hand, will keep growing as the country will consume more of oil (we import 80 per cent of our need), coal (for producing power and steel) and fertiliser (to sustain food production). Thanks to doubling of customs duty, gold consumption in 2012-13 is likely to be lower.

There is no doubt that we need to curb consumption of oil by raising prices, but the coalition government does not have the necessary support to do so. The fear of a spike in inflation is another reason why the oil price hike is delayed.

In a recent interview, CLSA Asia-Pacific Markets Economist Rajeev Malik said, “Weaker rupee or the pressure on the rupee is not really the underlying problem; it is just a symptom of the underlying problem. We haven’t seen any meaningful corrective action from the government to address any of this.”

Ineffective measures

While the government and RBI has taken several steps (see box) in the last five months to arrest the fall of rupee, it has defied all. Said a report by the FX Research & Strategy of Nomura: “Although we expect this measure to lead to a more sustained INR rally (compared with recent FX measures), this policy does not address medium-term concerns over the current account deficit.”

Many have also criticised the RBI for not doing enough to stem the rupee’s fall without realising the fact that the central bank has very limited fire power to do so. While the RBI has intervened intermittently, it did sell $20 billion in spot markets in six months till March 2012, but the rupee continued to fall.

Talking about RBI’s efforts, RBI Deputy Governor Subir Gokarn has said: “There is very strong pressure on the rupee to depreciate. We have done a number of things and will continue to do things that we think have an impact of stabilising the rupee.”

We should also remember that in the RBI’s total foreign exchange reserve of around $292 billion gold accounts for about $32 billion and the balance $260 billion is just enough to sustain about 7 months’ import.

Naturally, the central bank needs to conserve its cash to make sure it is able to pay for the import bill. Besides, low forex reserve, implying weak defence power, can make a country vulnerable to major speculative attacks by global currency sharks.

Large outflow of dollars from the Indian capital market, foreign funds are major net sellers of stocks in the first five months of 2012, is another reason for the fall of rupee.
As the government’s report card on economic reforms is miserable and it failed to open up many sectors to foreign investments, India ceased to be a preferred destination for foreign funds.

Strengthening of dollar against major currencies like Euro, Pound Sterling and Yen is another reason why the rupee is becoming weaker.

Few options

While there are several fundamental changes the country can initiate to strengthen the rupee, they are long-term in nature.

A few of these measures are: enlarge export basket, diversify export destination, cut down imports to bare minimum, decontrol all oil products, lower inflation and initiate reform to make investment climate attractive.

But the short-term options are few and less effective. Of course, the government can impose capital controls to drastically reduce foreign exchange outflow but such a draconian and internationally unacceptable measure can be considered as a last resort. We can buy oil in rupee from Iran without succumbing to American pressure.

Another possible option is to launch sovereign dollar denominated bonds with an attractive rate of interest, such as the India Resurgent Bond and the India Millennium Bond issued in 1988 and 2000, respectively.

The RBI can also directly sell dollars to oil companies, who are large buyers of dollars for oil imports, without affecting the market price.

Government actions fail to prop up rupee

* Restricts rebooking of can- celled forward contracts to stop forex speculation
* Cuts net overnight open position for forex holders
* Deregulates interest rates on rupee deposits from non-resident Indians
* Relaxes the interest ceiling on FCNR deposits to attract funds from NRIs
* Deregulates interest rates on export credit in foreign currency
* Defers budget-proposed GAAR rule to boost stock market
* Eases restrictions on the usage of foreign currency deposits
* Allows banks to use FCNR deposits at collateral against lending to local cos
*  Exporters told to convert 50 per cent of dollar earnings into rupee in 14 days
* Allows intra-day trading at 5 times the net overnight open position limit
* Imposes restrictions of $100 m on “position limit” for forward contracts by banks