Factors affecting the strength of Rupee - Part II
Unmanageable High Fiscal Deficit – the self inflicted wound
Imagine a situation where you overspend a huge amount of money more than your earning ability!!! Not once, but habitually for many years by borrowing from others!! This is irresponsibility of highest order. You would go broke in no time. If an institution does it, it will soon be out of business. But if the Government does it, no one notices or questions!!! However the repercussions will follow, in later years. Other wise how can Government spend more than 3,00,000 crores over and above its income. From where will the Government get this bounty?
It obviously borrows from banks with a promise to pay at a latter day. What will it do with the borrowings? It wastes by doling out subsidies like diesel, fertilizer, kerosene, food etc. The precious savings of public thus goes waste for consumption purpose instead of being used to create capacities in the economy. When such a situation follows for many years, a point will come where the income of Government will not be sufficient to pay even the interest costs of borrowing. We have reached the reaping stage for this sin.
The rating agencies have issued warnings of down grading the country for it's doubtful abilities to make payments. We are just one stage above the junk rating. If it happens, country will not be able to borrow dollars on soft terms. Eventually rupee will drift lower against dollar.
Problem of stubborn inflation:
Inflation refers to rise in costs of goods and services over a span of time. It is usually calculated over a period of one year. The inflation results, when there are shortages in supplies or due due to excessive money circulation.In both cases imports go up due to excessive demand. On the other hand exports fall due to cost escalation of domestically produced goods. The net result is demand for dollar goes up and value of rupee comes down.
Historically India has faced a inflation gradient against developed world. As a result value of rupee constantly erodes over a period of time. Indian rupee has been losing on an average anywhere from 3 to 5% every year due to this. It is interesting to note that dollar rupee equation in 1979 was Rs 7/dollar. Currently it stands at Rs. 54/dollar. This difference will accelerate further in years ahead. During last 5 years India suffered from a inflation of about 10% on ground compared to a inflation of 2-3% in developed world. This was one of the major reasons for collapse of rupee last year from 45 to 57 per dollar. Of late there is slight moderation in inflationary trajectory, however it is nowhere near comfort zone. Going forward inflation will continue to put pressure on rupee till inflation falls below a level of 5% .
Problem of Growing External Debt:
The interest rates differ widely between India and the developed world. The interest rates which are close to zero offer very good opportunity to corporates to raise money cheaply in international markets. For a country which is suffering from constant current account deficit this borrowed money helps to bridge the gap.
RBI has been constantly increasing the limits for external commercial borrowings over the last couple of years. However this is a double edged weapon. This works very well when the rupee is stable and appreciating. On the contrary, external commercial borrowings will eat into foreign exchange of the country as well as profitability of corporates when currency starts depreciating.
Many of the Indian companies are suffering now due to their past borrowings abroad. During last few years external borrowings have risen alarmingly. The total external debt of the country stands around 350 billion dollars much higher than the total foreign exchange on hand. Even within this, the short term borrowings have risen from 13% of total debt in 2005 to 23% currently. Nearly 50% of this short term debt has to be paid back in a years' time. Unless this debt gets rolled over, the country will struggle to pay off this debt and rupee can tumble down to uncomfortable levels. It is worthwhile to remember that the excessive short term external borrowings was the root cause of currency meltdown of countries in Asia Pacific region in mid 90's.India is too close to such a situation.
Remittances by NRI Community:
Non Resident Indians are scattered all over the world are estimated to be in excess of 25 millions. Most of them remit back their earnings to India. It is one of the major sources of foreign exchange for the country. The earnings of NRIs depend on the economic situation prevalent in the country of their residence.
As things stand today, most of this population is scattered around developed economies of USA, UK, Canada, etc. A great number of people are working in middle east region too. Barring the middle east region, the situation in other parts of the world is not conducive enough to expect higher remittances from NRI.
Last year, Govt. of India in its bid to attract and hold dollars, gave tax free status to NRI deposits and freed the interest rates on such deposits. NRI deposits suddenly became attractive. Making best use of interest rate differential between India and rest of the world, a lot of NRIs last year resorted for borrowing in their countries of residences at low interest rates and depositing the same in their NRI deposits. The net result is, they need to service these borrowings now and their remittances could be lesser this year.
Similarly the attraction of bubbling real estate has made NRIs borrow outside and remit dollars back home during past couple of years. These loans too need to be serviced, resulting in low remittances this year. Considering all this, higher level of dollar remittances from NRI community cannot be expected this time. The cause of Rupee devaluation cannot find support at NRI remittance level.
The only hope - FII inflows( Foreign Institutional investors) and other Capital account receipts:
Amidst all the negatives pulling down the rupee against the dollar, the only counter weight holding rupee is the relentless FII flows into the country. If situation in India is so bad, why are FIIs pouring money into India? The answer is not simple. The reasons could be many.
In a world which is slowing at many places, there are very few pockets which still offer growth. India is one of them. The returns from US treasuries has peaked and bonds are expected to be on a downward trajectory. A huge amount of money is exiting US Government bonds and finding place elsewhere in the world. India is one of them. India has been constantly increasing the limits for FII to invest in Indian bonds which carry attractive coupon rates. RBI has also increased limits for external commercial borrowings several times during last two years.
Round tripping of money Indians held abroad entering back through FII route cannot be ruled out. The calendar year 2012 saw India receiving 30 billion dollars ( 1,65,000 crores) and January 2013 saw another 25,000 crores coming in through FII route. The worst part is, all that huge influx of cash was not able to push the rupee anywhere near previous levels. After seeing a lowest of 57 per dollar, rupee could hardly recover to 54.
This shows the magnitude of problem on hand. Rupee, even to stay where it is, needs huge inflow of dollars from FII. The music of FII inflows should continue nonstop for the rupee to hold on!!! Let's forget music stopping all together, it can't even be muted, situation is so grave. But there is no guarantee of continuous and uninterrupted dollar flows. The risk and chances of rupee sliding down are heavy.