The falling rupee has evoked varied
response from the government in terms of announcing measures to increase
capital flows. There are serious thoughts on increasing tariffs on
non-essential imports. Also the media is abuzz with possibilities of getting a
high stock of dollars through an NRI bond. How critical is the situation today?
There are varied arguments on the rate of depreciation of the rupee. To the
extent that it is driven by global factors, there is nothing that can be done.
But if it is due to fundamentals, which have also weakened, then options exist.
To gauge the strength of the fundamentals, the single indicator is forex
reserves. They stood at $424 billion in March 2018 and have dipped to just
under $400 billion this month. They could go below in case the fundamentals
deteriorate or if the RBI keeps selling dollars to save the rupee. Therefore,
the question to ask is how strong are our reserves? The thumb rule is that a
multiple of three months of import cover is good enough. As of March-end, the
import cover was for almost 11 months, which is very high as there is a
carrying cost. Table 1 assumes that imports grew by 20% this year mainly due to
the oil bill and decline in forex reserves to alternative scenario levels of
$390 and $375 billion. With reserves at $375 billion and import growth of 20%,
we can still maintain a comfortable ratio of eight-month cover. In 1990-91,
when the country went through a balance of payments crisis which led to the IMF
loan, the import cover was just below three months
In
this context, it would be interesting to see what these numbers were in the
other episodes of an attack on the rupee. Table 2 gives the import cover ratio
for years when the rupee fell by more than 10% on an average post 1993. In all
these episodes, the import cover ratio has been in the range of 7-10 months.
However, in 1998, the panic button was struck during the course of the year and
the Resurgent India Bond was floated. In 2000-01 (not included here), the rupee
fell by around 5.3% after the government went in for the IMD (India Millennium
Deposits). In 2013-14, the option exercised was the FCNR (B) swap facility
where the RBI bore the exchange risk as they were issued at 3.5%.
The RBI took forward cover to hedge against
risk. Based on past experience, it does appear that presently there is no need
to look for a bond issuance to garner dollars. Two variables need to be
monitored. The first is how fast do our imports grow and the second is the
level of reserves. If there is depletion of dollars, it does appear that up to
the level of $375 billion, the situation would be comfortable. However, once it
declines below this level, an NRI bond can be contemplated. The timing will
also be important. It may be expected that by November the Iran part of the
external story would go to the background while the China trade war should have
also played out. A clear picture on the oil price will also emerge which can
become the anchor for taking a decision. Will a bond be preferable (whither NRI
or sovereign) or a swap facility? A bond would be better that is driven by the
market where the government can provide a hedge cover for banks. The end point
is that rather than the exchange rate, we should be monitoring the level of
reserves to gauge the vulnerability of our external account. This would capture
the net result of balance of payments flows as well as RBI action in the
market. We need not look beyond this number. (Views are personal)
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