Structural reforms and The Rupee slide

Problem: Rupee depreciation and associated volatility and structural reforms neede...
CAD(As % of GDP)
CAD(As % of GDP)




Volatile Stock Market:
When Indian economy does well, Foreign investors invest heavily into the stock market for
which the...
cheap labour force to further strengthen our exports. This would require modernisation of
agriculture equipment, better st...
the real rate of returns is more than gold which will eliminate the gold investment and reduce
deficit and also can help i...
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Structural reforms and the rupee slide


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Structural reforms and the rupee slide

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Structural reforms and the rupee slide

  1. 1. Structural reforms and The Rupee slide Problem: Rupee depreciation and associated volatility and structural reforms needed to strengthen Rupee. Introduction: On 26th of June 2013 Rupee slid to an all-time low of 60.76 against dollar and it would not surprise many if Rupee crosses the 70 barrier in coming months. Because of gloomy economic scenario all over the world and an improving economic situation in US almost every currency has taken a hit and dollar has gained position over them, but Rupee is amongst the worst hit currencies and has been very volatile not only over last few days but over a few months. Though it is true that world economic scenario and few measures by US federal reserves has triggered the slide for rupee but a little longer look over this issue and we can’t deny the issues within the Indian economy. We will take a quick look at the issues in our economy and then discuss the structural reform measures available to the government to make the Rupee more stable. Currency INR June 2011 44.84 June 2013 60.76 % Change -35.504 Russian Rouble 27.92 33.06 -18.40 Japanese Yen 80.32 99.09 -23.36 Source: Issues in Our economy: High Trade and Current account deficit: Balance Of Trade (US Billion $) 250 200 150 Balance Of Trade (US Billion $) 100 50 0 2009-10 2010-11 2011-12 2012-13 Source :
  2. 2. CAD(As % of GDP) 6 5 4 3 CAD(As % of GDP) 2 1 0 2009-10 2010-11 2011-12 2012-13 Source: We can see how trade deficit and current account deficit of India has been increasing.India's trade deficit has reached a low point of $190.91 billion and it has to do with the exports declining 1.76% compared to last year because of slowdown in all economies of world and imports rising on account increasing petroleum and bullion imports. India has also reached all-time low current account deficit(CAD) of 5 per cent of GDP previous fiscal. Because of high trade deficit and current account deficit we have to buy more of foreign currency and which ultimately results in reduction of value of Rupee. Higher Gold and petroleum Imports and high gold prices: Source: Very high prices for gold have created panic among investors and fearing a bubble there, investors started moving towards dollar. This demand in dollar is also causing depreciation of rupee.The two largest items on India's import bill are crude oil followed by gold. We produce little of crude domestically and virtually no gold. Yet, in the world markets we are third largest importer of crude and the largest importer of gold. This is the most important reason of India having very high trade deficit.
  3. 3. Volatile Stock Market: When Indian economy does well, Foreign investors invest heavily into the stock market for which they need Rupee and which results in higher demand of Rupee and hence Rupee appreciates comparatively. In today’s scenario where Indian economy is not doing well and so is most of the world's economies and this combined with US economy showing signs of recovery, foreign investors are pulling their money back which has resulted in buying dollars and rupee depreciation. The dollar is still the safest paper currency in the world! So, there is more demand for dollar in volatile condition like this. This will add to the rupee depreciation. Inflation: When a country experiences high inflation over the years it affects economic growth negatively, leads to capital outflows and ultimately depreciation of the home currency and India has been facing a prolonged inflation of around 10 % for more than an year resulting in worsening of economic prospects, Rupee losing its purchasing power or Rupee depreciation. Subsidies: We have subsidised all petroleum products and this has led to increase in its consumption over the years this has meant that renewable source of energy have not been able to find their feet due to lack of innovation and which has also meant that petroleum imports have been increasing continuously leading to high CAD and ultimately more demand of foreign currency and reduction in Rupee value. Political paralysis: Lack of Reforms Important policy reforms like Direct tax code (DTC) and Goods and services tax(GST) are yet to be implemented. A retrospective law like GAAR has already created doubts in the mind of investors. Measures to cut subsidy have not brought any relief as CAD has continued to rise. FDI in retail has come with many reservations and government has not been able to bring consensus on this. We are still apprehensive on opening many sectors for FDI. Environment clearances for major projects still come very late and bills related to Land acquisition and mining are yet pending. To add to this black money and corruption prevalent in Indian economy and all of these have halted flow of FDI into the country. Inefficient monetary policies: Today government is trying to reduce gold imports(and hence CAD) by further taxing the imports but the inherent issue is the fact that people have to save using gold as gold provides positive real interest after accounting for inflation while real returns via other financial products are either negative or lesser than Gold. Higher interest rates brings more investment but because of slowdown RBI had to reduce the policy rates further affecting flow of money into India and thus putting further pressure on Rupee. Structural Reform measures: Increase exports We should try to focus on the industries which we are already good in to increase our exports like IT, Gem processing, pharmaceuticals, agro based industries etc. which will help to reduce the CAD. At the same time we should try for self-sufficiency and slowly try to make our manufacturing industry export based. We already leaders in IT and doing well in Services as a whole. We have a very bright future in Agro-based industry as we employ half of our population there. Agriculture should be treated as an industry and govt. should invest more there to bring in another Green revolution because our yield per hectare is still lesser compared to many developed countries. With china the biggest food importer, a neighbour of ours, we can leverage this position and our
  4. 4. cheap labour force to further strengthen our exports. This would require modernisation of agriculture equipment, better storage facilities, and better transport facilities. As we increase exports our CAD will reduce and hence demand for foreign currency would reduce which will help to strengthen the Rupee. Elimination of subsidies: We should slowly remove the subsidies as it will help reduce fiscal deficit (and hence improve government savings). Elimination of subsidies on petroleum products would force the economy to be more fuel-efficient and cut the demand of crude petroleum by favouring innovations in other sources of energy.Direct cash transfer can be helpful in elimination of subsidies in phased manner.This will help in reducing our trade deficit. Thus by reducing the fiscal and trade deficit we will not need to buy more dollars to finance our economy ultimately strengthening the rupee. Reduce and stabilise inflation: We should try to address main reasons related to inflation: Agriculture: Since India is mostly an agro based country, we should try to increase our investment, modernize equipment, better storage facility, and more incentives to farmers, reduce transportation delays, reduce dependence on rain in agriculture sector as rise of food prices are an important factor in inflation. Policy: We have a very high dependence on imports for meeting our crude oil needs, and as crude oil rates increase which also result in inflation in the country, so as discussed in the above point we should try to reduce our dependency on imports for the energy needs. Improve Supply of common items for public: We should make more investments in S&M scale industries, give them more incentives so that we have more of manufacturing industries in India and supply of common products increase. Keeping inflation under control will keep the purchasing power of the currency in control and hence keep the growth outlook positive against other currencies including dollar. Improve infrastructure: Improving infrastructure in every sphere of Indian economy like better connectivity through roads and canals, improving the condition of ports, better storage facilities for agricultural goods will help us reduce the time in the transactions and most importantly attract more investment in every field of Indian economy through FDIs/FIIs. We should improving infrastructure for fuel deliveries to power plants to end electricity shortages. We need more projects like Golden quadrilateral, NSEW corridor and we should also look at the river connectivity programme which will provide water to the water deficient states and help to reduce floods in the flood prone areas of the country. Better infrastructure will create a better environment for investment and hence bringing up the demand of Rupee. Economic reforms: The country cannot rely on foreign institutional investment as these capital flows are volatile. The long-term solution lies in attracting more permanent capital in the form of foreign direct investment and in becoming export competitive globally. The government should consider further liberalisation of FDI norms and allow foreign investment into sectors like defence, telecom and asset reconstruction, easing foreign institutional investment limit in debt and issuing government bonds in foreign currencies and/or rupee bonds offshore. Govt. can also issue sovereign or rupee-denominated bonds for non-resident Indians. We should also create a National Investment Board (NIB), having members from all clearance parties which can be single point of contact for giving all approvals and fastening the investment processes. Transparent policies should be there for auction of all the resources like coal and other natural resources, spectrum etc. Higher Interest rates:We should set up the interest rates in financial products in such a way that Better investment environment:
  5. 5. the real rate of returns is more than gold which will eliminate the gold investment and reduce deficit and also can help in more demand of these products thus increasing the demand of Rupee. Better tax policies:GST and DTC implementation critical; practical timelines should be announced and adhered to FRBM Act:Government should restructure the act and it along with RBI should strictly adhere to this which can help to bring the deficit under control. Political Reforms: Faster and single point of approvals for investment projectsincluding environmental clearances helping in streamlining the investment process in the country. We should have tax treaties with different countries to reduce tax avoidance cases. Reduce corruption by legislations like Lokpaland by election reforms in the country. Govt. should give more powers and autonomy to institutions like CBI and CAG and more regulators should come in sectors related to natural resources. The above political reforms will create a better and stable outlook of the Indian government and India as a stable investment option which ultimately will increase the demand of Rupee. Conclusion: All the above structural measures political, economic or any other will be helpful in one or more of the following:1) Project India as a better investment destination thus bringing in more investment to the country for a long term and hence increasing the Rupee demand. 2) Reduce Fiscal and Current account deficits thus reducing the demand of Dollar. 3) Maintain the Purchasing power of Rupee in comparison to foreign currencies. Hence all these points ultimately result in strengthening the Rupee against foreign currencies like Dollar. References: 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12)