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Economy Aug 22, 2013

CAD pain: With rupee at 65, it’s raining bad news for UPA

By Sourav Majumdar

There are times when nothing seems to go right. When it rains, it pours. For the Congress-led United Progressive Alliance (UPA) government, this is such a time.

A time when growth is sputtering and a slowdown has hit the economy, the rupee has hit its life low against the dollar and the country's monetary authority, the Reserve Bank of India (RBI), has had to resort to sending out mixed policy signals in a bid to ease the serious liquidity crunch in the system.

Worse, none of the steps announced by finance minister Palaniappan Chidambaram and the RBI to try and control the currency's slide and seek to rein in the ballooning current account deficit (CAD), the chief cause of the current problems, have worked.

The rupee shows no signs of halting its slide and all eyes are on the US Federal Reserve for signals about when the tapering of its quantitative easing (QE) program will begin. The tapering of its QE program can potentially spell further trouble for the already battered rupee and the RBI has already made it clear that it's not clear whether future announcements on the QE front will cause further volatility in the forex market.


None of the steps announced by finance minister Palaniappan Chidambaram and the RBI to try and control the currency's slide and seek to rein in the ballooning current account deficit (CAD), the chief cause of the current problems, have worked. Reuters

The minutes of the Federal Open Market Committee (FOMC) 30-31 July meeting, released in Washington late on Wednesday night India time, also did not throw much additional light on when the QE tapering would actually start, with the committee split on the issue. A few members said tapering may be needed soon, while a few others emphasized the importance of being patient. However, the committee was 'broadly comfortable' with Fed chairman Ben Bernanke's plan to start reducing purchases of bonds later this year if the US economy improved, reports suggested.

Now consider the scenario back home: the rupee's life low comes after a series of measures announced by the government which virtually amount to partial capital controls, imposing restrictions on Indian companies and resident Indians in a throwback to the regime of the nineties. The RBI, on its part, had imposed liquidity-tightening measures which were widely seen as a threat to already-faltering growth. But the two-pronged attack to stem the rupee's fall yielded little, and instead, keeping the serious liquidity problem in mind, RBI on 20 August had to virtually reverse its stance on the long end by announcing a Rs 8000 crore bond purchase through open market operations (OMOs).

This helped ease bond yields somewhat, but analysts and market watchers see this as an acknowledgment that defending the rupee will be tough going forward, since there is the obvious tradeoff on liquidity and, consequently, growth.

This has spelt further problems for the rupee, which promptly hit its life low of Rs 64.54 to the dollar on 21 August, as the market waited with bated breath for signals from the Fed on when its stimulus would begin tapering off. The market fears an increased flight of capital once it becomes clearer when the QE would start being withdrawn, with most betting on September as the starting point.

An HSBC report of 21 August, after the RBI's partial reversal of liquidity tightening, points to the problems which still stare policymakers in the face: "Expectations of the Fed's tapering of its QE program have intensified concerns over the financing of the current account deficit in India. According to the Ministry of Finance's estimates, India will need around $70bn of funds in FY13/14 versus $88bn in FY12/13 to finance the current account deficit (CAD). Even though recent curbs on import items such as oil, gold, and non-essential imports may help to lower the CAD, it will still be difficult to finance $70bn without foreign portfolio/direct investments."

Yet, such investments may be difficult to attract given the current weaker demand for emerging market assets and the lack of clarity on India's reform process following the general election which is due by May 2014, HSBC says in the report.

JP Morgan, on the other hand, says in a report titled "Too Much CAD Pain" that it was downgrading India.

"Are we too late? We are certainly late in downgrading India. Our OW (overweight) case was less fiscal drag and a monetary stimulus leading to a modest cyclical acceleration in 2H13. The move in the rupee has overwhelmed this. Policy options are limited. They have announced reform plus technical measures to support the currency. These have not worked," the report says.

That Chidambaram's measures to rein in the CAD has had little impact on the currency market is evident. Faced with measures like controls on overseas investments, India Inc has also begun raising its voice in protest and there's intense debate about whether the country is back to the gloomy days of 1991.

While RBI, economists and analysts are clear that structural reforms are the need of the hour, there's little evidence that barring the announcements which came in thanks to the steep slide in the rupee, there will be any major reform measures announced by a government hemmed in from all sides with problems, many of them political, particularly with the countdown to the 2014 elections having begun in right earnest.

The HSBC report adds that the concerns over the lack of adequate structural reforms will lead to a further weakening of the rupee. "There is also a limit to the degree of central bank intervention in the currency market as total FX reserves ($254bn) amount to only six months of imports. The political timetable is also not conducive for immediate reforms with elections looming for India", it says.

A Reuters report also quotes Deutsche Bank as saying that the rupee, though fundamentally undervalued, could touch Rs 70 to the dollar in a month or so, though some revival could be possible by the end of the year.

For the RBI which has tried every trick in the book to calm the markets and a government staring at elections, this looks very much like annus horribilis.

by Sourav Majumdar

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