The crash of rupee is crash of confidence

The rupee has crashed from Rs 45 to Rs 54 to the dollar, before recovering slightly to Rs 52.80 on Friday. Dismayed corporations and politicians want the Reserve Bank of India (RBI) to intervene in currency markets and prop up the rupee.

This would be a terrible mistake. The rupee\’s fall is not a technical monetary phenomenon. Rather, it signifies a loss of confidence in India by foreign investors, and by Indians too.

Till recently confidence in India was high, and dollars flooded in from overseas Indians and foreign investors. Much of the black money that had earlier left returned through the Mauritius window. But now dollars are flooding out because people have lost confidence in the ability of the political system to make decisions or implement reforms. As long as confidence in India ebbs, so will the rupee.

This creates problems. Corporations and banks that have taken dollar loans suddenly face hugely higher repayment and interest rates in rupee terms. Importers face much higher rupee bills. By making imports more expensive, the rupee\’s fall can stoke inflation at a time when it is already over 9%.

For all these reasons, people want the RBI to sell dollars and prop up the rupee. Caution, please. Remember that exactly the same arguments were put forward in Thailand by businesses and banks in 1997 to prop up that country\’s falling currency. That propping up helped only temporarily, emptied Thailand\’s treasury and sparked the Asian financial crisis. We must not fall into that same trap. India\’s foreign exchange reserves of $308 billion may look big enough to warrant spending tens of billions on propping up the rupee. Danger: the benefit will be temporary but the damage to reserves may be permanent.

Foreign loans coming up for repayment in the next six months total almost $150 billion. In normal times, lenders would happily re-lend this sum. But with investor confidence in India ebbing and the Eurozone crisis deepening, lenders cannot be depended on to re-lend maturing loans.

The Eurozone banking system could go bust if European government bonds are downgraded sharply by rating agencies — something entirely on the cards. In the accompanying financial panic, investors will withdraw from all markets associated with risk— including emerging markets like India–and rush into safe havens like the US and just sit on cash.

If that happens, dollar flows into India could come to a sudden stop. In that case, repayments of old loans will halve our foreign exchange reserves in six months, and deepen the panic.

That is an extreme scenario. But even without a Eurozone banking collapse, confidence in India is ebbing. Several Indian businessmen are saying it is easier to get decisions and make investments abroad than in India. If even Indians are losing faith in India, will foreigners be any different?

In this murky situation, the RBI must conserve its forex reserves and not squander its dollars in a vain attempt to strengthen the rupee. But it should use other weapons in its armoury. On Thursday, it issued new rules limiting the net open positions of banks in foreign exchange, limiting some forms of currency speculations, and reducing the ability of importers and exporters to bet on the future of the rupee. These steps helped the rupee to recover from 54.25 to 52.80 to the dollar.

However, technical fixes of this kind can have only a limited impact. They cannot reverse something as fundamental as loss of confidence in India.

How do we restore that confidence? There is no quick-fix for this. Reputations are built slowly but lost quickly. Anger against corruption has reached boiling point, and that is a good thing. But the political reaction to public anger has not inspired confidence. Several people are being arrested on evidence that looks very thin, and seems guided more by politicking than a genuine attempt to catch the guilty. The opposition desperately wants to involve P C Chidambaram somehow in a scam originating in the DMK. The Congress government has responded by filing a case against telecom decisions taken by Pramod Mahajan when the BJP was in power.

Many bureaucrats and businessmen have indeed been complicit in big corruption. But the current wave of arrests looks increasingly like vendetta than a genuine desire to root out corruption. So, no bureaucrat wants to take any decision for fear of being hauled up by a vendetta in later years. Businessmen are reluctant to invest in such a murky atmosphere.

Optimists say the darkest hour is before dawn, economic fundamentals will soon reassert themselves and decision-making will resume after the UP elections. Maybe so. But the immediate portents are not bright.

5 thoughts on “The crash of rupee is crash of confidence”

  1. All the currencies except Japanese Yen (including US$) are falling in value (i.e. loosing purchase value). This is because the global economy is well integrated than ever and global production (all goods, commodities, services, etc.) is sufficiently adequate to meet demand. ‘Just in time global production capabilities’ are reducing the requirement of liquid assets/ capital than earlier days causing surplus availability. This is leading to devaluation of all currencies to adjust to the lesser demand of real capital.
    Hardly 15% of gold production is consumed in Industry. Rest is preserved as movable/ liquid asset. Indians are officially importing 60 billion US$ of gold annually. The market price of gold has touched price of platinum whose underground and above ground reserves are far below than gold. In addition much of platinum is consumed as catalyst in low emission automobile engine silencers and industry. Though it is precious and rare, platinum is not commanding premium in the market over its production cost. Some analysts say Platinum prices would fall to 50% of its present market price if electricity run vehicles get preference over Diesel/petrol automobiles.
    Why is Gold commanding premium over its actual production cost? The sole reason is Indians appetite for Gold. Indians are purchasing nearly 1000 tons / year through official or unofficial imports. The gold imports are close to oil imports in India. More over Indian citizens already hold nearly 2 trillion US$ of gold. The all in costs of gold production is 700 US$/ounce from exploration to marketing in the last quarter, 2011 whereas it is trading at 1600 US$ / ounce (nearly 2.3 times). International gold price declines when Indian rupee is depreciating with other currencies.
    If Indians want to bring back gold standard in international economy then Indian rupee has to relatively devalue against international currencies such that gold price in India is equal to its global production cost. If gold standard is going to take place, it seems that INR is going to depreciate by minimum 230% from now i.e. INR 125 per one US$ !!.
    Will it create economic turmoil leading to political upheavals in India? Whether Indian policy makers able to visualize the threat to India as it happened due to same reasons (lust for gold by Indians) earlier in the form of European colonization of India. Indian law makers should seriously think on the demerits of gold imports to contain rupee devaluation.

  2. Article provides nice insight.

    Also to be added in the list, which is making the confidence to be low are,

    High inflation, higher rate of interest, comparably higher operating cost (wages, rent or cost of real estate).

  3. The other option that the Government lost out was on the recent Retail FDI saga. The one aspect that I do not understand here is – it is not that private retail market does not exist in India – we have Reliance, Future Group etc well into the fray. The competition will heat up once foreign players enter the market. Organized retail is an imminent phenomenon – whether Walmart or Big Bazaar, does not a difference make. This combined with the collective failure in the Lokpal case just adds more REDS to the confidence report.


  4. I dont think the fall in rupee is a symptom of a fall in confidence in India. The FIIs have pulled money out of (risky) emerging markets – witness the drop in other asian stock markets – and converted them to (safe) assets that shore up their books. Each FII is motivated to show a good book, and hence the drain from (risky) emerging markets.

    So making policy decisions based on self-presumed guilt will be wrong.

  5. “Indian law makers should seriously think on the demerits of gold imports to contain rupee devaluation.”

    Gold is the only real money. When all the other currencies fail people will rush to gold. The good things about the Indian purchase is that Indians are buying gold when it is cheap. If the price drops they buy more and when they rise they buy less. This is precisely the tactic we must continue to follow, as in the long run it will give economic security to Indians.

Leave a Comment

Your email address will not be published. Required fields are marked *