<p>The accelerating fall of the rupee, from Rs 59.35 to the dollar on July 29 to Rs 61.70 on August 16, has finally made it to the front page of the Financial Times. It has done so because the government’s knee-jerk curbs on Indian private investment abroad have convinced corporate chiefs, financial institutions and economic analysts both here and abroad that ‘the government is groping in the dark,’ and that ‘India has lost its way.’ <br /><br /></p>.<p>This impression could not have gained ground at a worse time for it has drawn attention away from strengthening external balances of the Indian economy and the foundation it has laid for bringing interest rates down to revive growth. On Monday, August 12, finance minister P Chidambaram assured the country that the current account deficit on the balance of payments would be brought down from last year’s $ 88 billion ( 4.8 per cent of GDP) to $ 70 billion (3.7 per cent) this year. But, for once, he erred on the side of caution. For there are three good reasons to expect the CAD to fall well below the 3.7 per cent that he has targeted.These are the government’s success in curbing gold imports; the 7 per cent fall in oil and 11 per cent drop in imported industrial input prices since January; and the 11.8 per cent increase of exports in July.<br /><br />Chidambaram may have been cautious because the overall balance of trade data for April to July show a 1.72 per cent decline in exports, 2.82 per cent in imports and therefore a widening of the trade gap by $ 2.75 billion. But this has happened only because of a huge, speculative surge in the import of gold in April and May from a monthly average of $ 3 billion to $ 7 billion in April and $ 8.45 billion in May. Had this not occurred imports would have fallen by $ 9.5 billion, i.e- 3.23 per cent, and the trade gap would have narrowed by almost $ 7 billion.<br /><br />This decline will be fully visible in the next eight months because the curbs the government has imposed since June have virtually ruled out any future surge in gold imports. The quadrupling of the customs duty on gold to 8 per cent brought it down to $ 2.45 billion in June and $ 2.97 billion in July. The RBI’s end July decision to limit permissible imports to five times the value of gold and jewellery exports will ensure it will remain around the $ 2.5 billion mark for the rest of the fiscal year. Thus, gold imports are likely to fall, overall, by $ 18 billion from last year’s high of $ 58.8 billion. If these curbs continue it is a fairly safe bet that gold imports will fall by another $ 10 billion next year.<br /><br />The second reason to expect a sharply reduced current accounts deficit is the continuing slackness of international oil and commodity prices. This gives us good grounds to expect that the $ 7 billion April to July contraction in non-bullion imports will continue during the remaining eight months of the current fiscal year. Giving precise estimates of the future behaviour of exports and imports is always hazardous, but the accelerating decline in non-bullion imports from March till today suggests that the least the CAD will go down by on this account is another $ 14 billion. <br /><br />Revive them<br /><br />Finally, one swallow doesn’t make a summer, July’s sharp jump in exports does suggest that the devaluation of the rupee has begun to revive them. All in all, even a 5 percent rise in exports and 3 per cent decline imports for the rest of the year will bring down the trade deficit from $ 191 billion in 2012-13 to around $ 145 billion this year. If inward remittances and earning from software exports remain stable, this will reduce the current account deficit from $ 88 billion in 2012-13 to less than half that figure this year. As a percentage of GDP, this will be well below the 2.5 per cent considered acceptable by the international financial community. Better export figures could do even more.<br /><br />The government therefore has one last, golden chance to stop the haemorrhage of foreign exchange that has brought the rupee to its knees. But it cannot do this until it stops blaming the rest of the world -- first the EU and now the US -- for the rupee’s collapse. The root cause of the 45 per cent fall in its value since July 2011 is the ruinous interest rate policy adopted by the RBI since March 2010 with full support from the prime minister and his closest advisers. This came before industry had had time to recover fully from an equally debilitating 3 per cent hike in policy rates in 2007 and 2008, and is directly responsible for the 20 months of near-zero industrial growth that preceded its 2.2 per cent contraction in July. <br /><br />Today there is only one way forward: bring policy interest rates down by 2 or more per cent to where they were in March 2010; cut the cash reserve ratio to half of the present 4 per cent in order to ensure a pass-through of these cuts to investors, impose curbs on non-gold imports that only pamper the elite – such as the $ 55 billion we spend on consumer electronics-- and stop, instead of further encouraging external commercial borrowing, even by companies that earn and can repay in dollars, at least for a few months to bring down the debt to reserves ratio.<br /><br />Lowering interest rates sharply without attaching caveats about inflation will make share prices rebound. To see how fast and how far one has only to look at the behaviour of the Sensex every time there been even a whiff of hope that they will be reduced, during the past three years. As for the FIIs, few will take their money out of India when the US bond price rise has largely ended and they can make a great deal more by staying in the Indian market.</p>
<p>The accelerating fall of the rupee, from Rs 59.35 to the dollar on July 29 to Rs 61.70 on August 16, has finally made it to the front page of the Financial Times. It has done so because the government’s knee-jerk curbs on Indian private investment abroad have convinced corporate chiefs, financial institutions and economic analysts both here and abroad that ‘the government is groping in the dark,’ and that ‘India has lost its way.’ <br /><br /></p>.<p>This impression could not have gained ground at a worse time for it has drawn attention away from strengthening external balances of the Indian economy and the foundation it has laid for bringing interest rates down to revive growth. On Monday, August 12, finance minister P Chidambaram assured the country that the current account deficit on the balance of payments would be brought down from last year’s $ 88 billion ( 4.8 per cent of GDP) to $ 70 billion (3.7 per cent) this year. But, for once, he erred on the side of caution. For there are three good reasons to expect the CAD to fall well below the 3.7 per cent that he has targeted.These are the government’s success in curbing gold imports; the 7 per cent fall in oil and 11 per cent drop in imported industrial input prices since January; and the 11.8 per cent increase of exports in July.<br /><br />Chidambaram may have been cautious because the overall balance of trade data for April to July show a 1.72 per cent decline in exports, 2.82 per cent in imports and therefore a widening of the trade gap by $ 2.75 billion. But this has happened only because of a huge, speculative surge in the import of gold in April and May from a monthly average of $ 3 billion to $ 7 billion in April and $ 8.45 billion in May. Had this not occurred imports would have fallen by $ 9.5 billion, i.e- 3.23 per cent, and the trade gap would have narrowed by almost $ 7 billion.<br /><br />This decline will be fully visible in the next eight months because the curbs the government has imposed since June have virtually ruled out any future surge in gold imports. The quadrupling of the customs duty on gold to 8 per cent brought it down to $ 2.45 billion in June and $ 2.97 billion in July. The RBI’s end July decision to limit permissible imports to five times the value of gold and jewellery exports will ensure it will remain around the $ 2.5 billion mark for the rest of the fiscal year. Thus, gold imports are likely to fall, overall, by $ 18 billion from last year’s high of $ 58.8 billion. If these curbs continue it is a fairly safe bet that gold imports will fall by another $ 10 billion next year.<br /><br />The second reason to expect a sharply reduced current accounts deficit is the continuing slackness of international oil and commodity prices. This gives us good grounds to expect that the $ 7 billion April to July contraction in non-bullion imports will continue during the remaining eight months of the current fiscal year. Giving precise estimates of the future behaviour of exports and imports is always hazardous, but the accelerating decline in non-bullion imports from March till today suggests that the least the CAD will go down by on this account is another $ 14 billion. <br /><br />Revive them<br /><br />Finally, one swallow doesn’t make a summer, July’s sharp jump in exports does suggest that the devaluation of the rupee has begun to revive them. All in all, even a 5 percent rise in exports and 3 per cent decline imports for the rest of the year will bring down the trade deficit from $ 191 billion in 2012-13 to around $ 145 billion this year. If inward remittances and earning from software exports remain stable, this will reduce the current account deficit from $ 88 billion in 2012-13 to less than half that figure this year. As a percentage of GDP, this will be well below the 2.5 per cent considered acceptable by the international financial community. Better export figures could do even more.<br /><br />The government therefore has one last, golden chance to stop the haemorrhage of foreign exchange that has brought the rupee to its knees. But it cannot do this until it stops blaming the rest of the world -- first the EU and now the US -- for the rupee’s collapse. The root cause of the 45 per cent fall in its value since July 2011 is the ruinous interest rate policy adopted by the RBI since March 2010 with full support from the prime minister and his closest advisers. This came before industry had had time to recover fully from an equally debilitating 3 per cent hike in policy rates in 2007 and 2008, and is directly responsible for the 20 months of near-zero industrial growth that preceded its 2.2 per cent contraction in July. <br /><br />Today there is only one way forward: bring policy interest rates down by 2 or more per cent to where they were in March 2010; cut the cash reserve ratio to half of the present 4 per cent in order to ensure a pass-through of these cuts to investors, impose curbs on non-gold imports that only pamper the elite – such as the $ 55 billion we spend on consumer electronics-- and stop, instead of further encouraging external commercial borrowing, even by companies that earn and can repay in dollars, at least for a few months to bring down the debt to reserves ratio.<br /><br />Lowering interest rates sharply without attaching caveats about inflation will make share prices rebound. To see how fast and how far one has only to look at the behaviour of the Sensex every time there been even a whiff of hope that they will be reduced, during the past three years. As for the FIIs, few will take their money out of India when the US bond price rise has largely ended and they can make a great deal more by staying in the Indian market.</p>
