Macro

A Nervous Rupee Should Force India to Take a Hard Look at its Macroeconomic Risks

While there is no cause for panic, it doesn’t mean we should be complacent either.

The rupee that fell on Thursday to an all-time low of 69.09 against the dollar in intraday trade is expected to remain under pressure. Although the Reserve Bank has been, and is expected to continue to defend the currency, using its stockpile of foreign currency reserves, by selling dollars in the open market, forecasters estimate that the 70-level mark will be breached before the year-end.

While most Asian currencies are weakening, the rupee, among the three biggest losers, has lost over 5% of its value in the last three months, according to Bloomberg data.

For reasons both global and specific to India’s macroeconomic parameters, foreign institutional investors have pulled money out of Indian debt and equity for the first time in a decade in the first six months of this calendar year. They have sold equity and debt worth nearly Rs 46,190 crore so far in 2018, the worst outflow since 2009, according to Bloomberg data. This exit of dollars has added to the selling pressure on the rupee.

We are entering a new phase. As US President Donald Trump’s trade policies escalate tensions globally, the downward trend in currencies will continue. Rising international oil prices and the recourse of imports from Iran under threat are a risk for India’s macroeconomic stability.

The country’s import bill was being kept down by benign international crude prices. But the fiscal and current account deficits, which have been traditional vulnerabilities for the economy, have shot up again.

The government had inherited the current account deficit – the excess of imports over exports and expenditure over revenues – at 1.7% of GDP in 2014, which it brought down to 0.7% by the close of 2016-2017. This climbed back up to 1.9% by March-end this year. Higher oil prices are expected to keep the import bill and the current account deficit bloated this year again.

Exports could have offset the rising oil import bill, but that cushion is not available.

In the four years from 2013-14 to 2017-18, annual exports are down to $303 billion from $312 billion. As a percentage of GDP, they are down from 17.2% to 12.4%. In garments and textiles, India was second only to China but has slipped to the fifth and third positions respectively in the two sectors.

Exports lost competitiveness primarily because the rupee had been strengthening in the past few years. The disruptions and glitches on account of demonetisation and the rollout of the Goods and Services Tax added to the weakness. Now, small exporters say they are no longer in a position to take advantage of the depreciating rupee that ideally should have been good news for the competitiveness of the sector.

The stagnation in exports has weakened India’s defence against external shocks. As a result, a smaller hike in oil prices can have an outsized impact on the current account deficit. Brent crude even at an optimistic projection of $65 a barrel will send the current account deficit up to 2.4% of GDP, which is higher than in 2013-14 when the average Brent price was well above $107 a barrel.

Brent crude even at an optimistic projection of $65 a barrel will send the current account deficit up to 2.4% of GDP, which is higher than in 2013-14 when the average Brent price was well above $107 a barrel. Credit: Reuters/Richard Carson

Brent crude even at an optimistic projection of $65 a barrel will send the current account deficit up to 2.4% of GDP, which is higher than in 2013-14 when the average Brent price was well above $107 a barrel. Credit: Reuters/Richard Carson

In a note dated June 19, Sajjid Chinoy & Toshi Jain of JPMorgan wrote: “It is increasingly clear that emerging market current account deficit (EM CAD) economies are being clubbed together as an asset class and therefore at risk of some contagion from each other…. Just being an EM CAD country in this environment makes one vulnerable to redemptions and outflows.”

The other macroeconomic challenge is the fiscal deficit. The government has already missed the fiscal deficit reduction target for 2017-18, reaching 3.53% of GDP instead of 3.2%. The government inherited the fiscal deficit at 4.5% of GDP in 2014. Means, in four years, it has reduced the fiscal deficit by less than a percentage point, despite the huge tax bonanza it got by raising the indirect taxes on fuels.

Originally, the Fiscal Responsibility and Budget Management (FRBM) Act specified a target of 3% of GDP. Since its passage in 2003, this target has been achieved only once, in 2007-08, when it had dropped to 2.5%. The target has not been achieved again after that. The Act was amended twice, in 2012 and again in 2015, to defer the deadline for achieving the 3% target to 2017-18. The NDA government is not even trying to meet the goal now. The Budget this year amended the FRBM Act, for a third time, deferring the target to 2020-2021. It also deleted the revenue deficit target altogether from the FRBM Act.

The government has, in fact, repetitively relaxed fiscal rectitude targets it gave itself.

It adopted new statutory anchors and debt-GDP ratios for the Central government and general (Centre and states) government on the suggestion of the N.K. Singh committee. The panel suggested reducing these to 40% and 60% of GDP by 2022- 23, but the government has instead adopted 2024-25 as the deadline. The target set in the 2015-16 Budget for the Centre’s debt-GDP ratio was 42.8% for 2017-18. The 2016-17 Budget relaxed it to 46.8%.

Since the fiscal deficit was not contained within target when global conditions were not as bad, the forecast for this year has somewhat lost credibility in the foreign currency and government bonds market. With a general election imminent, the fiscal deficit is unlikely to be reduced this year.

So far, RBI’s strategy for defending the rupee has been to sell dollars from the forex reserves, which it is expected to persist with. Reserves declined to $407.81 billion as on June 22, from $410.07 billion reported for the week ending June 15.

That’s a safe ten months of imports. There is no panic yet, but there is no cause for complacency either.

Puja Mehra is a Delhi-based journalist

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