The Reserve Bank of India (RBI) in its mid-quarter monetary policy review on June 17 kept both the repo rate and the CRR unchanged though an effective cut in interest rates was direly needed to provide some boost to growth and investments. The RBI cited elevated food inflation, sharp rupee depreciation and uncertainty over the foreign fund flows.
Depreciation of rupee is bad for the economy. Between April 1 to June 14, rupee dived by 5.8%. It fell by 6.6% between May 22 and June 11 and continues to threaten to race towards new lows. The sinking rupee is taking a toll on capital intensive sectors, firms with foreign borrowings and those dependent on imports. Foreign loans and student loans are getting dearer, outbound tourism will get affected and imported items like fuel and consumer goods will become expensive. But sectors such as IT and Pharma that survive on exports will benefit. Weak rupee may boost NRI remittances. The sharp rupee depreciation in relation to the dollar to an all-time low over the last two and a half months has been prominent in the RBI’s calculations.
RBI’s focus this time has shifted to the balance of payments (BoP) situation. The exodus of foreign capital from debt markets accelerated the rupee’s plunge. The impact is not limited only to government finances but will also extend to companies that carry a larger forex-denominated debt on their balance sheets. India Inc’s seemingly smart strategy to take advantage of lower interest rates abroad has now backfired with such volatility in the rupee.
What is particularly of concern is that rupee’s aggravated decline has been caused by a sell-off by FIIs due to a possible end to the US Fed’s quantitative easing policy. US Federal Reserve Chairman Ben Bernanke has recently laid down a timeline for ending his bond buying program starting from later this year and ending it by the middle of 2014 provided the US recovery proceeds as per the Fed’s expectations. Besides, strengthening of dollar and improving US economy prompted investors to leave emerging markets and chase US assets. The situation over the last two months has exposed the vulnerabilities of India’s BoP, especially in the context of a persistently high CAD, which crossed 6% of GDP in December 2012. In the last two decades, the Indian economy’s exposure to risks stemmed from higher gold and oil imports and also from stagnant FDI and FII inflows. Such a high CAD (as compared to 3% considered as comfort level) is unsustainable and constitutes the single biggest risk to India’s economy.
The only silver lining has been the inflation front that has been easing for the last three months. The headline WPI inflation is down to 4.7% in May, far below the 7.4% average during 2012-13. All the constituents of inflation, with the exception of food, have been declining. Even the closely watched non-food manufactured inflation too has reduced. Still, the inflation outlook is by no means comfortable. The rupee depreciation has been a major reason for this as dearer dollars imply higher prices for imported fuel and edible oil. Other factors impacting the inflation prospects are possible administered prices revisions of essentials. These include minimum support prices of a number of commodities. Oil prices though are being taken out of the administered price regime in a phased manner which is a welcome process but will result in rise in oil prices in the immediate period.
The CPI i.e. retail inflation remains high at 9.3%. In sum, it seems that the weakening rupee and growing uncertainties have cast a shadow even on rate cut in the July monetary policy review. Rupee crossing 60 will be a serious matter of concern which in the immediate term will certainly invite RBI’s interventions and in the long term, a well thought-out action plan will have to be implemented. India has to increase its inherent competitiveness, diversify its export basket and promote its trade efforts more with new markets in Asia, Africa and Latin America. The effort should be on attaining self-sufficiency in oil and gas. Also, India has to be a country providing foreign businesses as well as Indian businesses a complete ease of doing business.
The author is a corporate economist and sustainability analyst. Views expressed are personal