Crashing around the ears-the strange case of the Indian rupee

The rapid fall of rupee has befuddled even the best of the economists. How come the currency of the country which was growing at a phenomenal rate is sliding at such a rate? Or for that matter why has 2011 been an year to forget for the fourth largest economy of the world?

Here are some of the reasons why the rupee fall has been so expeditious. The government has been unable to meet its fiscal deficit target of about 4.6%. What is fiscal deficit? Every government lives beyond its mean by reaping more than it sows. Fiscal deficit captures this anomaly. It is the difference between the revenues generated and the expenditures incurred by the government. The revenue generated do not include the borrowings of the government. India has been successful in meeting its fiscal deficit targets for the last few years on back of robust economic growth. Apart from 2008-09, when the financial crisis led to overshooting of the estimate, the record so far has been unblemished. But it is widely expected that India would miss the target by about 1%. While it does not sound such a big number, when converted to rupees, the gigantic number you stare at makes you understand the reason for worry. So what happens when you miss your targets? The market sentiment becomes negative. Investors stay away from your market. Also, the fact that US dollar is growing strength does not bode well in these times. With Europe deep in crisis, and recovering, US is being seen as safe haven by investors. The widening trade gap, with India now importing approximately 30% more than their exports does not inspire much confidence either. In September this year, government overshot its estimated borrowing of about 1.67 trillion dollars by almost 0.5 trillion dollars. Add to this the political turmoil in the country, where each day a new scam is unearthed and the government's inability to manage these and you understand why the negative perception is on the rise. Some Indian businessmen themselves are admitting that they would rather not invest in India. All in all, not such a good outlook for India.

What happens when your currency gets devalued? Why should you  and me be bothered? The reason is simple. All imported goods are going to be expensive.  So machine parts get expensive and hence you see all automobile companies raising their prices by about 1-2% in the coming January. This will undo all the efforts taken to reign in inflation which fell to 4.35%  last week.The impact can be seen in prices of gold also. While there has been a huge fall in the price of gold this week with it falling to about 1500 dollars/10 gram, the impact has been cushioned in India because of the falling rupee. Medical care, imported food products, automobile spares, foreign travel-these and many such sectors take a blow. The positive side is that exports grow. Companies like Infosys, TCS stand to gain in such a situation.

What to do so that the wrongs can be undone? The main problem is that with Europe in crisis, gold prices falling, and weakening Indian rupee, investors are sticking to their dollar bills. It is once again being seen as the  most trust-able currency. With the demand of dollar growing, and no circulation leading to decrease in supply, it is becoming more expensive. There is a need to attract FII and FDI into the Indian market so as to spur the investments and improve the market sentiments. The government move to introduce FDI in multi brand retail has met with much resistance with its implementation delayed till at least March. The good news is that FDI limit in single retail has now been upped to 100%, though with some riders. We an increase short term rates to attract FII's to invest in India. And then there is the most intuitive one, selling the Forex reserves. India has about 300 billion dollar as reserves. But I, for one, think its not such a great move. We have to realize that this is not the money we have earned, but what we have purchased. Already, we have the foreign loans repayment the next year, with due payments up to 150 billion dollars. This should not have been a problem, but these are difficult times. With the economy not doing well, lenders may not be willing to confer the money. And if the move fails to pay-off and the Europe government bonds are downgraded, the investors might withdraw money from all markets and stick to dollars. This would lead to further devaluation of currency and the foreign loans might become a difficult issue.

So we have to look before we loop. I have full faith in RBI Governor D. Subbarao as he has shown this year that he is capable of taking hard decisions.