Time for a total reboot

Clearly, rather than selling the incoming dollars in the spot market (which would have led to rupee appreciation), the RBI must have used these to close out some of its forward sales, earning some premium which would off-set part of the subsidy provided by the central bank on the scheme.

Thus, unlike in 2013 (the last time such a scheme was launched) when the rupee appreciated by nearly 5% over three months and nearly 9% over six months, the rupee has been largely steady.

This also suggests the RBI is more or less comfortable with the rupee’s current value, which is a bit surprising since it is well known that on a real effective exchange rate basis, the rupee is over 10% undervalued. Indeed, the weak rupee is beginning to impact many of the much-heralded PLI projects, including the India Semiconductor Mission, that are part of the government’s Viksit Bharat plan.

To my mind, this is not the kind of signal the RBI should be giving, particularly when we have just come off the major trauma of the past few months with the rupee crashing by more than 6% since the start of the year, reinforcing the long-held belief that the rupee can only weaken going forward. The RBI should be working to prevent the build-up of a “one-way street” mentality, which is not only self-fulfilling but also creates untenable pressure on the reserves, making these kinds of expensive schemes necessary.

Significantly, “the-rupee-will-always-fall” mentality exacerbates the pressure on the rupee through leads and lags — where importers rush to hedge while exporters hold back till the last minute. Several analysts have estimated that $150-185 billion of the decline in the reserves was made up of exactly such leads and lags; one author suggested a wonderfully creative way to address this — by charging an additional cash reserve ratio on import cover. This would increase the premiums on the import side, which would certainly slow down import hedging and, likely, increase export sales, which would keep the rupee from falling further, and may even lead to the much-needed appreciation.

There are many sound ideas like this being propounded by analysts, including the crying need to increase liquidity in the debt markets by changing the taxation of medium-term debt income to capital gains, which would not only increase the flow of investment to MSMEs, but would also make Indian debt more attractive to foreign portfolio investors, again easing the pressure on the rupee.

Another interesting aspect about the current scheme is that the RBI seems comfortable with investors using leverage — even SBI is announcing that it is happy to provide it. In 2013, most of the deposits were, indeed, leveraged, but it was undertaken quietly. Because of the leverage, the RBI needs to provide only a modest jump over US rates, which is good since it saves us money. It highlights the reality that NRIs, at least, are quite comfortable with India risk, at least as far as the financial sector is concerned.

Unfortunately, in the real sector which creates jobs — one of our many number one problems — India’s risk appears to be almost unsurmountable. It is well known that over the past several years net FDI has been largely flat — in other words, global investors are really not interested in investing in India, and have not been since around 2011. Net FDI as a percentage of GDP has moved between 0.7% and 2%, averaging 1.5% over the past 16 years, sharply down from the peak of 3.6% of GDP in 2008.

Tragically, but hardly surprisingly, domestic private investment, too, has been flatlining at around 12% of GDP for over a decade (as compared to 25-28% globally).

Clearly, we are doing something — or several things — wrong. It’s time for a complete reboot of Indian economic policy.