Falling rupee, rising deficit

The rupee, after touching the lowest ever value aga­inst the dollar at Rs 74.40 on October 11 had a respite for a few days and then gained, thanks to the falling price of crude oil. The rupee is now at around 73.37 to the dollar.

The record fall to Rs 74.40 to the dollar was a reaction to Reserve Bank of India’s (RBI) unexpected latest monetary policy decision. Business enterprises and households were reconciled to an increase in the policy interest rate, since the rupee had depreciated by 14% since January.

The RBI, however, left the rate unchanged at 6.25%, taking the stand that the domestic price stability (stability of domestic purchasing power) was its primary concern; and the external stability of the rupee (stability of external purchasing power) is better left to the interplay of market forces of supply and demand of rupee. The RBI made it clear that any intervention would be only for controlling the volatility in the rupee exchange rate, and not for managing it.

Outflows of capital were due to selling of assets held by foreign portfolio investors (FPIs) which began early this year. It brought down the value of the rupee. According to National Securities Depository Limited, the monthly outflow of capital in October alone has been massive at over Rs 12,000 crore. In the last 18 years, there have been only five instances when monthly outflow of capital has hit or exceeded that level.

The capital outflows were due to the growing perceptions of the risk-averse FPIs that equity markets in India and in other emerging economies were weakening. Thus, investments in Indian shares and short-term debt markets were not attractive in the context of rising interest rates in the US. India’s elevated inflation, emerging current account deficit (CAD) and uncertainties over the future of banking due to rising bad loans were the causes for the outflow of hot money. The outflows between January and September amounted to about Rs 69,000 crore.

Due to similar capital outflows, the Indonesian currency came down from 10,000 to 15,000 rupiah per US dollar. In response, Bank Indonesia has raised its interest rate five times since May 2018, besides intervening in the foreign exchange market. Indonesia’s Finance Minister Sri Mulyani Indrawati assured her nation that Bank Indonesia would manage the exchange rate.

The IMF’s August 2018 Staff Report on India made a pointed reference to the needed intervention. Further, in its Biannual World Economic Outlook October 2018, released before the IMF/World Bank Meeting in Bali this month, the IMF recommended: “Monetary policy should be tightened to re-anchor expectations where inflation continues to be high (as recently done in Argentina), where it is increasing further in the wake of sharp currency depreciation (witnessed in Turkey), or where it is expected to pick up (India).”

Feeble attempts

RBI’s efforts to arrest the fall in rupee value by selling dollars were feeble all along. Statements by officials that the falling rupee was not a major concern, but the widening of CAD was worrisome sent out wrong signals. Further, the brave talk that foreign reserves were sufficient to tide over the CAD for nine months led speculators to believe that the depreciation of rupee would continue. It appears that there has been no coordination between government and RBI.

The latest monetary policy decision not to raise the interest rate brought the rupee value down to the record low. The more aggressive interventions in recent week were too late to have any serious impact. During the week ending October 20, the foreign reserves plunged by $5.14 billion, the steepest fall in a week in recent decades. The reserves have decreased from the record level of $426.08 billion in April to $394.46 billion last week.

The results of bimonthly Consumer Confidence Survey by RBI in six metropolitan cities (Bengaluru, Chennai, Hyderabad, Kolkata, Mumbai and New Delhi), reveal the Current Situation Index (CSI) with Base May 2017:100, fell from 98.30 in July to 94.80 in September.

The latest news is that fiscal deficit in the first half of FY19 has widened to 95.3% of the budgeted estimate. It looks like the budgeted goal of fiscal deficit at 3.3% of GDP will be breached. So too, the goal of keeping CAD under 2% of GDP. A Nomura report has already estimated CAD to be at 2.8% of GDP for FY19 because of the falling rupee and rise in oil prices, as compared to a CAD of 1.9% of GDP last fiscal.

The uncertainties loom large. The US sanctions against Iran’s oil exports start on November 4. Further, if oil exporting countries do not increase the supply, the benchmark Brent crude price could head to $80 from today’s price of $77.45 per barrel.

The RBI should re-assess and announce a tightening of the policy rate without waiting for the December meeting. An anticipatory and proactive policy decision seems more appropriate.

(The writer is Adjunct Professor, Amrita School of Business, Bengaluru Campus)