Policy-makers must have valid reasons for going all out to defend the rupee, but the time has come to assess the impact of recent policy measures in their totality. Does the end justify the means? The collateral damage that some of these measures inflict cannot be ignored for long.
Both the government and the Reserve Bank of India (RBI) have said that a stable rupee is at the top of their agenda.
So far in this fiscal, the domestic currency has lost 12 per cent. As much as the extent of depreciation, it is the apparent inability of policy to arrest the decline that is extremely worrying. On Friday, the rupee fell below 62 to the dollar for the first time.
Since the middle of July, the RBI has been acting tough pushing up the interest rates and draining liquidity to check speculation on the rupee. Although backed by administrative measures, it has had limited success. While its commitment for a “stable rupee” is not in doubt, the means at its disposal do not appear to be sufficient.
The government, which was never a passive onlooker, stepped in vigorously to attack the burgeoning current account deficit (CAD). On August 12, the Finance Minister promised to contain the CAD to within $70 billion or 3.7 per cent of gross domestic product (GDP) this year considerably lower than the nearly 5 per cent at the end of fiscal 2013. To achieve the steep reduction, a series of measures were announced to boost dollar supply, on the one hand, and to moderate its demand, on the other.
Import duty on gold, silver and platinum were raised in a swift follow-up action.
The government hopes to bring about a reduction in the import bill of petroleum products through demand compression (assuming an unproven price elasticity), and by persuading bulk consumers to moderate their demand.
The savings in the import bill will be substantial, $4 billion for gold alone and another $1.5 billion for petroleum.
Dollar-boosting measures on the supply side include easing of norms for external commercial borrowings (ECBs), trade finance from abroad, and freeing of interest rates on non-resident external accounts. Select public sector finance companies have been asked to raise quasi-sovereign bonds to the extent of $4 billion.
If the government’s arithmetic holds good, the CAD will be within $70 billion.
It was RBI’s turn on Wednesday with a barrage of measures that strike at the convertibility status of the Indian currency.
Capital outflows by individuals and companies have been reined in. While current account transactions have not been restricted, India’s march towards full convertibility in a graded manner has received a setback.
The rupee battle, now being fought on several fronts, has raised some pertinent issues for the broader economy.
Monetary action has raised interest rates and lowered the financing windows for banks and is seen to be anti-growth.
The government’s focus on the current account deficit is welcome. But policy reversals that are implicit in some of its high-profile announcements do raise concerns.
Take gold imports. However high the tariff walls might be, it will not be possible to reduce the demand for the metal within India. Only, instead of legal imports, the trade will shift underground with its attendant deleterious consequences for the economy and even the society at large as past experiences with gold control proved.
Relaxations in ECB norms and non-resident deposit interest rates might be expedient now but because they increase the levels of debt are not recommended in the normal course. Besides, the new higher yielding non-resident deposits might cannibalise existing ones.
Companies might borrow abroad but the new loans will be on far onerous terms and might, in fact, go towards “ever-greening” without adding anything substantial to India’s forex kitty.
Finally, quasi-sovereign bonds are still an unknown quantity. Do the public sector undertakings really want them? Who will bear the exchange risk? What are the other hidden costs?
Moreover, the Finance Minister’s announcement to tap the dollar bond market is ill-timed, and will not help in securing the best terms for the borrower.
Policy options are not easy at this juncture. It would help if there is greater transparency.