Raise sovereign bonds, mandate exporters to sell in the forward market & ease KYC norms for foreign investors

The Indian currency looks highly vulnerable today. The trade deficit for the country is close to $20 billion per month and the overall current account deficit (CAD) is expected to be close to 5-6% of GDP. Exports were consistently falling in the last few months while the import bill had shot up significantly, especially oil and gold imports.

The external sector is vulnerable with all the major economies slowing down and this will have impact on both the exports and capital flows into the country. India is also seeing a major slowdown in growth with the latest advance estimates predicting a 5% GDP growth for the country, which is one of the lowest we had seen in many years. The combination of a high fiscal deficit combined with a high trade deficit is a recipe for disaster.

Globally, it is a balance sheet recession which is triggering the slowdown and you need coordinated action on both fiscal and monetary fronts to tackle that issue. This is the time both the government and the Reserve Bank of India (RBI) should work together to address the issue. Don?t forget that, world over, there is a race for competitive devaluation of the currency. But India has a unique problem where due to sharp depreciation of the currency we are importing more and more inflation, which, in turn, inhibits our ability to cut rates and spur growth in the economy.

The government and RBI should seriously consider some of the following ideas to handle the situation:

Raise a sovereign bond. India should seriously consider raising a sovereign bond in the international markets to the extent of $50 billion. Since 2008, RBI has sold close to $28 billion in the market; it needs to recoup those into reserves to provide comfort to the market on its ability to intervene. With an economy size of close to $2 trillion, this is a small amount to raise. Also, India can easily raise 30-year money at 4-5% interest rates and being a sovereign there is no need to hedge. A strong reserve position will help the central bank to do both verbal and actual intervention more effectively in the market.

Require exporters to sell mandatorily in the forward market. The rupee touched a low of less than 40 to a dollar in October 2007. Between January 2007 to July 2008, RBI bought close to $80 billion from the market. RBI had stepped in to protect the exporters at that time. However, from July 2011 when the rupee was at 44 to now, RBI had sold close to $23 billion but still the rupee is at 54 to a dollar. Today, the biggest problem is that exporters are not selling dollars in the market.

When the rupee appreciated drastically, RBI had stepped into protect the exporters. There is a case for RBI to mandate all the exporters to sell at least 60-70% of their net exports for the next one year in the forward market. This will enhance dollar supply and will drastically reduce the pressure on the rupee. What we are seeing today is that exporters are postponing the dollar supply to take advantage of the possibility that the rupee will weaken further. This may look like a short-term fix but it is very essential to remove the speculative element and increase the dollar supply in the market.

Rules on booking and cancellation of forward contracts. RBI should also seriously look at changing some of the rules on cancelling and rebooking of the forward contracts. Since an exporter cannot rebook the contract if he cancels, they are not even covering forwards in the first place. This is impacting the liquidity in the forex market. RBI should seriously consider removing that restriction so that more exporters will sell and provide the desperately required liquidity in the forex market.

FII inflows. The trade deficit for the country is very high and we need consistent inflows in the form of FDI and FII to manage the CAD. The KYC norms are the biggest pain point for an FII to register and bring in money into India today. This needs simplification. The registration process for an FII today is onerous and FIIs are wary of providing lots of personal information about the fund and its directors. If that process is simplified and the registration is made simple, then it could accelerate FII inflows into the country.

Most FII inflows into the country come through Mauritius or some other tax haven. KYC norms were also tightened as Sebi is concerned about the quality of the money coming through these tax havens. The data suggests that most FII inflows come through the tax havens only because of the short-term capital gains tax. The purpose of levying short-term capital gains tax is to avoid speculative investments by FIIs. But the whole purpose is defeated as close to 80% of the money comes through the tax havens resulting in avoiding paying any short-term capital gains tax. Looking at this issue with an open mind will help. There is a case for removing the short-term capital tax all together and even the Parthasarathi Shome committee had recommended this. This will allow more funds to bring in money directly into India rather than use the Mauritius route or some other tax heaven. This will be revenue-neutral and improve the quality of money coming into the country.

Trade deficit with China. While there are enough debates on the impact of oil and gold imports on the trade deficit of the country, there is absolutely no debate happening on the trade deficit with China. Today, the trade deficit with China is close to $40 billion. The increase had been dramatic considering that the trade deficit with our eastern neighbour was hardly a couple of billion dollars in 2002. This is too high and is only expanding. The trade deficit with China is close to 20% of the total trade gap or about 2% of GDP, and if you exclude the oil imports, it is almost 50% of the trade deficit. India needs to work with China to either open up its markets for India?s exports or curb Chinese imports.

At present, the economic situation is bad globally and to that extent India will run a high trade and current account deficit for some time to come. We need solutions which will address both the short-term and long-term issues.

There is a view that today the rupee reflects the fundamentals of the economy and the regulators should not intervene to correct the reality. However, for India, the issue of imported inflation due to weak currency is very high, which is hurting the growth in the economy. Also, the high leverage in foreign currency loans in the balance sheets of most capital goods and infrastructure companies is inhibiting their ability to take further risk and invest. Extreme situations always call for extraordinary measures. This is the time for both fiscal and monetary authorities to sit together and solve this extraordinary problem.

The author is member of the board, Infosys; head, Infosys BPO, Finacle and India Business Unit; and chairman, Infosys Lodestone