Sinlung /
21 August 2013

Rupee at 64: 5 Lessons from a man-made disaster

By Arjun Parthasarathy

The Indian rupee (INR) is trading at levels that can only be described as disastrous. Levels of Rs 63-64 to the US dollar mean all-time lows for the currency that has depreciated by a whopping Rs 20 – or 45 percent – over the last couple of years.

What has made the INR tank against the USD and join the ranks of countries such as Argentina and Iceland that have seen their currencies lose most of their value over the last decade? The Brazilian real is the only other currency that has depreciated more than the INR, falling by over 53 percent in the last two years.

Brazil’s problems largely stem from its sharp fall in GDP growth from levels of 7.5 percent seen in 2010 to below 1 percent seen in 2012. Weak commodity prices, with the Reuters CRB commodity index down by over 30 percent since the financial crisis erupted in 2007-08, bureaucracy, corruption and weak infrastructure are to be blamed for Brazil’s GDP growth fall.

Overconfidence was the undoing of the rupee: AFP
Overconfidence was the undoing of the rupee: AFP
India’s problems stem from overconfidence on growth, economic mismanagement, bureaucracy, corruption and weak infrastructure. The INR fall is completely man-made and policymakers blaming the forthcoming withdrawal of the stimulus by the US Fed is pure nonsense.

India offers a great learning tool for policymakers across the world on how not to manufacture currency disasters. India’s fall from strength in the mid 2000’s to a position of weakness post 2010 is well documented. High fiscal and current account deficits, rising inflation, falling economic growth and weak capital markets are the cause of the INR fall. What did the policymakers do to take the INR down to record lows and, more importantly, push India out of any kind of reckoning in the world economic order?

The following five man-made factors are the cause of the INR fall.

1. The government, public and private sector were living in a fool’s paradise believing that economic growth will never slow down. The government allowed subsidies to burgeon, as rising oil prices were not passed on to consumers while public sector banks lent heavily to infrastructure projects of the private sector where revenues were more mythical. The private sector floated projects based on valuations of licences and commodities rather than on future cash flows. The end result was a huge subsidy bill taking up the fiscal deficit by 300 bps (100 basis points make 1 percent), rising non performing assets of banks, that have gone up multi-fold, and a fall in valuations of over 80 percent of many companies in the private sector.  Government finances, banking sector balance sheets and health of corporates weakened considerably, leading to fall in valuations of the whole country that is reflected in the rupee fall.
2. The illusion of high foreign exchange reserves made policymakers ignore a potential spike in Current Account Deficit (CAD). India’s foreign exchange reserves touched record highs of around  $320 billion in February 2011 (around 11 months of import cover) but have plummeted by 12.5  percent since then to levels of  $280 billion (around seven months of imports). CAD has risen from levels of below 3 percent of GDP to 5 percent over the last few years. CAD was financed by capital flows that led policymakers to believe that a high CAD would not impact the INR. Structural issues of oil and gold imports, rising inflation and high fiscal deficit was ignored until too late.

3. Growth was given priority over inflation. The focus on growth by all stakeholders concerned pushed inflation to the back seat. The RBI was castigated in public by both the government and the corporates for taking any action on inflation as it was felt that growth would suffer. The numbers are stark. In the period 2008-12, wholesale price inflation came down to below zero to over 10 percent levels and then went back to over 10 percent levels. The RBI, in the meanwhile, raised the benchmark repo rate by 100bps and then cut the rate by 425 bps and then raised the rate by 375 bps. The seesawing of policy rates along with seesawing of inflation indicates that the central bank was being reactive rather than being proactive. The economy has suffered due to the wide fluctuations in inflation and policy rates, leading to the INR being dumped later on.

4. A falling INR hurt the pride of the government. The government felt that India was too much of a growth story for the INR to fall. The noises made by the government when the INR touched Rs 57 in June 2012 suggested that the INR was being pulled down due to reasons other than macroeconomic factors. The RBI forced speculators to reduce long USD/INR positions while the government made noises on reforms and growth. The government and the RBI did not show urgency in tackling the INR fall last year and that has hurt them heavily this year.

5. The INR fall to levels of below Rs 60 has awakened the ‘animal spirits’ of the government and the RBI. The FM has been touring the world to bring in foreign investments while the RBI has strangled liquidity and reintroduced capital controls. The end result is a fall to record low levels of Rs 64. These hasty “animal spirit” decisions have caused panic in the markets as any hope of economic growth pulling the INR up has been laid low. Policymakers are not focusing on growth at the right time and markets know that policy actions cannot stem the fall in the INR. Wrong policies at the wrong time.

Is there hope for the INR going forward? Yes, if the stakeholders learn from their earlier mistakes and take the right decisions.

The mistakes India has made on the INR will help other countries to tackle currency issues. 

Something good can after all come out of the INR fall. But it won’t help us right now.

Arjun Parthasarathy is the Editor of a web site for investors. 


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