Rescuing the rupee – getting facts straight

RBI is helping the rest of India grasp all that has gone wrong with the economy and the country in the last several years and thus begin to journey on the long road to recovery.

The first part of the title of this article is copied from a rather useful and well-written article by good friend Ajit Ranade in Financial Express on 12 August. Unfortunately but unsurprisingly, the measures announced by the government later on Monday did not include any of the measures that he had suggested in his article. The government continues to ease External Commercial Borrowings (ECB) for Indian companies. That helps financing in the short-term while it accumulates trouble for the medium to long-term. Yours truly has consistently highlighted in his blog that 50 billion dollars of ECB by Indian corporations in the last four+ years is part of the problem and not the solution.


Further, the government has hiked import duties on gold and silver and announced fresh curbs on their imports. I am not sure that these are necessary and would work. Their costs might exceed the benefits. Instead, the broad strategy of curbing demand through RBI interest rate shock causes fewer distortions even if it causes more pain all around.

There continues to be inadequate understanding of actions taken by the Reserve Bank of India (RBI) in mid-July. Some fault the action; some fault the dovish press release on July 30 after monetary policy review (I did too) and some fault the lack of clear communication on the motives of the mid-July interest rate moves.

I had already written enough on the mid-July interest rate hike in my blog. The rate hike was the right medicine, even if it was and is very bitter for many. In a supply-constrained economy – notice how even the recent government measures have nothing to do with improving/relieving economy’s supply constraints – the only way to bring down the current account deficit is to crimp demand. The interest rate move by RBI has prompted banks to hike deposit rates and that should bring more money into the banking system from savers. Monetary transmission will work over time. It does not happen instantaneously.

In a recent comment, Sajjid Chinoy of JP Morgan had to say this on India’s coal, iron ore imports: “The current measures can be interpreted as necessary fire-fighting to stabilize the Rupee. Yet, one cannot help but think that these measures are band-aid to stop the bleeding. The more fundamental – and therefore sustainable — measures to tackle the CAD will emerge when authorities are able to boost iron ore mining and exports (which will commensurately reduce scrap metal imports), reduce reliance on imported coal, and increase urea prices to disincentivise over-use and thereby curb imports. The trade deficit on these “policy fronts” has risen from $5 bn in 2006 to over $40 bn last year!”

Also, most commentators appear extremely reluctant to face the prospect of further declines in the economic growth rate. That is understandable, especially if it came from non-economists. But, economists have to think of two angles:

One, it is one thing to criticise the RBI for the damage that its interest rate hike has caused. But, it is important, at the same time, to think about the counterfactual. What could have happened without it? Would RBI not have thought of it? Or, can you imagine a world of corporate defaults on foreign loans, especially when the country is trying to plug a current account funding gap? Wouldn’t it shut the doors for Indian borrowers and those who seek equity at least for the next year if not longer?

Two, as Arvind Subramanian points out in a recent Op-ed in FT on the appointment of Raghuram Rajan as the next governor of the RBI, Indians have been more obsessed with economic growth than with containing and taming/slaying inflation. Until now, RBI has been hamstrung by its dual role of being a debt manager for the government and monetary policy authority. Finally, with some semblance of fiscal awareness on the part of the Government of India (not that I agree but that it is the perception), RBI is able to concentrate more on its monetary policy obligations. The real rate has to become positive for it to curb demand. Despite the recent interest rate move, real rates are not positive yet in India unless one looks at rates on longer maturity loans.

Growth slowdown hurts but growth slowdown might well have occurred even without RBI actions (and it has happened already despite real rates remaining in negative territory all along).

We should remember and repeat, ad infinitum, that India’s 2012-13 growth slowdown has nothing to do with RBI interest rate hikes but has everything to do with government policy omissions and commissions. Remember Pratap Bhanu Mehta’s article in the Indian Express and this insightful op-ed by TN Ninan in Business Standard, more recently.

As for critics calling RBI moves a failure, it is most disappointing to see them forget all about lags in economic policy. Give at least six months for RBI rate hike to work. Demand will be curbed; imports will decline. Indians have a lot of cleaning up to do. A more pronounced growth slowdown – a very bitter medicine to swallow – is what a good doctor would order. That is what will focus minds on survival and productivity.

As for the communication after the monetary policy review, as a good friend pointed out, it did not matter that the governor threw few words of comfort for the beleaguered fund management industry and politicians. The truth is that he did not rescind the moves made in mid-July either on July 30th or until now. I have to agree even though I would have liked him to sound hawkish and not even offer words of comfort.

As for RBI not sharing the rationale behind taking cognisance of rupee volatility “all of a sudden”, the central bank does not have the luxury of shouting ‘fire’ in a crowded theatre. The fact that India’ External Commercial Borrowings (ECB) had vaulted 50 billion US dollars in barely four+ years must be enough to convince onlookers that the rupee depreciation of the last few years must be wreaking havoc with servicing that debt, especially in the context of slowing top-line growth and rising costs for Indian corporations. See this story on the corporate balance-sheet problem.

In fact, that brings us to the issue of just exactly how much the Indian rupee has weakened. For example, Ajay Shah wrote the following in his article in the Economic Times (I blogged at length on his article here):

“In 2013, rupee fluctuations are not odd. There has been 12% rupee depreciation. Roughly half of this is simply about fluctuations of the dollar, euro and yen. An India-specific component of six percentage points in this year is in line with high inflation in India and weakening conditions in politics and the economy.

When compared with other emerging markets, the rupee is roughly in the middle of the pack.”

This is what we set out to disprove here. The Indian rupee is not in the middle of the pack. Perhaps, it is if you take a very narrow window of time and ignore the crisis and the post-crisis periods. See the table below:


The table shows percentage return for the spot US dollar exchange rate of these currencies. (Source: Bloomberg Finance, LP)

This table shows the performance (return in percentage) of all currencies labelled “Emerging currencies” by Bloomberg vs. US dollar. Three time-periods have been chosen. One is from July 2008 until Feb. 2009. It is the global crisis window. The second period is from August 2011 until August 2013 and that is when the Indian rupee depreciation started. The third window is from March 2009 until Aug. 13, 2013. It is the post-crisis global recovery window. The fourth window is the entire period from July 2008 until now, for the sake of completeness.

These are my conclusions, perusing the table:

(1) During the crisis period (col.2), the Indian rupee was certainly not the worst performer. The halo surrounding India remained strong.

(2) In the last two years (col.3), Indian rupee has certainly been one of the worst – worst three, with the South African rand and the Brazilian real. We will talk about Brazilian real parenthetically later.

(3) If one took into account, the post-crisis recovery period of around 4.5 years, Indian rupee has been the second worst performer after Argentine peso.

(4) Over the entire five-year period since July 2008, India is among the bottom seven. But, at least five of them had the bulk of their bad performance during the crisis period of eight months and not in the subsequent 4.5 years.

The long and short message is that the Indian rupee is not in the middle of the pack. It has been the worst performer (barring Argentine peso) in the last 4.5 years. Any responsible central bank will have to take cognisance of that. That is what the RBI did.

In fact, there is a lesson in the experience of the Central and Eastern European currencies during the crisis period, for India. They collapsed because their residents had borrowed in Swiss franc and the Euro for their housing mortgages. That is exactly Indian corporations have done in the last few years and that is why currency weakness, if allowed to persist, could be ruinous for India.

That is why RBI move of mid-July made and continues to make sense. It will put a floor under the rupee, it will curtail demand and hence put a floor under the current account deficit eventually and then also bring down inflation expectation.

On their part, both the government and businesses have to look hard at structural reforms in their respective spheres. That is not happening yet. In fact, both find it rather convenient to engage in breast-beating on economic growth and find a scapegoat in RBI for that.

Hence, the reason for pessimism on India lies in the response of the government (largely) and that of businesses (somewhat) to the current account deficit and the growth slowdown and not in the response of the RBI. That is why it was rather disappointing to see an experienced (ex) policymaker and observer like Shankar Acharya list RBI interest rate move as one of the five policy mistakes made since 2009. He has got it completely wrong.

By causing a further slowdown in economic growth, RBI is helping the rest of India grasp all that has gone wrong with the economy and the country in the last several years and thus begin to journey on the long road to recovery.

Photo: surabhidhake