Factors affecting the strength of Rupee - Part-I

Lot of readers have written to elaborate more on the subject. Of course one needs to know a little bit of economics to gauge the economic situation of our nation because these are the factors that affect the value of our currency. On understanding this it will be more easy for us to conclude why and how we and our investments get affected. Let us together try to analyse these points and understand the consequences and possible remedies.

Deteriorating Current Account Deficit:
The current account deficit is getting out of hand and running in the wrong direction. The Gap has been widening in successive quarters and at present is in excess of 5.4% of GDP.
For the beginners, the current account refers to trade income and expenditure statement of a country. It takes into account all the foreign exchange earned through material + service exports as well as remittances from NRI and foreign exchange spent on all our imports of goods and services.
If as a country we earn more Dollars through these exports than we spend them on imports, in such a case the current account will be in surplus. Presently this is exactly in reverse. We are spending dollars recklessly through huge imports and our exports are not matching to cover the cost of these imports.This is the single most important factor which decides the strength of a currency, needless to say Rupee is in the wrong end.
Even during the 1991 crisis India did not have current account deficit of such a magnitude.  Then CAD had just crossed 4% and we are way ahead of that mark now. The capital flows into the country is bridging this trade gap, otherwise Rupee would have collapsed by this time.
Depending exclusively on capital flows into the country to bridge this gap is like inviting trouble in future.So only way left for the country to solve this problem is by reducing imports or increasing exports. 

Chronic Problem of Uncontrollable Imports: 
One of the biggest problem plaguing the country is energy dependence on other countries. The country imports more than 80 % of its crude requirement. In a growing economy where population as well as affluence is rising fast, the energy needs continue to rise. In the absence of domestic production, import is the only alternative. Any attempt to bring down imports of crude oil will be counter productive.The import bill is directly proportional to international crude rates. For a long time crude prices remained in the range of 100 to 110 per barrel. It was expected that the prices will cool down and import bill would become manageable. However crude rates of late have moved beyond 110 and is currently quoting 117 per barrel. Situation is getting worse by the day.
The long term solution to this problem is alternate energy sources and increasing domestic production. It is also essential to develop good mass transport system and introducing energy efficiency norms for the vehicles. These required actions even if taken up tomorrow, will have a lag time of 5 to 10 years. Till then, in the short to medium term crude will hurt Indian trade account very badly.

Gold is the second biggest import of the country. In fact 25% of world's gold production is being consumed by India alone. Ever since the rise in gold prices, investment interest has added on to gold demand. The Gold  ETF and Gold saving funds of mutual funds have helped in popularization of gold as an investment. In spite of increase in customs duty on gold, it is unlikely that the demand would come down. A substantial fall in gold price in international market alone could bring respite to import bill of the country. Such a situation is not visible at the moment.
All in all, from an import point of view, there is limited scope to bridge the gap between imports and exports in trade account and Rupee will continue to suffer in the short to medium term.

The problem of Struggling Exports: 
Exports occupy the income side of current account. When exports are robust, they bring in dollars which could match our import needs. In many countries exports are more than imports. Examples could be found in China and Japan. In such countries current account is in surplus and it adds to strength of currency.
In India, historically exports have lagged imports. The resultant gap has been bridged by NRI remittances and other capital account receipts.
In the past two decades from 1991 till 2010, the Indian export basket went through total transformation. Thanks to advances in software technology, a great deal of foreign exchange requirement of the country has been earned through soft ware exports. The BPO segment was another great Forex earner.
The situation has changed materially now. The superlative growth phase of IT companies is behind us. It is a more mature industry and growing much slower. The crisis and sluggish growth in developed world is  another dampener. 
The BPO segment and IT industry as a whole is suffering from one another problem. The problem of cost escalation due to rise in real estate prices and wage hikes. This has rendered this industry less competitive for exports. There is growing evidence to suggest that the industry is going beyond India to China, Indonesia and other Asia Pacific Rim Countries. China is a classic example of export of manufactured goods to earn Forex.
For India this has never worked,the reason being lack of infrastructure. Thanks to all self serving politicians, the country is mired in power shortages, inadequate road and port connectivity, lack of reforms in land acquisition and labour laws, lack of clarity in taxation related issues etc.. 

 

No industrialists are coming forward to set up new industries in India. The growing population of the country consumes more and more food and that leaves very less of agricultural products to be exported. Exports are also a function of demand prevailing in rest of the world. There is no pocket in the world which is asking for more imports from India. The only exception could be middle east region.
All in all there is nothing of comfort in Indian Exports. In the short to medium term there is no concrete evidence to believe that exports will pick up due to improvement in domestic industries or pick up in international business climate. Rupee will not be helped by exports in any manner and will continue to suffer.

 

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