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What the mini-run on the rupee says about India
THE result of headless-chicken financial markets or a canary in the coal mine?
India is grappling with this question. On November 22nd the rupee fell to an
all-time low against the dollar. The speed of the rout (see chart) has been
scary for a place that was supposed to be largely insulated from the rich world
s troubles. It is 20 years since India had a balance-of-payments crisis and
for a long time the talk has been about it becoming an economic superpower. But
there lingers a memory of when it felt it was a financial hostage to the world,
and this helps explain the whiff of panic now in the air. Mumbai s financial
types say that firms are scrambling to find dollars and that desperate
euro-zone banks, which supply about half of India s foreign loans, are cutting
off credit lines.
That sense of fear strikes some as overdone. Jonathan Anderson, of UBS, a bank,
has tagged the rupee a drama queen . India s high inflation and chunky
current-account deficit, financed by capital flows, mark it out from most of
Asia. But neither attribute is new. Chetan Ahya, an economist at Morgan
Stanley, thinks India has its problems, but that the weak rupee mainly reflects
the trauma in global markets, which has caused capital flows to dry up. Hardest
hit by global risk aversion are countries with external deficits. The
currencies of other places with current-account gaps, such as South Africa and
Turkey, have been walloped too.
To be sure, the rupee deserves a beating, given how India s prospects have
dimmed. The currency markets have been late in reacting, reckons Samiran
Chakraborty, of Standard Chartered, another bank. The Indian business
community has been more negative than foreigners for some time, adds Roopa
Kudva, the boss of CRISIL, a ratings and research firm. India s growth model
has been to run a small current-account deficit, financed with high-quality
capital inflows, such as foreign direct investment and equity purchases. As a
poor country this makes sense: India should invest more than it saves. But bits
of its approach look rickety.
For a start the current-account deficit is likely to overshoot projections of
about 3% of GDP for 2011, if October s trade figures are anything to go by.
Exports slowed faster than imports, a chunk of which are non-discretionary
commodities and oil. The investment climate has soured due to stubborn
inflation, high interest rates and GDP growth that may dip below 7% in the
coming quarter. Pessimism about the government s appetite for reform has surely
hurt India s ability to attract capital. Neelkanth Mishra, a strategist at
Credit Suisse and a longstanding bear on the economy, reckons the quality of
capital coming in is falling too, with flightier and riskier debt rather than
stickier equity investments.
The falling rupee, then, partly reflects India s economic failings. But will a
cheaper currency add to these problems or help solve them? It should eventually
narrow the external deficit, by boosting exports and limiting imports. Still, a
sharp fall in the currency can be deadly if a country has borrowed in other
people s money. India s indebted government sells its rupee bonds to locals,
mainly banks, not jittery foreigners. The trouble is that since India s banks
are forced to stuff themselves full of loans to the state, Indian firms have
had to borrow abroad. Sanjeev Prasad at Kotak, a broker, says that the recent
results season saw a host of firms booking losses as the value in rupees of
their foreign debts rose. He worries about them being able to refinance these
borrowings.
And a lower rupee will fan inflation, which is already at 9-10%. The Reserve
Bank of India (RBI), India s central bank, and the government have been praying
that it will slow. But a rough rule of thumb is that a 10% depreciation adds
60-100 basis points to inflation, says Mr Chakraborty at Standard Chartered.
That s unhelpful.
For the authorities there are three possible responses. They have already done
the first: easing the rules on foreign lending to India, to try to attract
short-term funds. The second option would be to intervene in the currency
markets by selling dollars and buying rupees. That might, though, complicate
domestic policy, by tightening monetary conditions further. If the RBI bought
banks rupees then those lenders would have fewer available to buy government
bonds, further increasing the already high borrowing costs of the state. The
RBI could try to offset this by buying government bonds directly, but that
might in turn hamper its efforts to support the rupee.
And has India enough firepower? The country has $314 billion of reserves,
largely thanks to the central bank intervening in the past to stop the rupee
appreciating too much. But that cushion is not as big as it seems. Mr Mishra
reckons foreign debts that must be repaid within a year now equal 48% of India
s reserves. Using a similar approach of deducting short-term debts from
reserves, Mr Anderson reckons India s net position has deteriorated. Compared
with other countries it is only middlingly good (see chart) and the RBI may be
nervous of using too much ammunition.
That leaves a third option: for the politicians to make tough choices. If it
cut its fiscal deficit the state would probably lower the current-account
deficit. And if reforms were sped up, growth might recover, inflation could
fall and foreign investment would pick up. The priorities include freeing the
supply chains that have caused high food prices and cutting the red tape that
is choking industrial projects. So far the omens are not promising. On November
22nd, the first day of the winter sitting of India s parliament was adjourned
due to raucous behaviour. Sadly, the rupee is not the only drama queen around.
from the print edition | Finance and economics