| |
A problem of plenty for
India
By Indrajit Basu
KOLKATA - The most discernible indicator of
India's over a decade-long economic reform program and
success of its macro economic management has been the
surge in the country's foreign exchange reserves, so
feels India's federal bank, the Reserve Bank of India
(RBI).
In 1991, when India faced an economic
crisis that brought the nation almost to the brink and
even forced it to pledge its gold reserves to meet
foreign payment obligations, forex reserves were just
sufficient to support one month worth of imports.
But now, although the RBI refuses to admit it,
it's also a problem of plenty. According to the RBI's
latest count, India's foreign exchange reserves hit
US$70.29 billion, on December 27; a level sufficient for
over 14 months' imports.
The surge in dollar
inflows has resulted in a problem that the country has
not faced in many years: that of its rupee appreciating
against the dollar. After dropping from Rs 48.24 to the
dollar on January 1 last year to Rs 48.84 on June 30,
2002, the rupee has been rising continuously since then
to touch Rs 47.96 this mid-week. And, the rising rupee
is impacting adversely not only the RBI's monetary
policies, but the country's crucial IT industry,
exports, and even the mutual funds industry that was
given the freedom to invest in foreign debt instruments
recently.
Here's how a surge in dollars impacts
India's domestic finances. Since India hasn't yet made
its currency fully convertible, which means that no one
here, barring foreign citizens, can freely convert rupee
to any international currency like dollars, and
vice-versa, all dollars flowing into the country are
bought over by the RBI. And each time the RBI buys
dollars it releases rupee into the economy.
But
besides shoring up the country's dollar stack for
meeting its international payment obligations, the RBI
buys dollars for various other reasons. A very important
one of which is to ensure that the dollar is in constant
demand within the country, so that the rupee depreciates
evenly over years and makes the country's exports more
competitive globally.
In fact for years India's
exporters and the IT industry - which earns about 98
percent of its over $10 billion a year revenues from
exporting services - have depended on a depreciating
rupee for their topline growth. Over the past 10 years,
the rupee has seen an average depreciation of 5 percent
per year against the dollar. The rupee had even
depreciated by over 15 percent a year at times in
between.
However, over the past seven months,
the rupee has been appreciating steadily. It appreciated
by about 2 percent since June - despite an active
intervention of the RBI, that has been constantly
mopping up dollars, releasing a flood of rupees into the
economy.
For instance from January last until
end-December the RBI is estimated to have mopped up
about $17 billion, which means that it has pumped in
over 800 billion rupees (assuming that the RBI had
purchased each dollar for 48 rupees) into the country's
economy in less than 12 months.
Result: Indian
money markets are flush with liquidity, which has pushed
down the country's interest rates to its lowest since
1973, apart from pulling up further the value of rupee
vis-a-vis the dollar.
Where are all these
dollars coming from? One of the key reasons for the
flush is the country's surging IT and other exports
coupled with a lack of imports in the softening domestic
economy. The other reason is the continuous sliding of
interest rates in United States and elsewhere globally.
Despite the liquidity overhang and a fall of
4.75 percent over the past five years, interest rates
are still higher in India than they are in other
developed countries. And this has led non-resident
Indians (NRI) to rush in with their personal
investments.
According to the RBI, in the six
months until December 16, non-resident deposits in banks
- in a special NRI scheme called NRE Account- increased
by $2.9 billion, the highest ever.
Small wonder,
therefore, that the India's IT industry, exporters, and
even mutual funds are crying hoarse.
The IT
industry's woes are worst because a depreciating rupee
reduces their revenue growth and an appreciating rupee
hits margins - because its operating and capital
expenses are denominated in rupees. "Rupee appreciation
is something we have yet to adjust to," said Vivek Paul
vice-chairperson of NYSE-listed Wipro, one of India's
top software companies. "I believe an appreciating rupee
will continue to keep margins under pressure even though
pricing for projects have stabilized," he added.
The problems for India's exporters are similar
to the IT industry and, for mutual funds, the rising
rupee has put brakes - at least in the short term - on
their investment plans in overseas securities.
Mutual funds extracted permission for this new
investment avenue from the Securities and Exchange Board
of India in March after a fair amount of struggle. "The
rising rupee against the dollar has taken away the
attractiveness of this avenue," said Nikhil Johri, CEO
of Alliance Mutual Funds, one of the biggest funds in
the country.
But the surge in dollar inflows has
an upside as well; it has come as a sort of manna from
heaven for the country's federal government struggling
hard to keep its ever burgeoning fiscal deficit under
check.
But again, the benefit of the sudden
increase of money flow in the economy has been limited.
According to an internal RBI review paper prepared
recently, the sole beneficiary of all the money flow in
the economy and interest rate cuts as a result thereof -
over past five years, India saw its bank rates slashed
from 11 percent to 6.25 percent through 11 rate cuts by
the RBI - has been, and will be, India's federal
government and its borrowing program.
Here's a
look at some sleep-inducing but very revealing numbers
given in the RBI's very own latest year-end report.
According to the report, the total outstanding credit -
money lent out - of financial institutions increased by
15 percent, at $125 billion, for the year ending March
31, 2002; an increase 2 percent lower than growth in
credit in the previous year. However, total investments
by financial institutions in federal government bonds
increased by 22 percent in the year 2001-02 compared to
a less than 20 percent increase in the previous year.
Simply put, while Indian financial institutions
tightened their purses in 2001-02, they have been very
generous in lending money to the federal government.
The internal paper also adds that the borrowing
is now less expensive for the Indian government than for
Washington. For instance, the yield on the benchmark
10-year government bond is currently hovering around 3
percent (after adjusting for a 3.43 percent inflation),
while the real yield on the 10-year US treasury paper is
around 3.46 percent after adjusting for the 0.6-percent
year-on-year rise for US producer prices for October.
Data for other developed countries show that the
Indian government's cost of borrowing is also lower than
theirs. For instance, in Britain, the year-on-year rise
in the producer price index for October was also 0.6
percent, while the real yield on the 10-year bond is
4.59 percent. And, according to The Economist's producer
price data for France and Germany, and taking the
current yields on their 10-year bonds, the real yield on
the 10-year sovereign bond is 4.2 percent in France and
4.1 percent in Germany.
"We should be proud that
the government of our capital-scarce developing country
has been able to comfortably beat all these rich
developed countries in lowering the cost of capital,"
said an RBI official, adding a twitch of sarcasm.
The paper goes on to add that the continuous
slide in rates has failed to benefit most in the wide
spectrum of borrowers in the country. It says that
barring property mortgages - ie home loans - where
consumers have directly benefited from rate cuts, no
other class of borrowers has really benefited because
lenders have not passed on entirely their lower cost of
money to Indian borrowers. Most people feel that rupee
will continue to appreciate. Experts say that is because
dollars will continue to rush in and in the absence of
commensurate demand for rupee, the RBI would not be able
to continue purchasing dollars.
"India and China
are the only two economies which are growing at a much
higher rate than the rest of the world," said Subir
Biswas, country treasurer at the Dutch bank, ABN AMRO.
"Naturally, money will flow to these countries."
Onkar Goswami, chief economist at the industry
lobby, the Confederation of Indian Industry, said, "In
the absence of market demand, the RBI would not be able
to continue purchasing dollars by selling government
bonds."
Goswami even predicts that contrary to
the average annual 5 percent depreciation that the rupee
saw in the past decade, "India should assume a 3 to 4
percent appreciation for a while since supply of dollars
is likely to exceed demand."
Experts add that in
an optimistic scenario, even if the rupee doesn't
appreciate further but merely maintains its level, it
would still be a change from the average 5 percent
annual depreciation to which India had lately become
accustomed.
"This change in itself will lower
export realizations by 5 percent annually, make imports
cheaper by 5 percent and increase the attractiveness of
Indian assets by 5 percent," said Manas Chakravarty, a
widely followed commentator on India' economy. "India
then, could face an embarrassment of riches and that
would be a whole new economy."
(©2003 Asia Times
Online Co, Ltd. All rights reserved. Please contact content@atimes.com
for information on our sales and syndication
policies.)
|
| |
|
|
 |
|
