Recently, the rupee touched Rs 60 to a dollar - something which has never occurred. So, what is going on? The blame can be put on international as well as domestic factors. The main international factor has been the US Federal Reserve's announcement that it will be slowing down its monetary easing policy. Earlier, in a bid to resuscitate the economy the US central bank had pumped in dollars in the financial markets by buying government bonds, thus keeping interest rates very low. Since 2008 the Federal Reserve has pumped in $3.3 trillion and this process continued this year too. But recently the Chairman of Fed Reserve, Ben Bernanke, announced that he is planning a slowdown in monetary easing because there are signs of revival in the American economy and it is registering 2.4 per cent annualised growth. Unemployment has also fallen from 7.5 per cent to 7 per cent. It had an immediate impact on the stock markets worldwide and the dollar strengthened and bond prices crashed and yields rose.
Already the $ 3.3 trillion that has been released in the US economy made investors opt for emerging markets because of the near-zero interest rates in the US. Now the attraction of emerging markets is much less because the US economy is reviving and FIIs are withdrawing money from the bond and equity markets and going back to invest in the US Treasury bonds (the safest bet) as the interest rates are likely to be hiked. The Indian financial markets have also seen the outflow of FIIs and as a result, they are being starved of dollars. FIIs have sold Indian debt (bonds) totalling $3 billion in the past fortnight. They have sold equities worth Rs 1458 crore.
In 2013, around $15.4 billion came in and helped to finance India's burgeoning current account deficit and there was no shortage of dollars. The withdrawal of FIIs has created a big vacuum as importers are demanding dollars and exporters are not bringing in enough foreign exchange. The RBI has already spent millions to prop up the rupee and is not likely to act in a hurry. Because there is a danger of speculative elements coming into play and buying up dollars to let the rupee fall more. Forex reserves, however big they are, can be depleted in a matter of days then. So, the RBI is waiting and watching.
The situation would not have been so bad if the current account deficit had not deteriorated so much. The fall in oil prices, however, reduced it from 7.5 per cent of the GDP in December 2012 to 5 per cent in March. India would need $ 80 billion to finance it. The Finance Minister says it is because of the import of gold that the CAD has been ballooning. Who are the people buying so much gold? Obviously people with black money (including politicians) and there are millions of them, who are buying gold, and not the average housewife or the common man. Gold is now freely available in its purest form from banks. The banks are touting all kinds of offers for gold purchases instead of focusing on their regular business of lending to industry and other businesses.
It is the all-pervasive corruption in the country which is generating all this black money into the system and there is only one way to beat inflation and detection by tax authorities-buy gold and store it. No house or property deal can be completed with white money only, and black money is an integral part of it. With inflation near double digits for three years, it is inevitable that people with black money would find in gold a safe haven. No wonder, there is phenomenal increase in gold imports. On the other hand, export of jewelry is slowing down because of the scarcity of bullion.
The general export growth slowdown, on the other hand, can be blamed on the recessionary conditions in the western markets. The biggest buyers of Indian goods, the EU member-countries, are suffering from high rates of unemployment. Naturally the demand is less. Also, the manufacturing sector growth has slowed down to 2.5 percent because of infrastructure problems, high inflation and the flagging domestic demand. Also slowing down of new investment has been due to the high interest rate of 8.25 per cent which the RBI is refusing to scale down for fear of stoking inflation. After many months of tight money policy, inflation has come down to 4.8 per cent but not the food inflation which remains high.
Thus, we have an unbalanced situation in which imports are rising rapidly and exports are slowing down, and the current account is beyond sustainability. The FII inflows helped a lot to ease the dollar demand but now they are also moving out quickly because India's GDP outlook is less than promising and lower than the expected 6 per cent. A weak rupee has further contributed to their rapid withdrawal which is contributing to its weakening.
Opening up various FDI sectors cannot attract FDI overnight. It comes to countries with steady policy framework and stability of the regime. Right now India's transitional political regime may not seem attractive to foreign investors. Inflation also has been a deterrent as well as the problem of a steady supply of skilled labour and infrastructure. FDI has dipped by 38 per cent to $22.4 bn in 2012-13.
Various important bills are still awaiting parliamentary approval and no one knows when they will be passed. The land acquisition Bill is the most important one from the point of view of foreign investors. In its present form, with clauses about rehabilitation and compensation to people whose land is to be acquired, it will remain a controversial subject and may not get parliamentary nod anytime soon.
To woo back the FIIs would not be easy. To prop up exports will also not be easy in the current world market situation. It would be very difficult for the rupee to regain its former value unless commodity prices decline. Already oil prices have slipped a little and also gold prices have come down with the strengthening of the dollar. We should be prepared for a lower rupee unless the RBI steps in and boosts the rupee by releasing a huge amount of dollars. Besides, the the government should take steps to reduce the demand for gold. If the current spate of scams continues, bringing in more uncertainty in the market and lowering business expectations, there would be further problems ahead. And if export growth and industrial growth do not pick up, the outlook for a higher GDP growth may darken more.
(The writer is a Senior Fellow at Observer Research Foundation, Delhi)
Courtesy : The Tribune
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