Rupee: band-aid solutions futile

The government finally decided to act, much to the relief of all. With the September 14 announcement of a set of five measures to arrest the fall of the rupee against the dollar, the government made its intent loud and clear. It indicated to markets overseas that “enough is enough.”

The rupee fell to its lowest last Thursday. It was close to Rs 73 per dollar. On Friday came the finance minister’s announcement of the five steps.

With signs of escalating tensions between the US and Iran, the fear is that oil price will hit $80 per barrel despite assurances that Saudi Arabia, Russia and America could together raise output fast enough to offset falling supplies.

Mounting crude oil price has already pushed up value of oil imports in dollar terms and the trade deficit is widening. Given other earnings, the expanding current account deficit of 2.4% of GDP in the April-June quarter, as compared to 1.9% in the previous quarter, is a major factor behind the depreciation of the rupee.

Defending the rupee, although never aggressively done, was designed more for curbing volatility by supplying dollars for rupees and has already cost the economy over the last four months. The foreign exchange reserves have fallen below $399 billion from the record highest level of $426 billion registered in April.

Worried about the seemingly unstoppable trend in the depreciation of the rupee, the government announced its solutions on September 14.

Manufacturing units can avail external commercial borrowings of up to $50 million with a minimum maturity of one year instead of three years.
Removal of exposure limit of 20% of foreign portfolio investment’s corporate bond portfolio to a single corporate group.

For all infrastructure loans, with regard to external commercial borrowings, mandatory hedging conditions will be reviewed. For 2018-19, with regard to masala bonds (rupee-denominated overseas bonds), there will be exemption from withholding tax for issuance done this year up to March 31, 2019.

Removal of restriction on Indian banks market-making in masala bonds, including underwriting of masala bonds.
The stress in the first measure on reducing the period to one year is in order to attract quick capital inflows. 

The second measure is risky, as borrowers are exposed to exchange risks and no one is sure of stability in the immediate run.

The third measure relates to debt investment, and government wants more debt inflows.

The fourth and fifth seek inflows of rupee capital and the exchange rate risk is absent. In the current uncertain period, overseas investors with rupees would not be inclined to take any risk in investing in rupee bonds. It is unlikely that any capital inflows will materialise.

The market reaction has been mute and least inspiring. The initial recovery of the rupee by a few paise was quickly reversed.

Continuing dependency

It appears that policymakers are continuing to depend on capital inflows to finance the deficit rather than secure a long-term solution. The only solution is to step up exports and provide a long-term remedy. India’s trade deficit has increased over the last five years. Exports are not growing to match up with imports, which are rising to meet various developmental needs, including capital and intermediate goods.

In 2016-17, exports were $275.8 billion and imports were $384.4 billion, causing a deficit of $108.6 billion; in 2017-18, exports were $302.8 billion, imports were $459.7 billion, resulting in trade deficit of $156.9 billion. The 2018 IMF Annual Staff Consultation Mission Report has estimated the trade deficit for 2018-19 would be close to $200 billion, with imports at $546.6 billion and exports worth $349.7 billion.

Positive measures

Exports growth has been slow, at 9.8 % in 2017-18, which itself is the highest growth in six years after a period of stagnation. On the other hand, imports grew at close to 20% in 2017-18. Curtailing imports through quotas and tariffs, which are often easier, amount to protectionism. They would undo all the good done to the nation by reforms undertaken since 1990-91. If bureaucrats have their way, they would return us to the days of Licence-Permit Raj! 

Instead, there should be positive measures that include refund of pending input tax credits of a few thousand crore rupees to exporters and providing credit to a whole range of labour-intensive export industries, including gems and jewellery, garments and others dominated by micro and small and medium enterprises.

In this regard, there is a timely suggestion made earlier in July by former Niti Aayog vice chairman Prof. Arvind Panagariya to appoint a task force to devise strategies to expand exports. Implementing this suggestion, rather than spending energy and resources on futile band-aid solutions, would be a better option.

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