Stocking up the War Chest

By Hrishikesh Utpat

The month of August saw the Indian economy nose-dive. One significant indicator of India’s faltering economic performance is the Rupee-Dollar exchange rate. The Rupee fell to an all-time low of 68.825 against the dollar on the 28th of August 2013, down from 60.975 on the 12th of August.

It can be argued that the performance of the Rupee closely mirrors the performance of the Indian economy. A comparative study between the two will show that there exists a causal correlation between a depreciating Rupee and poor economic performance. The performance of the Rupee is important for a large variety of reasons. Depreciation in the value of the Rupee causes inflationary pressures; pressures that are generally countered by hikes in interest rates – further resulting in a liquidity crunch, limiting growth. Also, since India’s balance of trade is in the negative, a weakened rupee contributes to a widening deficit. Hence, the weakened Rupee is part of a larger slowdown in economic performance.

Some of the reasons to which the Indian economy’s poor performance can be attributed are:

• SHORT-TERM ISSUES:

1. Drastic FII outflows.
2. Price of crude oil increasing due to the Syrian Crisis.
3. Twin deficits – both Current Account Deficit (CAD) & Fiscal deficit. Furthermore, all indicators suggest that projections of both deficits will be overshot.

• POLICY ISSUES:

1. Threat of impending capital controls.
2. Land Acquisition Bill hurting industry.
3. Huge subsidies- Widely perceived to be populist measures. Subsidy rationalization is absent.
4. Inflation control via hiked interest rates causing liquidity crunch.
5. Roll-back of stimulus inserted to counter 2008 and 2010 global crisis.

• STRUCTURAL ISSUES:

1. Lack of investor confidence.
2. Weak manufacturing sector.

Naturally, external factors have also had a significant impact on the Indian economy. The slow-down in both Europe and USA have been particularly damaging for the services sector.

One element which has particularly hurt the Indian economy is Quantitative Easing (QE). Brought in by the US Federal Reserve to counter recessionary pressures within the US, QE is a monetary policy wherein financial assets are bought from banks causing increased monetary base. A part of this increased liquidity within the US was invested in India, leading to increased capital inflows.

The US Fed introduced QE-3 in September 2012. By June 2013, it was announced that QE policies would be tapered. Bond purchases were to be scaled down from the existing rate of $85 billion per month. It was believed that this program would be scaled down by at least $10 billion per month, and completely stopped by mid-2014. Surprisingly, the US Federal Reserve Policy statement on18th September decided to continue the program without any changes. The tapering-off was postponed till at least mid-December 2013.

As a reaction to this, the Rupee recovered. As of 24th September, the Rupee has recovered to 62.5. Although, there are a multitude of reasons behind the weakening of the Rupee, the postponement of the tapering-off of QE has provided some breathing space for the RBI. As the RBI Governor rightly mentioned in his policy declaration, the postponement of tapering is simply a postponement. When the tapering-off resumes, India is going to have to face corresponding dire consequences. Hence, India should use this temporary respite to build up a war-chest of dollars which can be used to counter the falling Rupee once QE tapering-off resumes.

The RBI can achieve this in many ways:

• INTEREST RATE HIKE: As a short-term strategy, interest rates for deposits should be hiked to encourage savings, particularly for NRI accounts. The recent hike in repo rates announced by the RBI Governor may help in achieving this. The higher interest rates will help attract dollar inflows into India. At the same time, to counter the resulting liquidity crunch, other avenues of capital availability must be opened up. The RBI’s move to reduce Minimal Standing Facility rates will help achieve this. This can be further supplemented by allowing greater access to External Commercial Borrowings.

• ENCOURAGING INFLOWS: Similarly, there are also several policy measures that can be taken to encourage inflows into India. Simplifying investment norms, rationalizing environmental clearance, fast tracking big projects in India, rationalizing subsidies and avoiding populist measures, reforms in fertilizers sector, reducing import bill by controlling gold and oil imports may led to an improved Indian economy.

• GROWTH-FRIENDLY ATMOSPHERE: However, it has to be stressed that these are short-to-medium-term solutions towards a larger malaise, implemented via leveraging exchange rates. The essential problem faced by the Indian economy is lack of an atmosphere conducive to economic growth – and this is an issue that has to be address on priority by political leaders, bureaucrats and policy. Perhaps it can be hoped that with a change of guard at the Reserve Bank and the temporary respite accorded to India by continuing QE, a paradigm shift occurs and such steps are taken.

Has completed his BE (Computer Science) from MIT College, Pune, and his currently pursuing a masters degree in Economics. He particularly enjoys social sciences, and has chosen to study Economics because it provides the “perfect blend of Science and Social Sciences”. Currently preparing for the UPSC Civil Services Exam, Hrishikesh hopes to serve the country by joining the bureaucracy – having cleared the Preliminary exams for the Civil Services in 2013, he will be appearing for the Mains exams in December. His passions include reading, writing, traveling, mountaineering and teaching. Currently affiliated with the prestigious Chanakya Mandal Pariwar organization in Pune, Hrishikesh teaches a wide range of subjects such as History, International Relations, Economics, Mathematics and Statistics.