Indian Rupee touched a fresh all time against the US Dollar in the offshore market at 68.95 levels on spot reference but it failed to do so in the onshore, thanks to the relentless intervention from the central bank. We have been seen a radical change in the way the foreign exchange department of RBI functions; the change agent has been Dr. Rajan and his team. They have recognized the importance of all kinds of derivatives and spot market. At least in the onshore, they have expanded their footprint to exchange traded market as well. In fact, now with Rupee liquidity being tight in the money market, RBI has shifted from selling US Dollars in the spot market, to selling Dollars through OTC forward markets and exchange traded futures market. When you square the intervention with the fact that Rupee has dropped to one of the weakest currency since New Year, we can realize how deeper may have been the cut if RBI maintained a hands-off approach. According to data on the NSDL website Indian debt and equity markets have seen a net outflow of USD 2.95 billion from the foreign investors. FIIs had invested USD 26.2 billion in debt and USD 16.1 billion in equity in 2014 and USD 7.4 billion in the debt market and USD 3.2 billion in the equity markets in 2015. So in two years, 2014-2015, FIIs have pumped USD 33.4 billion in debt and USD 19.3 billion in equity markets in India. Therefore, what we have seen as outflow is just a small portion of that. With global economy expected to slide more in the coming quarters and financial investors repricing risk, India’s vulnerability stems from the capital account.
Source: SWFI
Sovereign wealth Funds had been a major provider of sticky money to global equity markets. It is estimated that market capitalization of all stock markets around the world together reached a peak of around USD 70 trillion in 2014. According to the Sovereign Wealth Fund Institute, a Las Vegas-based firm that tracks activity by funds, there was around USD 3.26 trillion of invested were in equity assets from sovereign wealth funds. In 2015, they estimated that around 213 billion moved out to balance their home budgets. These funds were designed to act as rainy day funds and that day has come. The SWFI estimated that another USD 404.3 billion could be withdrawn from global listed equities in 2016 if oil prices remain between USD 30 and USD 40 a barrel. Remember, it is not just oil which is falling, prices of every other commodity is under massive downward pressure. As this sticky money move out and investor reprices risk and global economy slows down, we can expect a net outflows to rise in 2016. We should not forget the fact that economic impact of the plunge in global commodity prices, shipping and transportation and trade would play out over the next couple of years. Financial markets and economy do not move at the same pace. The latter lags and stretches over a long period of time. We therefore, would have to factor in the new world economic order into investment, hiring and consumption budgets of billions of global citizens over the next few years.
In this backdrop, how can India carve out a place for itself? Stabilise its ship and lean on the other direction. The economic survey which was released on last Friday was a glimpse of the work that we need to do to achieve the above result. It talked about cutting down inefficiencies in resources allocation and bringing in revolution in agriculture in India. Infact I am yet to fully go through the entire voluminous document.
However, based on whatever I have picked up till now it touched upon fixing our vulnerabilities first. For example, it talks about how subsidy in the name of poor is diverted to non-poor and that number could be over a lakh crore. How our disdain for failure has not allowed us to let businesses fail. We have many zombie companies, in the public and private space, which are floating around and consuming scare resources. Easy entry and easy exit are the two key requirements for an efficient economy. It talks about changing the way to do our cropping, moving away focus on water guzzling grains and cereals to pulses. Infact on agriculture, there needs to be a need of a new revolution. At the same time, state should look to improve the tax compliance in the nation. JAM initiative is a step in that direction. It is a way of preventing leakage of social spending, which is needed to uplift the poor. All of these steps would help in making our economy competitive over the next half a decade, over which time, the world economic cycle will turn and then we can all participate as an outperformer in the boom. In the medium term, we can only hope for a good monsoon, which can somewhat cushion the economic blow but do not expect miracles out of it.
Next week is the Union Budget and I would be looking at two key aspects of it. One, the quality of assumptions being made on revenue to arrive at whatever be the gross fiscal deficit data, be in 3.5 or 3.9% of GDP. Second, is there is push towards moving revenue expenditure towards capital generating fiscal spending. For example, schemes like Pradhan Mantri Gram Sadak Yojana would not only augment rural infrastructure but also lead to income buoyancy for citizens. We also need to acknowledge, that the change in resource allocation between Center and State brought about by 14th Finance Commission would also take time to show its benefit. Over the medium term, we can continue to face issues of state government expenditure on social schemes slowing down as the state takes time to build the necessary infrastructure to plan schemes, demand funds, direct those funds, monitor and report. We are already reading reports of states being left with unspent balances in development schemes of different departments.
However, we believe it is a step in the right direction from the central government to make the state governments more independent and powerful. Infact, I believe central government to bring in budgetary discipline at the state level, alongwith the already existing FRMB act, should also communicate clearly to markets that central government is not going to underwrite their credit. Let the state governments face the market, which would allow markets to discipline any fiscal profligacy.
Next week, we can expect volatility to pick up in the Rupee. Especially against the US Dollar Rupee which has been depreciating needs the Union Budget to create a feel good environment, as otherwise it will be difficult for RBI to prevent a slide beyond 69.00 levels. Technically, from an intermediate perspective, US Dollar bulls are in control as long as prices hold above 67.50 levels on spot, which way-off from current levels. Therefore, there is enough room to allow Rupee to go in for a counter-trend appreciation path, assuming Budget turns out to be a positive event for local markets, and still not damage the medium term bullish structure of the US Dollar.