If FY12 and FY13 were the years of our battle against inflation, FY14 has been a war against the falling rupee. The decline in the value of the rupee has been quite prodigious from R53.74 as of May 1 to R62.35 on August 19. We have taken our balance of payments for granted for a long time and have been liberal with imports with the comfort that foreign inflows would protect the current account deficit. But there has been, what Jeffrey Archer would have called, a twist in the tale, this time when the inflows got converted to outflows, and the rupee went down.
RBI, as usual, has been left holding the baby, as it is the case when anything goes amiss. It also runs the risk of facing the flak because every economic decision has a tradeoff, and some constituency gets affected. The latest buzzword is ‘collateral damage’ caused by too much intervention as bond yields have zoomed and the stock market has plummeted. The alternative would have been to do nothing and let the market decide the exchange rate, in which case the participants would have panicked in the expectation that RBI was targeting a higher number. The more uncharitable would have likened the state to that of Nero. Really, a hard choice to make under these circumstances.To cut short the often-explained story, the rupee has fallen due to fundamentals turning sour and adverse sentiment caused by the QE withdrawal. The government and RBI have acted together to control the fall in the value of the rupee and the approach has been, to use the oft-repeated cliché, calibrated. The fundamentals have been drawn down in a granular fashion and measures have been invoked to control the outflow of dollars and increase the inflows. The inflows will increase through FDI only over a period of time as India is no longer a hot destination under the given circumstances. ECB norms have been relaxed, which will help. NRI deposits have been provided an impetus with the increase in interest rates, which could get in more dollars in the medium run only. But none of these measures will get in dollars on a daily basis to strengthen the coffers. Sadly, a declining rupee has not quite spiked exports, which appear to be driven more by demand conditions in the West, which are still lacklustre.The so-called crusade against outflows has started off with the war against gold where the duty is now 10% and channels of finance have been cut drastically with only exporters and jewellery makers having relatively easy access. This has helped, going by the government data on import of gold, though one is not really sure whether the harvest and festival season will cause a reversal.More recently, curbs have been put on current account with the reduction in limit on outflow through remittances. Add to this restrictions on outward FDI, and the measures have been fairly stiff. Given that there are not too many companies that are investing 4 times their net worth or even a multiple of 2, and that there are not too many opportunities overseas given the stagnation there, the savings in dollars will not be significant. The curbs on external remittances are more of a nuisance at the household level, and will not really help to shore up the rupee. The next target could be non-essential imports, which cannot be ruled out considering that a very determined FM has averred with certainty that the CAD will be at 3.7% just as the fiscal deficit will be at 4.8%. Making imports more expensive is a good way of installing a deterrent as was the case with gold as a combination of additional 6% in duty plus depreciation of 16% actually pushes up the cost by over 20%. Has this worked?The answer is ‘not really’, because while imports have slowed down, at least for the time being (these months are also not the marriage season), the fall in the value of the rupee appears to be almost continuous. RBI has simultaneously squeezed liquidity by tightening the CRR norm, half closed the LAF window, sold bonds through OMOs, introduced weekly CMB auctions to ensure that no speculative positions are taken in the forex market on account of arbitrage opportunities. This worked in a time frame of 1-2 days, after which it appeared to be a ‘fall as usual’. The NDF market has been held responsible at some point of time, but all legitimate participants have to inform RBI of their actions, and while the volumes are substantial in this market, the impact would be low as it is only the difference in price that has to be paid for which will impact the spot market locally. The forex derivative market which is mainly on NSE and MCX-SX have witnessed volumes halve in the last month with curbs being placed on margins and position limits. The average daily volumes on NSE have come down from R25,000-30,000 crore to R10,000-12,000 crore. The rupee still seems to keep falling. FIIs in August have been positive in equity and negative in debt.RBI had sold $1.8 billion up to June (the number would be higher in July) while our foreign currency reserves have declined by $8.4 billion. The decline in reserves is symptomatic of the decline in the value of the rupee while the sale of dollars by RBI indicates that this also has not really helped. Quite clearly, the sentiment factor has been working in pushing the rupee down.What next then? It looks like once we put in additional curbs on imports, the government and RBI would have done all that is possible from the point of view of fundamentals. Speculative activity, to the extent that they are being played through the institutional route, has also been addressed. The impact has been limited. In a way, it is more like what Shakespeare would have said, “full of sound and fury, signifying nothing”. The logical corollary is to now sit back and let the rupee find its own level. That would lead to market equilibrium. But yes, we have to bear judgment here that a free fall in the value of the rupee is self-fulfilling—FIIs keep out, ECBs come down and FDI starts rethinking. Are we prepared for that?
RBI, as usual, has been left holding the baby, as it is the case when anything goes amiss. It also runs the risk of facing the flak because every economic decision has a tradeoff, and some constituency gets affected. The latest buzzword is ‘collateral damage’ caused by too much intervention as bond yields have zoomed and the stock market has plummeted. The alternative would have been to do nothing and let the market decide the exchange rate, in which case the participants would have panicked in the expectation that RBI was targeting a higher number. The more uncharitable would have likened the state to that of Nero. Really, a hard choice to make under these circumstances.To cut short the often-explained story, the rupee has fallen due to fundamentals turning sour and adverse sentiment caused by the QE withdrawal. The government and RBI have acted together to control the fall in the value of the rupee and the approach has been, to use the oft-repeated cliché, calibrated. The fundamentals have been drawn down in a granular fashion and measures have been invoked to control the outflow of dollars and increase the inflows. The inflows will increase through FDI only over a period of time as India is no longer a hot destination under the given circumstances. ECB norms have been relaxed, which will help. NRI deposits have been provided an impetus with the increase in interest rates, which could get in more dollars in the medium run only. But none of these measures will get in dollars on a daily basis to strengthen the coffers. Sadly, a declining rupee has not quite spiked exports, which appear to be driven more by demand conditions in the West, which are still lacklustre.The so-called crusade against outflows has started off with the war against gold where the duty is now 10% and channels of finance have been cut drastically with only exporters and jewellery makers having relatively easy access. This has helped, going by the government data on import of gold, though one is not really sure whether the harvest and festival season will cause a reversal.More recently, curbs have been put on current account with the reduction in limit on outflow through remittances. Add to this restrictions on outward FDI, and the measures have been fairly stiff. Given that there are not too many companies that are investing 4 times their net worth or even a multiple of 2, and that there are not too many opportunities overseas given the stagnation there, the savings in dollars will not be significant. The curbs on external remittances are more of a nuisance at the household level, and will not really help to shore up the rupee. The next target could be non-essential imports, which cannot be ruled out considering that a very determined FM has averred with certainty that the CAD will be at 3.7% just as the fiscal deficit will be at 4.8%. Making imports more expensive is a good way of installing a deterrent as was the case with gold as a combination of additional 6% in duty plus depreciation of 16% actually pushes up the cost by over 20%. Has this worked?The answer is ‘not really’, because while imports have slowed down, at least for the time being (these months are also not the marriage season), the fall in the value of the rupee appears to be almost continuous. RBI has simultaneously squeezed liquidity by tightening the CRR norm, half closed the LAF window, sold bonds through OMOs, introduced weekly CMB auctions to ensure that no speculative positions are taken in the forex market on account of arbitrage opportunities. This worked in a time frame of 1-2 days, after which it appeared to be a ‘fall as usual’. The NDF market has been held responsible at some point of time, but all legitimate participants have to inform RBI of their actions, and while the volumes are substantial in this market, the impact would be low as it is only the difference in price that has to be paid for which will impact the spot market locally. The forex derivative market which is mainly on NSE and MCX-SX have witnessed volumes halve in the last month with curbs being placed on margins and position limits. The average daily volumes on NSE have come down from R25,000-30,000 crore to R10,000-12,000 crore. The rupee still seems to keep falling. FIIs in August have been positive in equity and negative in debt.RBI had sold $1.8 billion up to June (the number would be higher in July) while our foreign currency reserves have declined by $8.4 billion. The decline in reserves is symptomatic of the decline in the value of the rupee while the sale of dollars by RBI indicates that this also has not really helped. Quite clearly, the sentiment factor has been working in pushing the rupee down.What next then? It looks like once we put in additional curbs on imports, the government and RBI would have done all that is possible from the point of view of fundamentals. Speculative activity, to the extent that they are being played through the institutional route, has also been addressed. The impact has been limited. In a way, it is more like what Shakespeare would have said, “full of sound and fury, signifying nothing”. The logical corollary is to now sit back and let the rupee find its own level. That would lead to market equilibrium. But yes, we have to bear judgment here that a free fall in the value of the rupee is self-fulfilling—FIIs keep out, ECBs come down and FDI starts rethinking. Are we prepared for that?
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