India needs to rethink its currency management
The economy is a fickle beast. Exactly a year ago, the rupee, having experienced a prolonged appreciating spree, had reached as high as 63.5 to a dollar. At the time, quite a few commentators wondered aloud if the Indian currency was overvalued and whether was a moderation was necessary.
 
The trend of the rupee has entirely flipped this year. It has almost slipped 10 per cent since January, closing below the psychological 70-mark this month for the first time in history. Now, a wave of concern has swept the economy on the possible drawbacks from a depreciating currency.
 
There have been a mix of external factors that have contributed to the downslide. The immediate reason has been the crisis in Turkey, where President Recep Erdogan has chosen to pick a fight with Washington. As a result, foreign investors have begun to withdraw money from emerging market economies fearing that what happens in Turkey won't remain in Turkey. 
 
But, India's currency slide predates the Turkey turmoil. Since the beginning of the year, foreign investors have sold $6.8 billion in equity markets and $5.15 billion in debt markets. A leading reason has been the raising of the interest rates by the US Federal Reserve as a part of the tightening of its monetary policy, which has prompted investors to pull their funds out of the emerging markets. Advanced economies are unwinding years of loose monetary policy practiced over the last decadein the post-crisis period. So, the financial market volatility arising out of it is here to stay for the developing world in the near future.
 
India, therefore, has not been alone with a weakening currency. However, it has been the hardest-hit in Asia. This points to inherent vulnerabilities in the Indian economy itself. Even though a case can be made that the currency has been merely adjusting to its true value after having appreciated a year ago, the issues that arise out of a weak rupee are hard to deny. 
 
The most problematic aspect is the rising import bill that is mostly led by oil for India. The country is the third-largest consumer of oil in the world after US and China and about 82 per cent of this is imported. Global oil prices have already been on the rise this year and a weak rupee merely acts as a double whammy for the economy. 
 
As a result, India's current account deficit, the difference between national savings and domestic investment, is also on the rise and is expected to touch 2.6 pervcent of the gross domestic product in this financial year compared to 0.6 per cent merely two years ago. The country's trade deficit in July had hit a five-year high of $18 billion. The other side of the story in a widening trade deficit is a sluggish growth in exports, which is a painful reality for the Indian economy. 
 
It is often argued that a depreciating currency is not bad since it helps boost exports. However, in this case, even such gains might not materialise. First, since the currency depreciation is not unique to India and is occurring throughout the developing world, domestic exports might not seem particularly attractive in the global markets. Some of the othercompeting emerging markets have witnessed even greater currency depreciations.
 
Second, recent evidence has shown that depreciation does not always boost exports. In the 2013 ‘taper tantrum' episode, when the Indian rupee lost about 20 percent of its value after the Fed hinted at winding down its quantitative easing programme, the country's export levels remained unaffected. 
 
Finally, as the world economies are becoming more protectionist in nature, the global demand is likely to remain subdued. Thus, India's export prospects seem bleak for the time being.
 
There is a dire need to address the repeated macroeconomic vulnerability of the Indian economy that is linked to its currency fluctuations. It remains difficult for any government to devote resources towards developmental efforts if cyclical external shocks keep defining policy constraints. In the short run, the excessive dependence on imports for crude oil has to be reduced. This would require a significant boost in domestic oil exploration and production, which has not been done in the last two decades. 
 
A more long-term approach should involve debunking the belief whatsoever that depreciation of currencies has any relation with higher exports. Instead, the focus should be on improving the productivity of the country's resources, which can help set its export basket apart from that of its competitors in the world markets. Such an approach would disassociate export performance from periodical external shocks and improve macro-economic stability. 
 
China, for instance, no longer competes on cheap labour and devalued currency. Higher efficiency and better quality are gradually becoming the hallmarks of Chinese manufactures. The country's mobile exports that are taking over the Indian markets are a case in point.
 
Finally, in addition to keeping its house in order, India can also address its macroeconomic vulnerabilities with higher international cooperation on the monetary and financial front. The world is missing effective international policy coordination that can ensure financial stability across global markets. India can take the lead on international forums with the support of developing nations that face similar financial risks and put such issues on the policy agenda. India needs to move away from a scenario of uncertain currency fluctuations as it has experienced over the course of last year. 
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article
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COMMENTS

Balakumar Paramasivam

3 months ago

You have ignored the Policy missteps that the current Government has taken in the last 4 years. A sense of invincibility and know-all attitude of the Government and Finance Ministry in particular have to largely led to this situation.

State of Indian economy: Is it time to go bearish?
Less than a year to the general election is a tricky time for setting a stable economic narrative.
 
The government will glorify its achievements. The opposition will skew comparisons against its own track record, preferring to affirm how things used to be "much better".
 
But an objective analysis of forces shifting our economic realities is needed. An analysis which, when stripped of embellishments, simply tells us... How are we really doing?
 
For starters, let us omit challenging the very purpose of an economic policy (i.e., I won't question whether demonetisation actually reduced black money. Would GST turn out to be a net positive? Whether RERA would bring or is bringing in more transparency in real estate?). Also excluded are comparisons across preceding political tenures.
 
While analysing existential factors with a historical baggage is an intellectually stimulating exercise, I am more comfortable in presenting a more current, apolitical and technical version of things, using data to highlight the actual state of the economy along with its expected trajectory. The logic stems from the reality that policy actions are already set in motion. Let us discuss their effects instead of their basis.
 
So, what are the set pieces here?
 
For one, interest rates and capital flows. The most significant trend driving global economies since late 2007 has been an unprecedented drop in interest rates in the rich world. Be it Federal Reserve, the Bank of England, or the European Central Bank (ECB), the combination of bond-buying and a deliberately loose monetary policy gave the rich world access to ridiculously cheap capital for a large part of the last decade. Japan in the far east ventured towards negative rates in 2016 (joined by ECB) after suffering decades of stagflation, which technically meant investors would be charged for depositing their money in Japanese and European banks (See Chart 1).
 
Rates in major emerging markets, including India, were moving in the opposite direction, hitting highs from 2010 to early 2016. Rising domestic inflation, driven by increasing crude oil prices, supply chain inefficiencies, and a growing consumption base resulted in a high rate environment.
 
This rate differential meant global capital flows in the early and mid-segment of last 10 years moved from the rich world to the emerging markets. Foreign investors were flocking to Asia hungry for yields, leading to significant rallies in domestic equity and bond markets.
 
The last segment of the bygone decade has been different. Rich world interest rates (with the US taking the lead) have been tipped to rise since 2016. The Federal Reserve has already announced its seventh rate hike in the last three years. Europe will follow suit, albeit in a more gradual manner from 2019 onwards (See Chart 2).
 
Key emerging markets during the same period have begun to loosen monetary policy leading to rate reductions. The divergence of the early and mid-decade is repeating itself, albeit now in the opposite direction. The result is a capital flight back to the rich world. The foreign investor flight seen in India is a case in point (See Charts 3a, 3b).
 
Though there are noises around monetary tightening coming back to the emerging world (considering a second crude oil price rise in the decade with recent consecutive rate hike by RBI as a reaction) -- capital outflow, especially in the Indian scenario, should not be expected to correct itself immediately.
 
India would hence need to depend on domestic investors and liquidity to fund its growth.
 
India sources over 80 per cent of its annual crude oil requirement externally, making us one of the largest oil importers in the world. Being a relatively price inelastic product, such an external dependence makes crude oil a key force driving our macro-economic realities.
 
Crude oil's second price rise (See Chart 4) brings with it another leg of rising trade and current account deficit (trade deficit hit a 61-month high in June) for the country. Domestic retail inflation is at a five-month high. Interest rates are expected to go up. The rupee is at an all-time low. Assuming the upward (or moderately upward) trajectory of oil continues, need we be worried?
 
The single-biggest lever a higher oil bill can pull is to reduce the government's appetite to spend. Our fiscal deficit is already widening thanks to petroleum subsidies, etc. Petrol and diesel pricing pains can exert additional pressure on excise duties leading to further revenue loss. Another pain point is the rise in interest payments on government debt. Ten-year government bond yields have been continuously increasing (See Chart 5) since the beginning of this year (due to a weakening rupee, which is driven off other macro factors). These higher interest payments would only constrain government spending further.
 
However, the present government's commitment to fiscal consolidation implies there would be a hard stop at around the 3.3 per cent FY19 target mark. Considering we've already reached more than 50 per cent of the deficit target in the first two months of the fiscal means that the government would be severely constrained to drive further investment in the next few months (See Chart 6).
 
And we do need investment, especially with a wave of capital outflow thanks to a rate differential with respect to the rich world as illustrated earlier. The country's gross fixed capital formation (an indicator of investment) also corroborates with the low investment hypothesis we've already set (See Chart 7).
 
The US China trade war is only expected to accentuate other headwinds, including possibilities of moving to faster interest rate appreciation in the US (thanks to increasing prices due to push down of Chinese imports). Though President Donald Trump is pushing for a less aggressive rate hike plan, I don't see the Fed suddenly change its trajectory. US unemployment is at an all-time low and corporate tax reliefs ensure equity investors stay bullish. The interest rate appreciation links to our capital outflow hypothesis and will also further weaken the rupee.
 
To assess whether the private sector can fill this capital shortage, it is key to see how some forward-looking indicators are panning out. A significant starting point may be to look at growth of credit across manufacturing, services, and agriculture. The underlying logic being that sectoral credit can be a proxy for investment appetite. Considering scheduled commercial banks still form the backbone of India's financial ecosystem, this data can be quite revealing (See Chart 8).
 
Looking at sectoral credit growth as per RBI data, lending to both agriculture and industry has not really picked up. Industrial credit growth trend is mostly driven by large companies (See Chart 9). Though already sluggish, if we break the numbers into its further constituents, it is visible how micro and small, and medium industries are hit even worse, with not much indications of recovery.
 
Such a credit crunch, driven by the twin balance sheet problem plaguing India's banking system, further accentuated through retributive actions against the banking community would be difficult to normalise.
 
There is thus not much to be excited with respect to the Indian economy in the short to medium term. Government spending is expected to stay muted, considering external headwinds such as a rising crude oil and an increased cost of funding. Government's fiscal consolidation target is an additional constraint.
 
Private sector investment looks no better, thanks to outflows expected to go up due to widening rate differential with respect to the rich world, as well as Indian banking system's twin balance sheet problem crippling access to credit. RBI's stress tests under its current macro-economic outlook does not exude confidence, with an expectation of gross NPA of the banking sector to go further up from 11.6 per cent this year to 12.2 per cent by March 2019.
 
Unless of course, the government, one, drops its pursuit of fiscal tightening and enhances spending to drive public investment; and/or accelerates reforms with sound implementation around land, labour and capital to spur private investment. Without this, it is fair to say that things look rather bleak.
 
With the advent of an election year, one can expect some progress on the spending side in an ad-hoc, populist manner. A splurge is, however, unlikely -- given budget estimate for the full year would be aligned by February 2019, i.e. before the general elections. It is indeed wishful thinking to expect a complete wash out of the fiscal consolidation narrative right before hitting the polls.
 
Worse, expect no progress on reforms as that's too long-term a strategy to reap any immediate benefit.
 
Either way, from an economic perspective I don't see anything aside from the status quo pan out and hence would continue to be a closeted Bear.
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.
 
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COMMENTS

Nilesh Todarmal

3 months ago

Not able to see the charts in the article

Consumption economy & infrastructure: Two sides of same coin
Driven by rising incomes and steady growth, consumption patterns of e-commerce, mobile data, entertainment and consumer goods will see an uptick in India. World-class infrastructure is needed to enable these rising levels of consumption.
 
Essentially, consumer-driven businesses and infrastructure are two sides of the same coin and have a symbiotic relationship.
 
As mobile data usage increases and the data-dependent economy gathers momentum, the corresponding infrastructure must keep pace to ensure seamless transition into a more digital world. Growth in the digital world implies the growth of both wireless and fibre infrastructure to eventually enable a hassle free 5G ecosystem in India.
 
Better and faster data speed that can allow digital services requires better connectivity through both a greater number of telecom towers and more fibre infrastructure.
 
This need for more telecom towers and fibre in India will require significant infrastructure investments from the various players in the telecom ecosystem. Incumbent companies in the tower and fibre space may not always be able to use their capital-constrained balance sheets to fund the infrastructure expansion. Thus, a funding gap emerges.
 
This funding gap creates an opportunity for capital-rich investors to tap into a growing and dynamic investment opportunity through innovative financing mechanisms. There are the three main components of the Indian telecom market where investors can make fortunes: (1) The consumer-facing telecom business, (2) the telecom tower business and (3) fibre business. And these three different markets offer investment opportunities for a diverse group of investors.
 
Beyond the financial aspects of tower and fibre expansion, policies such as the "Right of Way" rule that enables expedited infrastructure creation deserve attention. Laying fibre requires telecom operators to deal with a myriad set of rules and charges that can at times be a severe impediment to infrastructure creation. Greater clarity around such policies for greater consistency and rational pricing which makes economic sense are required to promote investments in fibre and telecom tower expansion, investments so critical for the data consuming customer.
 
Beyond data speeds, e-commerce in India needs greater connectivity through the integration of backend infrastructure with front-end businesses. For e-commerce to realise its full potential one cannot view e-commerce as being distinct from data speed, logistics, transportation and data storage.
 
For e-commerce to reach the next 200 million active users we require greater logistics infrastructure (independent from the e-commerce vendors), more fulfilment centres, efficient and modern warehousing, and more cost-effective transportation. The entire ecosystem needs to be developed and financed effectively.
 
It may be underscored that creating the entire consumption economy driven ecosystem requires different kinds of balance sheets at play. For instance, investors who undertake technology risk to drive the front-end e-commerce businesses aren't focused on creating infrastructure at the backend and vice versa.
 
In general, investors looking to invest in telecom towers or logistics infrastructure are very different from those investing in consumer-facing technology businesses. It is essential to create an environment that allows different balance sheets to invest, operate and exit investments.
 
A financial ecosystem that provides investors with the right financial instruments, secondary market liquidity and high corporate governance will be vital. For great consumer-facing companies to be created, exceptional infrastructure is required.
 
For infrastructure businesses to be financially sustainable and for investors to be willing to invest for long periods of time, the Indian consumer-driven growth story must deliver results. Therefore, both consumer-driven businesses and infrastructure must develop in tandem.
 
For both investors and policymakers, it is essential to keep in mind that the quantity of infrastructure is vital but so is its quality. For example, while high-speed data is crucial to enable a digital economy, it is also critical that there is the consistency of data speed. Only when quantity and quality with regards to infrastructure converge can the end-consumer get access to high-quality services.
 
As consumption and incomes grow in India, the coming decades have the potential to unleash significant economic growth. To truly maximise the economic value of the consumption-driven boom, it is essential that both front-end companies and back-end infrastructure get attention.
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.

 

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