Posted in Finance Articles, Total Reads: 3268
, Published on 25 May 2013
The year is 2008 and the United States of America has just been hit by the sub-prime crisis hurricane. 125 Firms vanish overnight and others face extinction. The domestic demand has slumped, the unemployment is rising and the dollar is facing a credibility crisis. As the dollar is the most traded currency, the cascading effect is soon felt by the world. UK faces a crisis and so does France. Even the republic of Iceland runs out of money.
Soon the effect comes to India with job cuts in the sector that is most closely associated with the American economy. The IT exports have fallen to its lowest in a decade. And the fall in exports have skewed the balance in the favour of the now weak Dollar. The IT industry faces with a bleak future with recruitments, promotions and pay hikes frozen. The L word is now in the air. In short, it was a bad time to be an employee or a businessman. And the outlook for the future was bleak at best and fatalistic at worst.
US dollar vs Indian Rupee from 01 January to 31 December 2008
Cut the chase to 2010. With assistance in the form of monetary easing, the Indian economy seems to be finally learning to walk on its own. The RBI and finance ministry take the decision that it is high time to relieve the economy of its crutches and decides to rollback quantitative easing. What follows is a saga of contractions culminating in a recessionary phase coupled with persistent inflation. A slowdown in the economy seems imminent.
What started in 2010 exacerbates in 2012. Inflation gets comfortable around 10%. Slowdown in exports coupled with a surmounting current account deficit further accentuates an already deplorable situation.
The rupee had to bear the brunt of the bad phase of the Indian and world economy. The merry jig of the rupee caused great heartburn to companies, regulators and companies. It appreciated to 48.6 against the dollar at the start of 2012 and then went to its all-time low of 57.3 only to recover to 51 toward the end of October. Since then, the rupee gets into a downward spiral since July 2011 with the currency depreciating 24% then.
But is there a ray of hope in this sad story?
The quintessential hindi movie shows how the hero battles all odds to fight the villain and win his damsel. The Indian economy has stubbornly battled several crises to emerge as one of the most important economies of the world. The question is that is the current economic crisis another one of those battles for which we are prepared or is it something which has caught us unawares.
To provide a cure, it is first necessary to diagnose the disease. So lets look at the symptoms one by one.
Exports have been badly hit and the Eurozone crisis did not help matters. This robs the finance ministry of the excuse of the high current account deficits. The items in which exports grew around 40% have decelerated in recent years. The Eurozone crisis has further added to the problem. The Indian economy which thrives on the basis of export of services witnessed a decline on this front too. Services exports too grew a meager 2% compared to 27% in the same quarter last year.
FDI fell by 44% to $12.8 billion between April and December in 2012 which will further accentuated the current account deficit. Even the IMF revised its export estimates for India from 2% to 1.5%. Under such circumstances, the only glimmer of hope for India is the price of crude oil staying between $80 to $110.
The Indian economy is facing a negative trade balance. Foreign exchange reserves fell by around 7% from $295 billion at the end of October from a peak of $320 billion. The depleting foreign reserves and rising external debt meant that the ratio of foreign reserves to external debt stood at 83%, the lowest since 2003-04.
The external debt outstanding at the end of June 2012 was $349 billion which comprised external borrowings of 40% and NRI deposits 17%. The forex reserves cover on short term debt is quite low at 52%. Another Eurozone crisis akin to 2008 could make refinancing these debts with short term securities more difficult
All the above factors combined with a sticky inflation persisting at around 10% (measured at CPI) brings up a question: Is it time for the hero to make a comeback? Is it time to devalue the rupee? Is Rs. 60 to a dollar the ideal value of the rupee? Should Chidambaram have done what Manmohan Singh did in 1991?
The Road Ahead
In a lot of ways, the situation we face today is quite similar to what we faced in 1991. The only difference is that we had more forex reserves at that time. This is a reason for both regret and hope. Regret, because we failed to yet again realize our mistakes and anticipate the situation just like in 1980s which led to the situation in 1991. Hope, because we faced the earlier crisis with resolute action. Our esteemed prime minister was instrumental in bailing us out in 1991 as the finance minister. So it should be easy for him to understand the need of the hour.
First, our export system is broke. Over the first 10 months of the previous year, exports crashed and imports leapfrogged, causing a huge trade deficit of over 10 percent of GDP. Though exports may not revive till global growth recovers our huge current account deficit (CAD) needs to be taken care of.
Second, this devaluation will push up cost of raw materials we use, especially imported oil. So there should be a hike in the domestic price of diesel by Rs. 5 effective immediately and by another Rs. 5 effective July 2013. Hike will mute domestic demand and reduce current account deficit which will help getting rid of the oil subsidy entirely if global crude prices remain where they are. Over time, this will improve our dollar inflows, resulting in a more stable rupee. Short term inflation has to be borne for the sake of long-term stability.
Those well versed with hindi movies should know that it will be foolhardy to write-off the rupee and the Indian economy. Getting the policy-makers to make some unpopular decisions can relieve the economy of the crutches. Because tough times call for bold decisions. As a popular actor once said, in life like movies, everything gets alright in the end. And if it is not alright, it is not the end.
The article has been authored by Akshat Agarwal, TAPMI
1) The Hindu Business Line
2) The Economic Times
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