Rupee falling? No need to hit the panic button… yet

Publish Date: September 18, 2018

The Indian economy, at the moment, is like a cat on a hot tin roof. It seems to be edgy due to a falling rupee. Globally, the growing intensity of the US-China trade war and high crude prices haven’t helped matters either.

The deepening crisis has sparked a growing clamor for government and central bank intervention. Talks of increasing interest rates and floating NRI bonds have gained steam.
But would that be a good idea?

Increasing borrowing rates and floating NRI bonds

These steps seem too drastic at the moment. Although they are valid options, we shouldn’t be in any hurry to exercise them.

While hiking interest rates may help in curbing inflation, it may adversely affect economic growth going forward as private businesses may suffer due to liquidity constraints.

As far as tapping the NRI population is concerned, that option need not be exercised at the moment because the country’s foreign reserves are at fairly comfortable levels.

Sure, India has successfully floated NRI bonds in the past (1998 and 2000) to stave off pressures on the currency. In 2013 as well, the Reserve Bank of India offered a swap window to NRIs in a bid to to improve foreign currency deposits. It helped the country raise about $34 billion.

Related read: What does high CAD mean to investors?

However, the country’s fundamentals right now are much better than what it was during 2013’s ‘Taper Tantrum’. The retail inflation is manageable — 3.7% now compared to 4.9% at the time of the 2013 crisis and, the forex reserves stand at a healthy $400 billion when compared to $275 billion then.

The data suggest that the government doesn’t have to rush in by raising borrowing rates and launching NRI bonds as of now. These options can be explored if the trade war between US and China escalates further and crude prices become more expensive. Crude prices may go north because of US sanctions on Iran, which means India can’t buy some of its oil for cheap from November 4.

Related read: How high crude oil prices and Iran dilemma will impact India

Rupee concern

The rupee has declined by almost 13% against the Greenback since the turn of 2018. Strengthening of the US dollar and contagion fears in the emerging markets have eroded the rupee’s value in the last few weeks. The growing current account deficit on the domestic front has put further pressure as well.

Related read: All you need to know about the rupee slide

Reacting to the currency depreciation, the Reserve Bank of India (RBI) last week stepped in and announced a five-pronged strategy to address the current crisis. You can read the RBI policy in detail by clicking here.

But, should the RBI do anything more to halt the slide?

In our opinion, they shouldn’t. It would be better for the RBI to adopt a wait-and-watch policy because it is important to note that the rupee has been overvalued for the last two years. The rupee was over-heated because foreign investors have been confident about India’s financial markets. That seems to be changing now though. According to the Securities and Exchange Board of India, foreign institutional investors have sold Indian equities worth $939 million from January 1 to September 12.

However, we believe that the rupee is now simply correcting to its fundamental levels. If you look at the 36-country real effective exchange rate (REER) index for August, it has slipped to 114 as against 121 in July. Above 100 on the REER index suggests that the currency is overvalued, while less than 100 signifies undervaluation. The fact that the REER has dropped this month suggests that the rupee is finding its right valuation.

Importance of meeting fiscal target

We believe the government should instead focus on ensuring they meet their fiscal deficit target of 3.3%. Any slippages on that front could adversely effect the economy as the RBI would have little choice but to raise interest rates.

The two ways the government can meet their fiscal target is by meeting the GST collection and divestment revenues target. The worry is that the government is behind the curveball on both fronts. While GST revenues are short of the monthly required run rate of Rs 1.05 trillion (it has raised an average of Rs 950.25 billion in GST revenues so far), the divestment revenue has been pegged at Rs 129 billion as against the annual target of Rs 800 billion. The failure to sell Air India, Hindustan Copper and Mecon have set back the government in its chase to meet the divestment target. Now, it is relying on the power sector to meet this year’s objective.

What else can the government do?

There are alternate ways to raise divestment revenues too. For instance, the government can raise Rs 850 billion if it decides to sell its minority stakes in four private companies (Axis Bank, Hindustan Zinc, ITC and L&T). It can also raise additional revenues through dividends of cash-rich public sector units (PSUs) like Coal India, BHEL and NMDC. If push comes to shove, the government can raise around Rs 3 trillion if it decided to sell its 51% stake in all PSUs.

In short, the government can raise additional revenues by meeting the GST and divestment target. Plus, the healthy forex reserves is a bonus as it can pay for eight months’ worth of imports, which is far better than the 2013 crisis. However, the decision-makers need to keep their eye on the ball. A rupee slide of more than 20%, unmet GST and divestment targets and widening CAD will certainly cause the alarm bells to go off.

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