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Posted on 30 January 2012 |
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The rupee will sink, period
Bharat Jhunjhunwala foresees a series of unfortunate currency circumstances
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Illustration: Tanmaya Tyagi |
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THE RUPEE has hovered around 44-45 to a dollar for the past 10 years from 2002 to July 2011, followed by a steep fall now. It touched a low of 54 to a dollar recently though there had been some improvement lately. That is small solace because the fundamentals are stacked against it. The rupee is likely to continue on its royal downward ride. The Economic Survey published by the Ministry of Finance shows a Wholesale Price Index of 14.3 in 1970 and 130.4 in 2010. Prices have risen about nine times in the past 40 years. The rupee has fallen about the same. A dollar was exchanged with Rs 5 in 1970. Today it is exchanged about Rs 45 to a dollar. Indeed, the fall ought to have been a bit less. The depreciation of the dollar due to inflation in America should have led to appreciation of the rupee but other factors appear to have overwritten this.
The declining trend of the rupee was arrested in the past ten years because of the inflow of dollars from FIIS. This inflow of dollars led to an increase in the supply of the greenback in our forex markets, a decline in the value of dollar and a corresponding increase in the value of rupee. Thus the rupee was stable around Rs 45 between 2002 and 2010 despite 7-12 per cent domestic inflation. The steep decline of the rupee since July has less to do with our domestic economy and more to do with global factors. The European crisis has shaken confidence of global investors in the Eurozone. Greece, Italy, Ireland and Portugal do not seem to have a clue about how they would repay huge accumulated debt. They cannot devalue their way out of the crisis — tied as they are to the common currency. And it is extremely difficult to reduce the wages of government employees or to downsize. They are stuck with the huge expenditures committed in the 1980s and 1990s. They are borrowing yet more and trying to roll over the debt. That is not a solution.
The looming European crisis has led to global investors jettisoning the euro in favour of the dollar. A strange spectacle is unfolding before our eyes. The downgrade of the US securities last year was followed by yet greater demand for the same. That does not extinguish the downgrade. It only indicates that the downgrade in the Euro is far greater. Thus, among the two major currencies, investors are dumping the feeble euro in favour of lessweak dollar. This has led to huge demand for the dollar and appreciation of that currency; and a parallel fall in the rupee as measured against the dollar. The rupee was not affected much by the American economic crisis of 2008. The rupee retained its parity against the dollar, which means it declined in real terms as the dollar slid. That decline in the rupee was real but went unnoticed.
Our domestic circumstances have not helped. Anna Hazare’s movement has shown that the government is not able to carry people with it. The government is not in a position to have a major legislation passed in the parliament. It is dependent upon allies who are not convinced about the policies espoused by the Congress. That is the message that emanates from the backtracking on FDI in retail. Indian businessmen do not tire of complaining of policy paralysis in the government. This atmosphere is unnerving for foreign investors who are unwilling to invest in India. The FIIS have been hit by a double whammy. The results of Indian companies are lacklustre and the sensex is down from 20k to 17k. On top of it, they have suffered huge losses on account of depreciation of the rupee. Some analysts estimate that FIIS have lost 36 per cent value in the past six months. No wonder, inward portfolio inflows have been a meagre $1.2 billion this fiscal against $24.4 billion last year. These inflows until recently covered up the decline of the rupee that was happening due to domestic inflation. That covering having been removed, the underlying decline has come into the open.
The future of the rupee would depend on the interplay of these two tendencies — the strength of the dollar and domestic inflation. Let us examine the domestic economy first. Fiscal deficit is increasing rapidly. Quality of government expenditures is deteriorating — at least this is what Team Anna reckons. The economy is sagging into a limbo because of this deterioration in quality of government expenditures. Money stashed away in Swiss banks siphons out blood form the Indian economy. This has led to reduction in tax revenues while the expenditures have continued to increase. There is every chance that expenditures would continue this upward dance in view of the General Election barely two years hence. There would be increasing compulsion on the government to loosen the purse strings. My assessment is that the domestic economic situation would deteriorate and this would lead to further increase in fiscal deficit and fuel inflation.
THE SECOND factor of the dollar is dicey. The American economy remains in trouble. It is like a company that is incurring huge losses but puts up a brave face because it has been able to line up a fresh line of credit. The famed innovativeness of the American people is not producing commercially viable export products. Research too is being increasingly outsourced to India. The American economy is weak but its size gives it a sense of value and invincibility. That does not sustain in the face of unfavourable fundamentals, however. The European crisis is leading to a flow of capital from the euro to the dollar. But that does nothing to restore the inner vitality of the US economy. My assessment is that the US economy would face a bigger crisis shortly. It would result in global mayhem should it happen. The European Union may not be around to hold the reins of the economy this time around. A US crisis will lead to FIIS pulling out in the short run. That would add to the woes of the rupee. However, the FIIS are likely to return as they see India standing firm in the face of deepening global crisis. But that is in the long run. And, as Lord Keynes remarked, in the long run we are all dead.
The decline of the rupee would yet take place even if by some fortuitous circumstance the American economy revives. In this case the rise of the dollar would lead to a decline in the rupee as has happened in the past six months. The future of the rupee does not look bright. Domestic economic compulsions would lead to higher fiscal deficit and inflation. The rupee would decline against the dollar if the US economy somehow revives. It would yet again decline against the dollar if the US economy collapses and FIIS make a rapid exit to cover their losses.
Bharat Jhunjhunwala is a former economics professor at IIM Bengaluru.
bharatjj@gmail.com
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