Andy Mukherjee August 20, 2013 Business Standard
Let the rupee sink
Abandoning the defence of the rupee will allow India to shift focus to boosting exports with tax cuts
India's failing defence of the rupee is doing more harm than good. It's time New Delhi left the plunging currency to market forces and shifted its focus to boosting exports and investment.
A country that decides to defend its exchange rate has only two options: impose capital controls or surrender independence over monetary policy. The Indian authorities have tried a bit of both. They have put restrictions on resident individuals and companies looking to invest overseas and in gold. The central bank has also raised short-term interest rates, thereby giving up its ability to use monetary policy to lift GDP growth from its 10-year low.
Capital controls on residents make matters worse because foreigners fear they might be next in line. Their rational response is to rush for the exit before the gates close. Indian stocks plunged 5.7 per cent in two days after the country made it harder for residents to take their money out.
The higher interest rates engineered by the central bank since mid-July have also backfired. With the rupee in free fall, global investors are unlikely to be lured by 10-year government bonds, even though their 9.3 per cent yield is far more attractive than the 2.9 per cent return on comparable US Treasuries. Investors will bite only if they can get a positive return after hedging the currency risk. But strong demand for protection against a rupee collapse means hedging costs are too high for that.
Meanwhile, higher interest rates are hurting banks that are increasingly reliant on short-term money market funding. Rolling over their Rs 3.6 lakh crore ($58 billion) in market debt, at interest rates that are now three percentage points higher, is bound to squeeze lenders' earnings that are already shrinking as loan losses mount. Rising yields on government debt will also force banks to write down the value of their bond portfolios. The longer local interest rates remain high, the greater the risk that the currency crisis turns into a banking fiasco.
A better strategy would be to just accept the 15 per cent slide in the rupee since early May. India is getting punished because it has an external funding gap when the US Federal Reserve is getting ready to reduce the glut of excess dollars. The Brazilian real, the South African rand and the Indonesian rupiah are also under pressure, and for much the same reason.
So how large will India's external funding gap be if investors take flight? Even a reduced current account deficit of about 3.5 per cent of GDP will require $70 billion in financing this fiscal year. To that, add the $172 billion in foreign borrowings by India's government, companies and banks that need to be repaid or refinanced by March 2013. If all this - plus some inevitable capital outflows - is to be financed out of India's existing $279 billion in official foreign exchange reserves, the kitty will soon be depleted.
With elections near, the ruling Congress party can't afford the humiliation of asking the International Monetary Fund for a bailout. It may, however, still be possible to tap India's diaspora. The monetary authority recently allowed Indian banks to pay an extra percentage point to non-resident Indians on dollar deposits of three to five years. That might help lure back the $1.4 billion of foreign currency deposits that have left the banking system since July 2011. But mobilising at least the $11 billion that overseas investors have pulled out of Indian equities and bonds since June will require much higher rates than banks are ready to pay.
Allowing the market to dictate the exchange rate might drive the rupee down to 70 to the dollar - from almost 64 today - and even beyond. Some hedge funds are buying options that will only pay out if the Indian currency sinks to 100 to the dollar in the next year, Reuters reported on August 16.
The biggest drawback of this approach would be the impact a collapsing rupee might have on already-strained corporate finances. Between 40 per cent and 70 per cent of the loans taken out by the country's 10 most highly leveraged business groups are in foreign currency, according to Credit Suisse, and the increase in these liabilities because of currency weakness since April is already equivalent to 35 per cent to 153 per cent of last year's earnings. These strains will make it harder to refinance Indian companies' $21 billion in overseas debt falling due this year.
However, companies that get into trouble can always sell assets, or restructure their debt. If the entire local banking system begins to creak as a result of higher domestic interest rates, then it will be difficult to salvage the situation. The government, which controls many of India's largest lenders, doesn't have the cash to recapitalise them.
Choosing not to defend the currency will at least give New Delhi a chance to shift its focus to policies that encourage exports and investment. After all, if exports don't respond to a more competitively priced currency, the balance-of-payment vulnerabilities won't go away. One idea could be to pare back India's minimum alternate tax, which Finance Minister Palaniappan Chidambaram imposed back in 1997, ending the zero-tax regime that Indian exporters used to enjoy. A reduction in the 20 per cent levy on book profits would encourage exporters to take greater advantage of the cheap currency.
The government's rickety finances don't allow it the luxury of sacrificing revenues, so any fiscal handout to exporters would have to be financed by increased consumption taxes and lower public spending. Overall, fiscal policy should squeeze demand from the economy, so that inflation can ease from near-double-digit levels. That, in turn, would create room for the central bank to reverse its tight-money policy.
A strategy that reduces the share of consumption, government spending and imports in the economy and increases the share of investment and exports will involve short-term pain. But it would also put the economy back on a sustainable growth path, which in India's case means lowering the chronic current account deficit. The other options on the table just won't do that.
A country that decides to defend its exchange rate has only two options: impose capital controls or surrender independence over monetary policy. The Indian authorities have tried a bit of both. They have put restrictions on resident individuals and companies looking to invest overseas and in gold. The central bank has also raised short-term interest rates, thereby giving up its ability to use monetary policy to lift GDP growth from its 10-year low.
Capital controls on residents make matters worse because foreigners fear they might be next in line. Their rational response is to rush for the exit before the gates close. Indian stocks plunged 5.7 per cent in two days after the country made it harder for residents to take their money out.
The higher interest rates engineered by the central bank since mid-July have also backfired. With the rupee in free fall, global investors are unlikely to be lured by 10-year government bonds, even though their 9.3 per cent yield is far more attractive than the 2.9 per cent return on comparable US Treasuries. Investors will bite only if they can get a positive return after hedging the currency risk. But strong demand for protection against a rupee collapse means hedging costs are too high for that.
Meanwhile, higher interest rates are hurting banks that are increasingly reliant on short-term money market funding. Rolling over their Rs 3.6 lakh crore ($58 billion) in market debt, at interest rates that are now three percentage points higher, is bound to squeeze lenders' earnings that are already shrinking as loan losses mount. Rising yields on government debt will also force banks to write down the value of their bond portfolios. The longer local interest rates remain high, the greater the risk that the currency crisis turns into a banking fiasco.
A better strategy would be to just accept the 15 per cent slide in the rupee since early May. India is getting punished because it has an external funding gap when the US Federal Reserve is getting ready to reduce the glut of excess dollars. The Brazilian real, the South African rand and the Indonesian rupiah are also under pressure, and for much the same reason.
So how large will India's external funding gap be if investors take flight? Even a reduced current account deficit of about 3.5 per cent of GDP will require $70 billion in financing this fiscal year. To that, add the $172 billion in foreign borrowings by India's government, companies and banks that need to be repaid or refinanced by March 2013. If all this - plus some inevitable capital outflows - is to be financed out of India's existing $279 billion in official foreign exchange reserves, the kitty will soon be depleted.
With elections near, the ruling Congress party can't afford the humiliation of asking the International Monetary Fund for a bailout. It may, however, still be possible to tap India's diaspora. The monetary authority recently allowed Indian banks to pay an extra percentage point to non-resident Indians on dollar deposits of three to five years. That might help lure back the $1.4 billion of foreign currency deposits that have left the banking system since July 2011. But mobilising at least the $11 billion that overseas investors have pulled out of Indian equities and bonds since June will require much higher rates than banks are ready to pay.
Allowing the market to dictate the exchange rate might drive the rupee down to 70 to the dollar - from almost 64 today - and even beyond. Some hedge funds are buying options that will only pay out if the Indian currency sinks to 100 to the dollar in the next year, Reuters reported on August 16.
The biggest drawback of this approach would be the impact a collapsing rupee might have on already-strained corporate finances. Between 40 per cent and 70 per cent of the loans taken out by the country's 10 most highly leveraged business groups are in foreign currency, according to Credit Suisse, and the increase in these liabilities because of currency weakness since April is already equivalent to 35 per cent to 153 per cent of last year's earnings. These strains will make it harder to refinance Indian companies' $21 billion in overseas debt falling due this year.
However, companies that get into trouble can always sell assets, or restructure their debt. If the entire local banking system begins to creak as a result of higher domestic interest rates, then it will be difficult to salvage the situation. The government, which controls many of India's largest lenders, doesn't have the cash to recapitalise them.
Choosing not to defend the currency will at least give New Delhi a chance to shift its focus to policies that encourage exports and investment. After all, if exports don't respond to a more competitively priced currency, the balance-of-payment vulnerabilities won't go away. One idea could be to pare back India's minimum alternate tax, which Finance Minister Palaniappan Chidambaram imposed back in 1997, ending the zero-tax regime that Indian exporters used to enjoy. A reduction in the 20 per cent levy on book profits would encourage exporters to take greater advantage of the cheap currency.
The government's rickety finances don't allow it the luxury of sacrificing revenues, so any fiscal handout to exporters would have to be financed by increased consumption taxes and lower public spending. Overall, fiscal policy should squeeze demand from the economy, so that inflation can ease from near-double-digit levels. That, in turn, would create room for the central bank to reverse its tight-money policy.
A strategy that reduces the share of consumption, government spending and imports in the economy and increases the share of investment and exports will involve short-term pain. But it would also put the economy back on a sustainable growth path, which in India's case means lowering the chronic current account deficit. The other options on the table just won't do that.
http://www.business-standard.com/article/opinion/let-the-rupee-sink-113082001081_1.html
Jamal Mecklai August 22, 2013 Last Updated at 21:44 IST
The only way out
The Reserve Bank of India (RBI) and the government have painted all of us into a terrified corner as the draconian measures they have been announcing almost daily have failed to halt the continuing traumatic collapse of the rupee. The collateral damage in the bond and equity markets is there for all to see.
While there may be a sense of bravado behind these desperate measures - we will hold the current account deficit to such and such level - it is patently obvious to anyone that the speculators that the regulators have been pursing with such fury are nowhere to be found. Indeed, the entire approach of pursuing speculators is being shown up for what it is - a feeble attempt to transfer the blame for failed policy making over the past several years.
Speculators, far from being swashbuckling buccaneers (notwithstanding the stylistic preferences of George Soros or Steve Cohen or Raj Rajaratnam), are actually supremely conservative, as becomes people who manage large sums of money - their own or other people's. They would never put a penny (or dollar, as the case may be) down unless they were doubly - indeed, multiply - sure that their "bet" had a substantial chance of success. These bets are sometimes insured by insider information, sometimes by simple, solid economic logic, the latter being the case in India today.
In fact, the recent actions have doubly confirmed to investors (a more polite word for speculators) that their bets were correct and the rupee can go nowhere but down. Thus, when - and it has to be when, not if - the RBI lifts some of its terrifying constraints on the market, the rupee will whoosh lower at a pace that will startle all of us.
Unless, of course, the government and the RBI recognise that there is a way out - the only way out that I can see. Even better, it is remarkably simple, easy to implement and, best of all, will have an immediate impact on the rupee's debauched weakness.
The finance minister and the RBI governor should jointly - and immediately - approach the trustees of Tirupati Trust Foundation. Three of these are state government appointees, and, given the current political dispensation, this is a distinct advantage. They should, of course, offer prayers and an opportunity for the already hugely rich trust to make significant additional amounts of money.
While there are no definitive statistics available, I believe the Tirupati Trust Foundation has well over 1,000 tonnes of gold. The number I was actually told was 1,700 tonnes, which is about five per cent of all the gold held in India (between 30,000 and 35,000 tonnes). To get really excited, multiply that total amount of gold by $48.5 million (the value of a tonne of gold at $1,350 an ounce) which comes to between $1.5 trillion and 1.7 trillion - that's right, trillion.
These, by the way, are assets - it is money we Indians own. And, given that they are foreign currency assets, it is hard to understand why we have a foreign exchange problem.
The finance minister and the governor should offer the Tirupati trustees annual earnings of, say, Rs 3,000 crore (two per cent interest on 500 tonnes of gold) plus savings of the cost of storage of the gold, which, itself could be a significant amount. And, of course, that the gold would be safe with, say, State Bank of India (SBI) and that it can be retrieved at one day's notice. It's hard to see how any trustee could turn this down.
On the market side, SBI could hold part of the gold hoard - even as much as 40 per cent - to support any sudden withdrawal, although the beauty of starting with religious trusts is that they don't need to ever withdraw the gold. The balance - 60 per cent, or 300 tonnes - can be sold in the domestic market, with the price risk on the sold gold hedged off-shore (at a cost of around one per cent a year). SBI would get about Rs 85,000 crore (300 tonnes at $48.5 million a tonne) at a modest cost of two to three per cent, which it could deploy in lending or, till demand picks up, in government securities. And, critically, gold import demand would collapse, taking the current account deficit down with it.
The plan should be announced as soon as it is finalised - and I see no reason why that should take more than a few days. The RBI and the government should then expand the plan to other religious trusts and, ultimately, to individual gold holders. In parallel, they can unwind some of the egregious constraints they have put on the market.
Immediately, upon announcement, the global gold price will fall sharply and the rupee will strengthen to better than 60 to the dollar.
Come, let us pray!
While there may be a sense of bravado behind these desperate measures - we will hold the current account deficit to such and such level - it is patently obvious to anyone that the speculators that the regulators have been pursing with such fury are nowhere to be found. Indeed, the entire approach of pursuing speculators is being shown up for what it is - a feeble attempt to transfer the blame for failed policy making over the past several years.
Speculators, far from being swashbuckling buccaneers (notwithstanding the stylistic preferences of George Soros or Steve Cohen or Raj Rajaratnam), are actually supremely conservative, as becomes people who manage large sums of money - their own or other people's. They would never put a penny (or dollar, as the case may be) down unless they were doubly - indeed, multiply - sure that their "bet" had a substantial chance of success. These bets are sometimes insured by insider information, sometimes by simple, solid economic logic, the latter being the case in India today.
In fact, the recent actions have doubly confirmed to investors (a more polite word for speculators) that their bets were correct and the rupee can go nowhere but down. Thus, when - and it has to be when, not if - the RBI lifts some of its terrifying constraints on the market, the rupee will whoosh lower at a pace that will startle all of us.
Unless, of course, the government and the RBI recognise that there is a way out - the only way out that I can see. Even better, it is remarkably simple, easy to implement and, best of all, will have an immediate impact on the rupee's debauched weakness.
The finance minister and the RBI governor should jointly - and immediately - approach the trustees of Tirupati Trust Foundation. Three of these are state government appointees, and, given the current political dispensation, this is a distinct advantage. They should, of course, offer prayers and an opportunity for the already hugely rich trust to make significant additional amounts of money.
While there are no definitive statistics available, I believe the Tirupati Trust Foundation has well over 1,000 tonnes of gold. The number I was actually told was 1,700 tonnes, which is about five per cent of all the gold held in India (between 30,000 and 35,000 tonnes). To get really excited, multiply that total amount of gold by $48.5 million (the value of a tonne of gold at $1,350 an ounce) which comes to between $1.5 trillion and 1.7 trillion - that's right, trillion.
These, by the way, are assets - it is money we Indians own. And, given that they are foreign currency assets, it is hard to understand why we have a foreign exchange problem.
The finance minister and the governor should offer the Tirupati trustees annual earnings of, say, Rs 3,000 crore (two per cent interest on 500 tonnes of gold) plus savings of the cost of storage of the gold, which, itself could be a significant amount. And, of course, that the gold would be safe with, say, State Bank of India (SBI) and that it can be retrieved at one day's notice. It's hard to see how any trustee could turn this down.
On the market side, SBI could hold part of the gold hoard - even as much as 40 per cent - to support any sudden withdrawal, although the beauty of starting with religious trusts is that they don't need to ever withdraw the gold. The balance - 60 per cent, or 300 tonnes - can be sold in the domestic market, with the price risk on the sold gold hedged off-shore (at a cost of around one per cent a year). SBI would get about Rs 85,000 crore (300 tonnes at $48.5 million a tonne) at a modest cost of two to three per cent, which it could deploy in lending or, till demand picks up, in government securities. And, critically, gold import demand would collapse, taking the current account deficit down with it.
The plan should be announced as soon as it is finalised - and I see no reason why that should take more than a few days. The RBI and the government should then expand the plan to other religious trusts and, ultimately, to individual gold holders. In parallel, they can unwind some of the egregious constraints they have put on the market.
Immediately, upon announcement, the global gold price will fall sharply and the rupee will strengthen to better than 60 to the dollar.
Come, let us pray!
Growth prospects better but rupee fall to spike inflation: RBI
Central bank says growth depends on removal of supply constraints, good governance
The Reserve Bank of India (RBI) on Thursday cautioned the fallingrupee would exert pressure on the inflation front. However, it provided some hope on economic growth, saying it expected this to be more than the five per cent of last financial year.
“There is a need for close attention to food management and taking policy action to address structural factors that constrain agricultural supply responses...the pass-through of the depreciation of the rupee’s exchange rate by about 11 per cent in the first four months of 2013-14 is incomplete and will put upward pressure, as it continues to feed through to domestic prices,” RBI said, adding inflation pressures were already visible.
On growth, it said, “Recovery is possible and can take shape later in 2013-14, but is predicted on better governance, removal of supply constraints and maintenance of stability.”
The central bank added despite new risks emerging on the global and domestic economic fronts, the real gross domestic product growth outlook for 2013-14 was better than in 2012-13, owing to growth-supportive measures taken by the government and the good southwest monsoon. According to RBI, the normal and spatially well-distributed rainfall so far this season augers well for the agricultural sector and is expected to boost demand for industrial goods and services in rural areas. RBI’s foodgrain production-weighted index showed rainfall was 10 per cent above normal till August 13 this monsoon season. “Ample rainfall has resulted in an improvement in the water shortage levels in reservoirs,” RBI said in its annual report.
It added these improvements would benefit the kharif and rabi crops, as also hydropower generation. “Encouraging prospects for crops auger well for rural demand. The current slowdown, in any case, has impacted economic activity in urban areas more than in rural areas. As such, the rural economy could provide some buffer on the back of a satisfactory monsoon,” said the central bank report.
“The emerging macroeconomic scenario for 2013-14 is challenging, amid the wide current account deficit, risks to fiscal targets, persistence of high consumer price inflation, risk of exchange rate depreciation feeding into inflation, slowing growth and deteriorating asset quality,” RBI said.
It reiterated monetary policies needed to be carefully calibrated to maintain stability without compromising growth.
“There is a need for close attention to food management and taking policy action to address structural factors that constrain agricultural supply responses...the pass-through of the depreciation of the rupee’s exchange rate by about 11 per cent in the first four months of 2013-14 is incomplete and will put upward pressure, as it continues to feed through to domestic prices,” RBI said, adding inflation pressures were already visible.
On growth, it said, “Recovery is possible and can take shape later in 2013-14, but is predicted on better governance, removal of supply constraints and maintenance of stability.”
The central bank added despite new risks emerging on the global and domestic economic fronts, the real gross domestic product growth outlook for 2013-14 was better than in 2012-13, owing to growth-supportive measures taken by the government and the good southwest monsoon. According to RBI, the normal and spatially well-distributed rainfall so far this season augers well for the agricultural sector and is expected to boost demand for industrial goods and services in rural areas. RBI’s foodgrain production-weighted index showed rainfall was 10 per cent above normal till August 13 this monsoon season. “Ample rainfall has resulted in an improvement in the water shortage levels in reservoirs,” RBI said in its annual report.
It added these improvements would benefit the kharif and rabi crops, as also hydropower generation. “Encouraging prospects for crops auger well for rural demand. The current slowdown, in any case, has impacted economic activity in urban areas more than in rural areas. As such, the rural economy could provide some buffer on the back of a satisfactory monsoon,” said the central bank report.
“The emerging macroeconomic scenario for 2013-14 is challenging, amid the wide current account deficit, risks to fiscal targets, persistence of high consumer price inflation, risk of exchange rate depreciation feeding into inflation, slowing growth and deteriorating asset quality,” RBI said.
It reiterated monetary policies needed to be carefully calibrated to maintain stability without compromising growth.
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