7/6/13

Falling rupee, flawed policy | Business Line

Falling rupee, flawed policy

Ritesh Kumar Singh Prerna Sharma

To attract foreign investment, cut out the red tape.

If slowdown in household consumption and protracted global recovery were not enough, Indian businesses (a large many of them have partially or substantially unhedged forex exposure) will now have to deal with the reality of a weakened rupee that finally breached the psychological mark of 60 to a dollar on June 26. And there is no guarantee that it will not go down further after all, there is not much change in Indias macroeconomic fundamentals. Since the start of the sub-prime crisis in 2007-08, central banks (US Federal Reserve, in particular) had injected $12 trillion, that is roughly 16 per cent of the worlds GDP which primarily kept emerging economies such as India and others afloat in the post-crisis period. The recent global sell-off of stocks, bonds, currencies and commodities post the Feds hint at tightening of the lid that oozes out cheap money into the global financial system, is an indication of the things to come.

Reason for rupee fall

The fall of the rupee may have been triggered by the Feds announcement on tapering off its $85-billion-a-year asset purchase programme that led to a massive bond market outflows to the tune of $6.5 billion since mid-May. It is no coincidence that emerging economies with large current account deficit (CAD) such as India, Indonesia, South Africa, Brazil and Chile have witnessed the steepest fall in their currencies. Obviously, the fundamental cause of weakening rupee lies in Indias poor macroeconomic management e.g. slowing growth, high inflation, and CAD that is increasingly being financed by volatile FII inflows, ECB and short-term trade credits. Not to mention the role of rising imports of coal and fertilisers, besides the usual suspects, namely, crude and edible oil, and gold. The RBIs leniency in approving ECB and FCCB ($140 billion in the last five years) to provide a supposedly cheap source of financing to India Inc has made matters worse. ECB now accounts for 31 per cent (up from 10.2 per cent in 1991) of Indias total external debt of $390 billion. Going forward, servicing of maturing ECB/FCCB is going to be a serious concern.

Impact of rupee fall

The major casualty will be Indias efforts at taming inflation, since the rupee price of imported goods such as coal,
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Falling rupee, flawed policy | Business Line

crude, edible oil and fertilisers will go up. Since 60 per cent of Indias edible oil requirements are met by imports, a depreciating rupee will adversely affect margins of food processing firms. Increase in rupee cost of crude oil will increase the under-recoveries of oil marketing companies and, in turn, subsidy burden, thereby adding to Indias fiscal woes in the run-up to the general election. Most Indian corporates keep up to 25 per cent of their forex exposure un-hedged. Net importing firms manufacturing consumer durables or electronics, and infrastructure companies that have heavily borrowed in foreign currencies will witness erosion of their margins. Moreover, in such a scenario, the RBI may have to postpone rate cuts, which will disappoint India Inc. As a result, equity markets will get a cold reception from investors, further dampening the sentiment. Ideally, rupee depreciation boosts a countrys net exports depending upon the demand elasticities of its exportables and importables. Thus, firms in the net exporting sectors such as IT & ITES, pharmaceuticals, textiles and clothing should post better results. However, textile and IT sectors lack pricing power and may have to under-cut price in line with depreciating rupee. Further, simultaneous depreciation of the currencies of other emerging markets (often competing in third country export markets) will erode the actual gain on Indias export competitiveness caused by the decline of rupee. In FY 2012, the top 559 listed companies, excluding oil and gas and banks, imported goods and services worth $83 billion when their combined export was worth $57 billion. Thus, net importing firms will also lose from the declining rupee. However, weakened rupee will provide some relief to domestic manufacturers of items such as apparel as imported substitutes will become expensive.

Export as a natural hedge

Because of the currency fluctuations and import parity pricing of inputs, currency risk is a reality that businesses will have to deal with, whether they use domestically produced or imported inputs. To deal with the adverse effect of currency volatility, a firm must go for hedging its forex exposure by getting into forward contracts or using the tools of currency futures to lock in its forex liability (or gain in case of exports). However, there is a cost to hedging, often in the 5-6 per cent range of the value of exposure. Export can, thus, be a natural hedge against declining rupee.

The way forward

Though a sharp decline in the rupee may have been triggered by the US Feds announcement, the remedial measures have to be indigenous, aimed at reducing trade deficit, the primary cause of the problem. In the short-run, the RBI can intervene in the forex market to support the rupee. However, determining the quantum and timing of intervention is not easy. Besides, the central bank would like to preserve its forex reserves (around $290 billion, sufficient for seven months of imports) given the still high CAD and payment obligation with respect to maturing ECB/FCCB. However, the following steps can help: Its time India took serious efforts to address the concerns raised by successive World Banks Ease of Doing Business reports in order to attract sufficient FDI inflows i.e. $100 billion/annum. Looking at the actual inflows post the opening up of FDI in retail one can easily say that raising FDI caps in a few sectors will not help. At $40 billion, Indias trade deficit with China stands at 2 per cent of its GDP. India must engage with China to push its exports in the country. Making duty free import of garments from Bangladesh under SAFTA conditional on sourcing of inputs such as yarn or fabrics from India will push textile exports. Expediting trade talks with highly protected markets of Pakistan and Latin American bloc Mercosur will boost Indias
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exports from day one. Checking coal import by ramping up domestic production and removing export duties on iron ore will give quick result. Dematerialising investment in gold will reduce its import. Economic pricing of fertiliser (urea) and petro products will encourage their efficient use and lead to saving of foreign exchange. India also needs to push export of IT services beyond the EU and the US. (Ritesh Kumar Singh is Group Economist of a corporate house. Prerna Sharma is a research analyst agri. commodities. Views are personal.)
(This article was published on July 5, 2013)

Keywords: weakening rupee, govt and rupee policy, current account deficit, Fed QE policy, tapering of funds, economy, financial markets
Printable version | Jul 6, 2013 8:59:14 PM | http://www.thehindubusinessline.com/opinion/falling-rupee-flawed-policy/article4885341.ece The Hindu Business Line

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