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.

The Iran Driver for the Rupee

Teheran Market

India wants its businessmen to sell more to Iran. No big deal, you may say in these days of global slowdown. But here’s the caveat – North Block wants Indian business to sell in rupees and not in the dollars they are used to and has this December, sent out trade delegations to Teheran to explore rupee trade deals.

India had agreed to buy about 45 per cent of the $ 11  billion in oil it purchases from Iran in rupees, to be liquidated by that country in buying Indian goods, early this year, after US and EU imposed sanctions ended the earlier preferred routes of paying through Turkish and Gulf based banks. The money was to be parked in Uco Bank to facilitate Iranian purchases from India. Not much happened after that.

Strangely, instead of the Indians getting worried about the $ 5 billion lying idle in Uco Bank, it was the Iranians who started fretting. Iranian ministers and diplomats complained that Indians lacked business acumen and pointedly compared them with the Chinese, who in their words “were flooding the markets of Iran with Chinese-made goods” traded in Renminbi, which Iran had accrued by selling some 25-30 million tons of crude a year, to the Middle Kingdom.

To push Indian business to try liquidate the huge rupee positions Iran is building up, the Indian government has started encouraging Indian trade delegations to make their way to Teheran.  From December 17-19, a trade delegation of pharmaceutical  firms were sent out to explore rupee deals to sell bulk drugs to Iran.

This followed a letter from the Commerce Ministry which informed drug makers that “ECGC has agreed to provide guarantee cover up to Rs.300 crores ($600 million) to UCO Bank and also to waive the restrictive clause of “insufficient funds” for negotiation of L/C  (letter of credit) by the banks. “ Incidentally, the December trip was the second one organised for pharmaceutical firms, in 2012 to Iran which has a $ 3 billion market for medicines.

The pharmaceutical firms are not the only ones, being encouraged to fly down to Teheran. Engineering firms were sent on trips  to Teheran to explore similar rupee based deals. India wants to rachet up two-way trade from a current $ 14 billion to $ 25 billion over the next four years, with trade evenly balanced between the two countries, instead of the current situation where Iranian sales of oil and gas outweigh Indian sales of food, medicines, chemicals and engineered goods by 11:3.

Iran is already the largest importer of rice from India, with India exporting around 1 million tonnes of basmati rice to Iran. Iran is also one of the biggest buyers of Indian orthodox quality tea, consuming about 15 million kg every year. India has also sealed deals to export 176,000 tons of sugar to Iran so far this year .“The chances of selling more food to Iran are consequently limited. India needs to sell manufactures to Iran, if it wants to take on China … its brands have to be present in Taheran markets more prominently,” said Commerce Ministry officials.

But there are problems in doing business with Iran too. In theory,  Uco Bank will pay Indian exporters out of the account maintained by it on behalf of Bank Markazi, the Iranian central bank, when any of four Iranian Banks  — Bank Parsian, Saman Bank, Pasargad bank and EN Bank — issue valid letters of credit.

However, in reality, LCs take a long time in coming as importers and exporters are put on bureaucratic queue by the Iranian banks. The quick-fluctuating price of Rials makes pricing a tough job too. Even when Indian exports have reached Iran, payments against LCs take a huge time, with Iranian banks taking their own sweet time.

However, the good thing about the Indo-Iranian rupee trade, officials in Finance Ministry say is that this is “encouraging the idea that the rupee can become a currency for international trade … yes there are glitches, but if resolved, India could start exporting more in rupees and cutting out the risk of global forex fluctuations.”

Both the Indian rupee and the Chinese currency are convertible on the current account but not on the capital account, but the Indian rupee’s value is market determined while the Chinese currency’s value is fixed by its central bankers. However, it’s the Renminbi which is talked about in international banking circles, whenever debates occur over new hard currencies which would join the Dollar,  Euro, Pound and Yen in global trade.

Currently, the rupee is officially used for international transactions only with Bhutan and Nepal. Though unofficially, traders in UAE, Singapore, Malaysia, Afghanistan and other neighbouring Asian nations deal in rupees.

According to reports, the Sri Lankan Central Bank’s Monetary Board which earlier this year decided to include Renminbi in the list of designated currencies permitted for international transactions through banks in Sri Lanka, is considering placing the Indian currency too on its list of designated currencies.

Growth, Rupee and dollar incomes

Hit by global recession and costly credit, India’s economy may expand at its slowest pace in three years at just 6.9 per cent during the current financial year (till March 31, 2012) , compared to a more respectable 8.4 per cent in the previous fiscal.

Indians used to 8-9 per cent GDP growth and aspiring to see their economy grow at double digits, weren’t exactly happy with the news. Business leaders were quick to say “I told you so”, pinning blame on high interest costs for slowdown in investment and consumer demand. A tight money policy to combat commodity inflation has seen interest rates for buyers of homes and cars as well as industry hoping to set up new factories rising to 12-16 per cent compared to 8-12 per cent, two years back.

The government admitted slowing industrial growth was a problem but also blamed the   Eurozone crisis and continued slow recovery in the US and Japan, India’s major markets. A  quarter of India’s GDP is accounted for by foreign trade and this has obviously taken a hit.  

The problem for the Congress led government has been that if it does not give the Reserve Bank a free hand to combat inflation, it risks alienating millions of poor people who have voted it to power and whose very daily meals are at threat because of rising food prices.   

On the other hand. Slow growth, shut factories means millions remain unemployed. Not exactly good news for a party which wants to woo 18-25 age group voters.

The problem of course was industrial growth at a mere 3.9 per cent compared to 7.6 per cent last year and double digit growth for most of last decade. Industrialists have long been protesting that 13 rounds of increases in the Reserve Bank’s policy rates which now stands at a high of 8.5 per cent, has made it difficult for them to borrow to set up new plants and factories or to refinance old debt

India Inc.’s top brass including the likes of Wipro’s Azim Premji, truck-maker Keshub Mahindra and banker  Deepak Parekh had also written letters to Prime Minister Manmohan Singh blaming the government for a policy logjam which has seen several key policy initiatives including bringing in foreign investment in retail, pension funds and aviation delayed and mining sector held up by unclear environmental laws.

High interest rates slowed down sales of big ticket consumer items such as housing stock and cars. Auto sales halved from 30 per cent in 2010 to just over 14 per cent in 2011, while housing sales remained sluggish in 2011 and could be in negative figures in 2012 according to credit rating agency Fitch. The latest figures issued by the Central Statistical Organisation placed growth in construction at 4.8 per cent in 2011-12, against 8 per cent in 2010-11.

Mining output shrank by 2.2 per cent. Partly because of policy logjams which saw much of the area earmarked for coal mining declared `No Go’ where mining would not be allowed on environmental considerations and partly because of heavy Monsoon rains which saw many mines shut down in central and eastern India.

Farm output is expected to rise 2.5 per cent, compared with 7 per cent in the year before. However, this is seen as a statistical glitch given that last year farms recovered after a bad farm year in 2009-2010, when agriculture grew by just 0.4 per cent. Only services provided a silver lining. Trade, hotels, transport etc. grew 11.2 per cent while finance, insurance, etc. grew 9.1 per cent.

In its mid-year Economic Review, the government had pegged GDP growth at around 7.5 per cent and at  9 per cent in its pre-Budget survey released early last year. Worryingly, economists do not see much improvement next year despite hopes that the RBI will now relent and allow interest rates to drop in a bid to push growth.

Most economists expect the economy to grow next year by 7.5 per cent or so. Not great news but still music compared to negative or marginal GDP growth rates being posted by the west.

Postscript:

The latest data also showed that per capita income will be above Rs 60,972 per annum during the current fiscal. In terms of rupees this means incomes have gone up 14 per cent in a single year! Not bad at all despite inflation eating into earnings. However,  because the Rupee’s value has fallen it means in Dollar terms Indians on an average now earn $ 1240  a year instead of $ 1177 they used to in February last year, an increase of just over 5 % !