The Great Indian Rupee Trick - Redux

A lot has already been written about why the Indian rupee has gone into a free-fall. Some of it is utter nonsense, such as stuff which claims rupee should actually be appreciating instead of depreciating. But, otherwise, the narrative has mostly been sane and restricted to the straight and narrow.

What, however, does not get written is Indian government's strategic intent, or the lack of it. Most analyses tend to paint the Indian government as a hapless bystander, hit athwart and stunned by debilitating global financial flows. The fact is this: the portends were strewn in the four winds many moons ago. But, our policy makers were busy frying other fish.

Authorities have been blaming "global conditions" for the rupee volatility. This is an euphemism for Federal Reserve Bank's loud thinking about ending its accommodative monetary policy, or now known as "tapering" in the international bond markets. In essence, it implies the Fed is thinking aloud about when to start reducing (or tapering off) its $85-billion-a-month bond buying programme. 

Arguably, if this does materialise (as some are convinced that it might in September or October), then interest rates in the USA are bound to rise from their current near-zero levels. Plus, that would also imply an improvement in the US economic prospects, because the Fed has categorically stated that it would "taper" only if unemployment rates fall and inflation bumps up.

Now, given all the problems with the Indian economy -- widening current account deficit, slowing economic growth, stubbornly high consumer inflation, stagnant industrial production, a spike in short term foreign debt, growing reliance on populist measures, corruption scandals and impending elections -- the US bond market definitely looked more interesting. Therefore, as soon as news started filtering in about "tapering", investors dumped Indian stocks and bonds and rushed to get back into dollar assets, such US treasury bonds.

This rush to sell Indian assets, take the rupees and exchange them for dollars, created a spike in demand for dollars, leading to the rupee's fall. As the rupee started to fall, more investors started getting out because staying on would mean a further erosion of yields. This self-perpetuating crisis was fed a bit of fuel by emergency measures implemented by Reserve Bank of India.

One leg of the strategy should have been to encourage flow of foreign direct investment which is typically sustainable and long term in nature. But they made a complete mess of it.

But the point here is that the Fed has been talking about "tapering" for quite some time. Sample Fed chairman Ben Bernanke's testimony to the joint economic committee of the US Congress on May 22: "At its most recent meeting, the Committee made clear that it is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes." (read it here)

On the same day, the Fed released the minutes of the meeting of the Federal Open Markets Committee (the round table of Fed knights that sets the interest rate) held on April 30 and May 1. This is the paragraph that showed up on investors' radars with a loud bleep: "Participants also touched on the conditions under which it might be appropriate to change the pace of asset purchases. Most observed that the outlook for the labor market had shown progress since the program was started in September...A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome. One participant preferred to begin decreasing the rate of purchases immediately..." (read the full text of the minutes here)

Fed chairman Bernanke testimony to the US House of Representatives on July 17 had similar strains (read it here). Please note: he never once mentioned that the Fed had decided to withdraw the accommodative measures, leave alone finalising a date to begin the tapering off. He only reiterated that the economy was doing well, there was still some distance left to cover, that the expansionary strategy would continue even after Fed began  "tapering off" and so on.

In addition, many Fed governors had been debating the same point -- about the appropriate timing of the Fed's "exit strategy" -- in their various speeches for months. 

It is, therefore, surprising that while the whole wide world, its grandmother and all the portfolio investors could feel their antennae tingling, the Indian government and its various policy-making arms were oblivious to these developments. There was no counter-strategy, no emergency measures. Nothing.

Forget the past six months. Ever since Fed launched its expansionary monetary policy and flooded the global markets with excess liquidity, it was well known that this money would flow back as soon as there were hints of increases in US bond yields. And, yet they dithered. 

A columnist in Washington Post also said:  "The Fed has telegraphed the tapering and eventual end of its QE policies with with increasing specificity for months now, so you would expect, in a perfectly rational world, for currency and bond markets to have long ago priced in plans of Bernanke & Co. The wild thing about the most recent bout of market volatility in the last few weeks is there's been no earth-shattering news about the prospects for the Fed tapering and then ending its bond purchases. Both US economic data and comments out of senior officials have been broadly consistent with where they were a month ago." (read the column here).

There's only option left now: pray.

Petrol On Fire

In all fairness, the government shouldn't be blamed for policy paralysis. They have acted with such alacrity. Petrol prices were hiked by Rs 7.5 per litre as soon as Parliament went into recess. So, no shouting brigades, no loud thumping of desks, no rushing into the well of the House, no hectoring or haranguing, and no "pliss-pliss". Good only, no?

Actually, the petrol price increase raises two other issues. One, we can expect to finally see the extent of the increase pared down by Rs 2-3 per litre. The protests from allies has already started acquiring a high decibel level. By Wednesday evening, both Mamata Banerjee and Karunanidhi had voiced their displeasure over the increase. SP's Mulayam Singh Yadav, who is being courted assiduously by Congress as a counter-weight to Didi, also expressed his opposition to the price hike. Ditto for RJD's Laloo Prasad Yadav. So, once all these protests reach a crescendo, and acquire some kind of a shrill heft, we might expect to see the Congress top brass relenting and "rolling back" the hike partially. My bet? By Rs 2-3 per litre.

Even The Economic Times is betting that the price rise might finally be tempered somewhat (read here), though for a different reason. Their take: oil prices in the Singapore bulk market have been cooling off a bit.

But, ironically, BJP and CPI(M) have been misleading the public from every forum. By the way, isn't it strange how the right and left get into bed conveniently when they want to squeeze out the centre? Their beef: petrol price hike has a cascading effect and is likely to have a spiralling impact on inflation. That's a load of nonsense. Here's why. Petrol has a negligible weightage (1.09%) in the wholesale price index and its ability, therefore, to bump up headline inflation remains marginal. Also, bulk goods movement --such as essential commodities -- are moved by modes of transport that use diesel as fuel (think trucks) and not petrol.

Are there any reasons to protest against the petrol price increase? Of course, shiploads of reasons to crib about the price rise, but certainly not on account of its impact on headline inflation. The current hike comes on top of the existing inflationary pressures weighing down the middle class. And, this current episode of high inflation and inflationary expectations has its roots in the survival strategy crafted by the government in the aftermath of the 2008 global financial freeze, but let it stay on for far too long. In short, this lifeline to the economy should have been withdrawn much earlier. Plus, of course, the government has been loath to either cut down on wasteful subsidies, or re-align its expenditure strategy which is actually ending up further fuelling inflation. And, let's not even get started on this business about governance deficit. So, of course there's plenty to cry about, but not because a petrol price increase will lead to inflationary pressures as the voices from the right and left are asserting.

The government should have increased prices of diesel along with petrol prices if it really wanted to bring down the current account deficit and stabilise the rupee value. A diesel price hike might certainly be seen as inflationary, but at least these high prices would've curbed demand for the commodity. In return, it might have squeezed the import bill a bit, checked the runaway current account deficit and pulled up the falling rupee.

It is well known that fuel prices needed to be increased, and even the Reserve Bank governor's statements have alluded to the fact about how domestic fuel prices lagging international prices does lead to a build-up of inflationary expectations.

But, guess why diesel prices cannot be increased immediately, though news reports suggest the government will be meeting tomorrow to consider the possibility? The answer: it's summer in this part of the world and, with kharif sowing to begin soon (in the next 30-45 days), pols can't afford to get farmers cross about high diesel prices. In many parts of the country, farmers will need to run their pumps at full tilt, even though we've been told to expect a normal monsoon.

If there was any reason to carp, the grouse should have been why the government didn't spend on improving irrigation infrastructure in the 60 years since Independence. And guess what MPs and MLAs are mostly concerned about? Getting a red beacon on their cars!