Time for a big bang: Rupee needs to be made convertible on capital account

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Published: November 21, 2019 12:14:16 AM

RBI, of course, has been steadily buying dollars—its reserves have risen by over $1 billion for seven straight weeks—no doubt aware that a stronger rupee would be disastrous for both the export sector, and local manufacturing.

Dr Rajan, who had just come in as RBI Governor, launched his rescue effort, which helped the rupee recover to 58 in about a year. Dr Rajan, who had just come in as RBI Governor, launched his rescue effort, which helped the rupee recover to 58 in about a year.

The rupee’s sudden slip below 72 to the dollar last week, the first time in a year that it fell so low, reawakened concerns of another major step down. While it recovered a little equanimity by the end of the week, the big question is how long this respite will last.

Looking at the rupee’s history since 2009, from the (then) all-time low of 51.95, it strengthened steadily to a high of nearly 44 under the influence of shockingly easy money (QE); however, the sudden sharp rise in crude in May 2010 (from 61 to over 120) slammed it down, and in a few months, it fell by more than 20% to 54. As oil steadied, albeit at this higher level, the rupee bounced back—still global easy money—to just below 49. By this time, the Euro debt crisis started heating up and threatening global trauma; the rupee once again fell sharply (by over 15%) to 57 in a few months. But, with QE still in play, the rupee yet again climbed grudgingly higher to 54 till the taper tantrum hit in 2013. The Fed merely suggested that it would soon stop its quantitative easing; the main prop under the rupee fell away, and it crashed by nearly 25% in a couple of months to nearly 69.

Dr Rajan, who had just come in as RBI Governor, launched his rescue effort, which helped the rupee recover to 58 in about a year. However, since the market believed that the days of zero cost money were coming to an end, the rupee slowly, but surely drifted lower, and, despite the fact that oil prices had fallen sharply (to around $40), it remained generally weak. Over the last five years, it tested the 69 low a couple of times; finally, about twelve months ago, when oil climbed above 80 again, it broke the barrier and hit the all-time low of 74.50.

This capsule history is to point out that the rupee, thus far at least, has only fallen sharply under global pressures—rising oil prices, threat of another global crisis, or the threat of the end of easy money. Domestic considerations—falling exports, growth in the gutter, etc—don’t seem to have a significant impact. This is, perhaps, unsurprising because the net demand for dollars (from the current account deficit, debt repayments, outward investment, etc) in the domestic forex market is generally overwhelmed by portfolio flows and, historically at least, direct investment.

Currently, portfolio flows remain strong—they have reached $17 billion this year, the fourth highest since 2011. Importantly, absent a global crisis, these will likely continue given that more than $15 trillion of bonds globally currently provide negative yields; the issuers include some AAA corporates as well as some governments, like Romania and Bulgaria, that are normally considered emerging economies. India, despite the major problems with growth and governance, is certainly as good a bet (or better) than some of these and provides fully-hedged dollar returns that are positive. There is also the nearly $7 billion closure of ArcelorMittal’s purchase of Essar Steel through the IBC, plus expected disinvestment proceeds, which the government is budgeting for before the end of the financial year, that could further support for the rupee.

RBI, of course, has been steadily buying dollars—its reserves have risen by over $1 billion for seven straight weeks—no doubt aware that a stronger rupee would be disastrous for both the export sector, and local manufacturing.

The government appears to be clueless, perhaps even unaware that there is a problem; to be more charitable, perhaps they are waiting for another global event, which could happen anytime—tomorrow or a few years from now. But, that’s hardly sensible—if the rupee were to collapse (to, say, 80 or 85) in the next global firestorm, chances are many other currencies would fall as well, and our relative competitiveness would either not budge or, possibly, take a further hit.

It is clear that we need to grab the bull by the horns, and undertake another set of big bang reforms, part of which would be making the rupee convertible on the capital account. There would be an immediate burst of demand for dollars as people pushed and shoved to send money overseas; there would also be huge speculative short rupee positions, and the rupee could fall as far as 100, perhaps even 120. At such, much weaker levels, investment flows would grow sharply, pushing the rupee back up to, perhaps, 80 or 85. Volatility would rise, and exports would finally become much more competitive.

To be sure, this disruption will only be effective if there is a parallel deregulation of markets for labour, land, and capital. Tax authorities, regulators, the judicial system and governance would need to be overhauled as well. A huge job, but, with appropriate planning, it can be done—indeed, it must be done.

The government needs to get its head out of the sands of self-congratulation, acknowledge the crisis and do its job.

The writer is CEO, Mecklai Financial. Views are personal

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