Friday, June 21, 2013

The Rupee Conundrom


On June 5, 1966, the then prime minister, Indira Gandhi, had already taken the decision to go ahead and devalue the rupee by a huge 60 percent the next day. People close to her say she watched Dr Zhivago to get over her nervousness over the momentous decision. It was a big step. she would be devaluing the Indian rupee which stood at about Rs 4.76  to the dollar by to Rs 7.50 to the dollar – everything India bought from the international market would become that much costlier.

In the words of B.G.Verghese, her information advisor “the storm broke the next day.” Till 1966, the Indian currency which was pegged to the British pound, was officially or unofficially acceptable tender over a large part of Asia and Africa, ranging from Beirut to Hong Kong. Aden, Oman, Bahrain, Qatar, Trucial Gulf states ( present day UAE), Tanganikya (former name for Tanzania), Uganda, Seychelles and Mauritius were among nations where the rupee was legal tender.

With the devaluation, Indian rupee suddenly turned global pariah, with few takers anywhere. What prompted Mrs Gandhi to take the step included a huge trade and fiscal deficit, an end to aid from the West ( a punishment for defending itself against an unprovoked attack by Pakistan) and a rising oil bill. The idea was that the devaluation would help India sell more abroad, earn much needed dollars to pay for its imports of oil, food and machinery. 

Mrs Indira Gandhi being sworn in as Prime Minister

Exports did not surge as expected and Indian financial prestige suffered even further. The conservatives within the Congress including K.Kamaraj felt it was a disaster. Import substitution, and austere curbs on import of most goods helped Mrs Gandhi’s government stave off embarrassing foreign exchange flows problem. 

Cut to July 1991, Dr Mammohan Singh managed to persuade his boss, the then prime minister,  P.V Narasimha Rao to agree to devalue the rupee by some 20 per cent in two steps to Rs 25.95 in an operation code-named `Hop-Skip and Jump’. Rao, too was nervous, he remembered the criticism, his former boss Mrs Gandhi had, had to face. Since 1975, the rupee had been pegged to a basket of currencies which included the Dollar, Yen, Pound and Deutsche Mark.

Dr Singh walks the reforms path
That time round, however, the ` jump’ happened. The slew of reforms which followed, including partial decontrol of the rupee, trade and investment liberalisation, unleashed the “caged tiger”, that India had become. Though the trade deficit quickly rose after falling for a few years, a surge in foreign investment inflows saw India’s financial fundamentals strengthening and global prestige rising.

June 2013 is no different. India’s fiscal and trade deficits have risen to unmatched levels. India’s annual fiscal deficit has hit an all time high of Rs 4,90,00 crore, while its trade deficit for 2012-203  stood   at over $ 190 billion. For just the single  month of May, the trade deficit  was $ 20.14 billion.

This time round however, the rupee is not pegged, it was on free float and the market decided what it’s worth was.  One month of aggressive selling by global financial giants in India’s bond market had helped push the price down by 12 per cent, with the currency losing 1.4 per cent in just one single day – Thursday, June 20.

The question uppermost in many people’s minds, is will Dr Singh be able to recreate his 1991 magic and match the fall of the rupee with unleashing a wave of reforms which will take India forward or will it be a 1966 story, a drop in value followed by more economic disasters.

The problem for the good Doctor and his lieutenant, finance minister P.Chidambaram, is that they are hamstrung by two major problems – lack of sufficient support in Parliament to push through significant reforms like raising the foreign investment cap in insurance and paucity of time – general elections are slated for early next year and in a few months from now, the government will have to slip into populist mode and forget about taking hard headed economic steps which may be unpopular.

Some tweaks can be expected – increase in gas prices, raising the cap on foreign investment in defence and telecom industries – decisions which do not require legislative approval. However, the biggest obstacle  to reform remains red tape – a $ 12 billion investment plan by Korean giant Posco remains on paper as departments battle it out over forests which may or not be cut down for mining and steel plants.

Indians' appetite for gold increasing
However, to give credit to Dr Singh and his team, at least some wise decisions have been taken. There is no move to ban gold imports or to raise taxes on it. Despite the fact that a fall in gold prices coupled with debasement of the Indian rupee’s value, can be expected to further whet appetite for bullion among domestic customers, many of whom see gold as a hedge against inflation and financial market turbulence.

However, the Singh’s government seems to have ruled out any quantitative curbs on gold imports or of higher taxes. Gold imports are already being taxed at 8 per cent and this has started telling with increasing reports smuggled gold being intercepted at airports.

Reduction in duty in the 1990s, had virtually killed gold smuggling. However, a recent increase in duty on gold from 6 to 8 per cent is being seen as a cause for increased smuggling.

More common sense decisions could save the day for the Congress-led government.

One simple policy prescription which the government is believed toying with is allowing upto 49 per cent FDI in most sectors which are security non-sensitive without the mandatory clearance by foreign investment boards.