Friday, July 5, 2013

What's causing Rupee to hit 60 against Dollar and what can be done?

Everyday when I look at Rupee v/s Dollar I am astonished at the apathy of the Central Government which doesn't want to do anything but keep quiet since it believes the real voters are poor people who will anyway be given free food through the Food Bill and then in return get votes and come back to power.

In 2012 I had written an article explaining journey of dollar from 1947-2012. Read here if you want to gain some insight. I had also written an earlier article highlighting the fact that Indian economy is in shambles because of self inflicted wounds. I had also highlighted (click here) how India escaped recession between 2008-10. If you notice between 2010-12 there were great expectations from the present government. In fact, Manmohan Singh was re-elected because the expectations were very high from an economist in a time where economies of developed countries were in a deep mess. What has ended up happening is that Manmohan Singh's inactivity has put the country into such a deeper mess that it would take years to fix.

While the government claims that global factors don't help India's economy, here is my take on how government's calculations are misplaced and what it can really do to boost the economy. We are not in an impossible situation but the government has made it impossible by being passive. The economy is directly impacting the rupee's fall.

What exactly happened between 2010-13? Till about 2008, Indian economy was having surplus money and foreign capital mainly because of higher GDP growth, higher domestic demand, increased productivity, increased exports and decreasing imports. The confidence in India growth story was very high that external money in the form of FDI and FII continued to surge. This helped the government to finance all its welfare schemes. (Note: Foreign Institutional Investors -FII -  is just money flowing into market. It can enter anytime into the market and exit anytime. The dependence of this money is not good. FDI on the other hand is investment in partnership to start business. In other words FDI is more reliable and less easy to exit. So, if business rules in India are simplified then FDI will bring in enough capital, best practices and better governance mechanism).When the recession struck the global markets Indian government had cushioned the losses of exporters by giving them enough stimulus and generating domestic growth. Since India doesn't export much the amount needed to cushion was also less.

However, since 2011 end to 2013, one by one scams began to unearth and Govt sat quietly doing nothing. No reform, no major policy initiative, and no confidence building measures were taken. This is shameful and disgraceful.

Analyzing imports, exports and deficit driving the country to low confidence:

Let's look at some interesting graph below that explains export and imports of India. (source)


Note that Indian imports are far greater than exports. While China deals with 10 times more than this in imports and exports, its imports are very less compared to exports. In addition to an export driven economy China is aggressively driving towards unbelievable growth in terms of roads, railways and electricity. The only state growing at a pace similar to it is Gujarat.

Unless India doesn't reduce imports and increase exports, the deficit will never be controlled and economy will continue to be weak and rupee being the most impacted. The major import India does is crude oil to meet its electricity and fuel needs. Kerosene which is a product got from crude oil is extensively used because of erratic power supply.  Crude oil is not abundantly found in India and for its gas needs it needs to depend on it. However, coal accounts for 59% of electricity needs. Why can't this change? It can - We have never tapped solar to its fullest extent despite high temperatures in various parts of country. If we can increase our dependence on solar and wind, coal dependency reduces and thereby one major portion of our import bill goes down. For this we need aggressive actions on increasing solar presence in India. The National Solar Mission set up by the Government aims to do this but it is going at a snail's pace. In contrast, an excellent example can be found in states like Rajasthan and Gujarat where the share of electricity from solar has tremendously increased and the dependence of coal is minimized. As of 2013, Gujarat accounts for 66% of solar energy in India and 20% coming from Rajasthan (Source). Contribution from all other states are very less. Why is this? The central government uses reverse bidding mechanism where it first gets the bidders and once finalized decides to hand over the project to it, while Gujarat's solar policy is to set a fixed tariff and then attract the foreign investors. This has made the terms favorable and that is why both Rajasthan and Gujarat are tapping solar to fullest extent. Imagine if each state that has high temperatures and soaring heat began to depend on solar aggressively our coal import will drastically reduce, thereby reducing import bill and pollution because of coal. If crude oil import cannot be reduced other components of the import bill can easily reduced. The government simply doesn't want to do more. The more you import crude oil everything gets linked to inflation and falling rupee increases inflation. Vegetables - like tomato is now Rs.80 per kg and everything else will increase.

The next important import I would like to highlight is gold and coal. Gold is a status symbol in India and it will never change for another 100 years. Be it marriage or savings gold is a must.  The import of gold will never reduce.

India needs to step up its manufacturing base. Look at electronic goods imports bill. When will India start manufacturing many of the components like China does? The PM announced Manufacturing Zones to be set up. Where are they? Everything is on paper. Has any action been taken? Is the PM serious? These are questions not be asked nor to be told to the public since the major public giving votes to the party are poor people and the party doesn't really care about middle class. 

It is good that pharmaceutical products, transportation equipment and gems are exported in huge quantities. The amount of textiles, ready made garments exported is very small compared to what China does. The government doesn't really boost these segments through major policy initiatives. These sectors which help the economy are not in a good shape.  Doing business in India needs simplified and no one wants this in the government at present. Our export base therefore cannot be easily broadened.

Analyzing the Money flow into and out of the country:

Now, after analyzing this great tragedy of imports v/s exports another there is another sad situation that needs analysis and that is the amount  of money flowing into Indian market. In the last 3 years FII as against FDI has been increasing. FII drastically increased when US economy fell into recession. The Indian government continued to rely heavily on this FII and never encouraged FDI , disinvestment policy and aggressive manufacturing policy. The government did not create competition in insurance, health, road and other sectors which require huge investment. FDI in retail was introduced but it takes years to see its benefits. The government did not step up the pressure on building highways and railways. It neither did create enough domestic demand. Reduced money flow, reduced demand, reduced competition, led to reduced confidence. Between 2000-2004 because of huge roadways growth and electricity generation the country became attractive to money from other countries who were willing to invest and generate jobs in these sectors. The result was high confidence, huge FDI flow, more jobs. In fact, the money was generated from within the country by increasing disinvestment that made public sectors more productive.But now everything has taken a full U turn and there is no economic confidence. 

In 2013, when this FII began to deplete because US economy began to grow at 2%, (source) the government did not have enough reserves. RBI has only up to 30 billion dollars (Source) that it can safeguard by supplying dollars into the market to cushion the outflow. Beyond that it cannot do anything unless the government cuts down inflation and reduce imports.

If US grows at just 2% and FII deplete dramatically like this, what would happen if US grws at 3% will dollar reach 80?

Supply side constraints and inflation:

Inflation continues to rise and rise and AAM AADMI is suffering and there is no way government shows the resolve to tackle this. Unless our supply of goods is more organized and the supply chain model of vegetables and fruits change we will continue to face these. FDI in retail was precisely done to address this, but it takes years. While this happens, it can force states to amend APMC acts to make farmers easy to supply and sell their produce. Because these things are not done, the middle men continue to hike prices thereby causing inflation to only increase.It's time to bring buyers to farmers rather than farmers going to buyers. Interested readers can read my article to understand how prices of vegetables are priced so haphazardly that inflation is intentionally created. Every time the excuse given is no proper crop yield, no proper rains and huge wastage of the produce due to inadequate storage facilities.

The Goods and Services Tax (GST) was supposed to be introduced in 2011 to encourage a uniform taxation and uniform price mechanism. This would have helped curtail to some extent pricing mechanism that directly affects inflation. Nothing has been done so far.

These 3 major factors unless corrected rupee fall cannot be stopped or mitigated satisfactorily. If the Govt acts tough then rupee will slowly continue to reach below 55, but if it doesn't then short term fixes will make it hover around 58-59.

Global factors which Government cites is not convincing enough. The fall of Euro does affect Indian currency but how did we grow despite Euro's fall in 2008-10? Here is an NDTV article that clearly explains the factors and no Euro is mentioned in it. Read here