"Unless the Government and the regulators act quickly and effectively, devaluation will worsen the already double digit domestic inflation, impact industrial output and further weaken the Indian economy"The above quote aptly highlights the current state of the Indian economy and what might eventually follow if authorities refuse to take cognizance and act accordingly to contain the rapid fall...
"Unless the Government and the regulators act quickly and effectively, devaluation will worsen the already double digit domestic inflation, impact industrial output and further weaken the Indian economy"
The above quote aptly highlights the current state of the Indian economy and what might eventually follow if authorities refuse to take cognizance and act accordingly to contain the rapid fall of the Indian rupee, which slid down to an alarming '56 to a USD from '45 to a USD in 2010-2011. The Indian rupee is under great stress as overseas investors are paring their exposure to Asia’s third-largest economy amid international uncertainty and mounting worries over the domestic economy.
'Adjust and adapt' should be the mantra that our regulators must implement, in order to steer the country out of its worst financial phase. Earlier as well, the Indian rupee has been unsettled whenever the global economy showed signs of trouble as we experienced in 2008.
Over the last few months, Shri Pranab Mukherjee (former Finance Minister), along with other Indian think tanks, has been persistent in his accusations that the Euro zone crisis is the sole cause for devaluation of Indian currency. These accusations may only be partially true. There are a number of parallel factors that have been equally instrumental in pushing the economy into its current state.
Our political scenario is one of the prime reasons why an investor today, feels disinclined towards investment in the Indian market. Also, there is uncertainty over GAAR proposed by the Government, which has been termed as negative for FIIs (Foreign Institutional Investors) investing in India, imbalance in the dollar demand-supply, and fiscal & current account deficit. Fluctuations in the rupee exchange rate within such a short span of time are unsettling and leave their imprint on the rest of the economy.
The depreciating rupee will add to the pressure on the overall domestic inflation and since India is structurally an import intensive country, as reflected in the high and persistent current account deficits month after month, the domestic costs will rise on account of rupee depreciation. The rupee depreciation will particularly hit the industrial sector and put greater pressure on the costs of items like oil, imported coal, metals and minerals, imported industrial intermediate products etc. To understand the impact better, let's take a brief look at the sectoral impacts which are on the horizon or already in place as a consequence.
The Indian import industry would have to pay more in terms of rupees for procuring their raw materials. This would happen despite a drop in global commodity prices, only because of a depreciating rupee against the dollar. Corporate India is a net borrower of dollars and to that extent, a depreciating rupee would impact its balance sheet adversely. Companies with foreign debt on their books would also be impacted and they would need more rupees to repay their loans in dollars. This will increase their debt burden and lower their profits. Obviously, investors would do better to stay away from companies with high foreign debt.
India is suffering from near two digit inflationary pressure. A depreciating rupee would only add fuel to the situation. It would lead to high inflation, as India imports around 70 per cent of its crude oil requirement and the Government would have to pay more for the crude oil in terms of rupees.
As regards the Indian oil industry, oil companies import huge amounts of crude oil, which is denominated in US dollars. With the weakening of the rupee, they have to shell out more cash, thereby hitting their operating margins. The extent of the loss would depend on the amount of backward integration of oil companies. More the backward integration, the better it is. However, most state-owned oil companies in India lack their own crude oil resources and have to bear the brunt of the same. As a natural corollary to this scenario, devaluation will have a favourable result for Indian exporters.
India is suffering from near two digit inflationary pressure. A depreciating rupee would only add fuel to the situation. It would lead to high inflation, as India imports around 70 per cent of its crude oil requirement and the Government would have to pay more for the crude oil in terms of rupees. Due to the control on oil prices, the Government may not easily pass the increased prices to the consumer, leading to high import bills, which in turn will lead to rise in fiscal deficit for the government and will push inflation.
FIIs are reducing their exposure to Indian equity markets. With FIIs pulling out of India, brokering firms are seeing a significant decline in volumes. This would have a negative impact on the company’s profitability. Those brokering firms which have more number of foreign institutional clients are likely to be hit more.
It is not all bad though, as with any democracy there are promises, promises that it will bounce back, and assurance that it is not as bad as it looks. Most of it is because the Indian democracy currently is not at the liberty of being pessimistic as that would prove to be the final blow.
Considering the above, policies and measures going forward will forge the road ahead for the country. Some intervention from the Reserve Bank of India could become a critical stabilising factor. Indeed, the Reserve Bank had earlier intervened at times when the rupee was appreciating to protect the interests of Indian exporters. A similar intervention is demanded in times of rupee depreciation as well. Some of the measures that seem helpful would include:
- Temporary import reduction.
- In order to avoid undue bundling of imports, oil import demand could be staggered and purchases coordinated.
- Initiatives which encourage and increase the flow of foreign investments into India may be undertaken. For e.g., increase in the investment limit for investors in government security and corporate bonds is a step in the right direction.
- FDI in the aviation industry and retail can also attract foreign investors
- The Government can make investments attractive and invite long term FDI debt funds in infrastructure sector.
The demand factor in the Indian economy will always help it to emerge strong, out of whatever difficulty it faces, policy measures nevertheless can turn the tide and therefore they should be treated very delicately. Because though India may have put its poverty-stricken, militarily weak, socially fractured and diplomatically isolated country image from the days of the Cold War behind it, unless issues like red tapism and political dysfunction and derailed regulatory measures are tackled, the country’s hopes of becoming a global power would remain a distant possibility.
Natural consequence of devaluation in the short run would be to degenerate the balance of payment situation and increase the burden of India's foreign debt and debt service liability and foreign loans repayment would break the back of the budget, which would in turn enlarge the trade gap. It will stall many ongoing projects due to rising costs; distress all the cost price relationships in the economy and lead to galloping inflation.
Disclaimer–Views of the author are personal and do not reflect the views of the firm.
>