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The Dancing Baby Elephant : The Fall of Rupee & the Indian Economy

Postat den 6th November, 2013, 09:40 av Aman Agarwal, Delhi

India, the largest secular democracy in the world, is home to 1.21 billion people (i.e. about 17.4 % of world population). In terms of economics, India accounts for 2.5% of world GDP in US dollar terms and 5.5 % in purchasing power parity (ppp) terms. India’s rich civilisation history dates back to over 10,000 years, going back to the Harrapan and Mohanjadaro periods having high appreciation for architectural layout of townships and structured lifestyles. In the last 5,000 years till the invasion by the Mughal and the British, India was referred as the Golden Bird with the highest possible respect for women and mankind. Texts and temples of these periods clearly reflect the richness in the society and the importance of gold in a common man’s life for the use of cloths, utensils and for consumption as part of food (which is re-emerging in modern India).

The currency regime in India (then Hindutav Raj / Bharat /Hindustan) goes back to about 1,000 BCE with the creation of coins in gold and hence forth in silver for long periods of reins much prior to the Chandragupta Maurya glorious period of 350 BCE. Chanakya’s (Kautilya) work “Arthashastra” is the first ever written text in economics – in 350 BCE (2362 years back), outlining: the way a kingdom is to be run ; the role of a King ; the functions, duties and role of his officials and the way civilian functions should work in the society. Kautilya’s teachings given in the Arthashastra (meaning economics in Sanskrit) holds very well in today’s time, though Adam Smith’s work of “Wealth of Nations” is no longer valid in today’s context. Hence, I always refer to Chanakya (more commonly known as Kautilya), a teacher, as the father of economics.

India has been one of the earliest issuers of coins (around the sixth century BCE). The first “rupee” is believed to have been introduced by Sher Shah Suri (1486–1545), based on a ratio of 40 copper pieces (paisa) per rupee. Among the earliest issues of paper rupees were those by the Bank of Hindustan (1770–1832), the General Bank of Bengal and Bihar (1773–75, established by Warren Hastings) and the Bengal Bank (1784–91), amongst others. Until 1815, the Madras Presidency also issued a currency based on the fanam, with 12 fanams equal to the rupee. Historically, the rupee, derived from the Sanskrit word raupya, which means silver, and it was a silver coin.

Over the years, the Indian Rupee (INR) has emerged as a strong currency having a strong base with good fundamentals. This is in special reference with the economic conditions in the West (U.S., Europe, Russia, Latin America and other regions), where they suffered from high inflation, low GDP, liquidity crunch and banking sluggishness. The following positive developments could be noted: Indian GDP growth has been stable around 6.9% for last three years and over 8.4% in the last eight years preceding these two years ; there has been control on inflation, which before had soared up to double digit and has been brought down to a sustainable level ; foreign exchange reserves hanged around US$ 290 million for the last four years ; FDI flow strengthened over the last year ; fiscal deficit was under control ; international confidence in Indian had been strong and building up; the economy was relatively self-sufficient ; flows of NRI remittances increased; the conservative banking system proved to be stable.

All these noted strengths show the true potential for the Indian currency (INR) to strengthen and attain the well-deserved level of Rs 35 – Rs. 40 against a US$ if it is allowed to float freely in the short run (next 8-10 months). The Reserve Bank of India (RBI) has always tried to keep a managed floating exchange rate since the early 1970s.

Numerous challenges-cum-opportunities lay before the Indian economy given the steep recent fall of the rupee and the trembling global economy. These challenges bring four serious concerns for the dancing baby elephant like

(a) a threat to India’s National Security and Indian’s tomorrow as an outfall of the rupee deprecation ; (b) challenges for the trade participants and the business in India ; (c) the appropriate mix of financial volatility, a relatively stable exchange rate and the conduction of a robust monetary policy ; (d) concerns about fiscal discipline and the role of the government ; (e) rising inflation and the costs for major parts of the population ; (f) the possible impact of the Fed’s and the ECB’s future policies.

National security implies a state or condition where our most cherished values and beliefs, our democratic way of life, our institutions of governance and our unity, welfare and well-being as a nation and people are permanently protected and continuously enhanced. The fundamental elements that lie at the core of national security, and therefore further amplifies our definition of national security, are a strong and stable currency; socio-political stability; territorial integrity; economic solidarity and strength; ecological balance; cultural cohesiveness; moral-spiritual consensus and external peace. The transition between great civilization and an economic power house is a slow process that is centered on the incumbent’s struggle to balance short-term national security demands and long-term economic interests. It is impossible to predict exactly what the future of the currency holds, it is impossible to also predict exactly the second and third order effects of a persistent currency collapse/fall.

However, such a persistent depreciation/fall in the value of the currency would have important consequences on the Nation’s continued reliance on deficit financing. The inflow of foreign financing would be dramatically, if not wholly, reduced as the value of the currency falls. Hence the country would have to pay higher interest rates to fund future debt to offset the increasing uncertainty about its future value which would place a restrictions on future government spending. Any hope of covering this spending shortfall by increasing revenue through taxation is also unlikely to succeed in the short-term because of potential impacts to the domestic economy (Everingham and Anderson, 2011). Such a crisis would force the Government to make immediate budget cuts (especially in defense and social security) due to the loss of international funding. Even modest reductions in government spending would affect funding support for the national security strategy, since the costs for the up-gradation/procurement of the latest technology defense equipment/aircrafts/missiles would impound up the need for foreign currency.

Some of the reasons which seem to have been driving the rupee to its low levels in past months have been (a) elections coming forth (having huge funds moving into the country to fund them) ; (b) the Fed’s guidance being sought which also should enable the U.S. economy to have a smooth comeback ; (c) RBI’s management of their balance sheet ; (d) the Ministry of Finance wanting to manage the fiscal deficit at the same level ; (e) the IPL Scam, where the investors and the Cricket Team Funding Organizations/Groups from overseas would be withdrawing their funds given the uncertainty of the IPP moving forward; (f) the exporters’ lobby who would like to bring their funds kept in US dollar or euros or other currencies back into India for their quarterly results to be shown as good ; (g) the non-implementation of the second phase of economic reforms ; (h) no focus and development of the agro sector, agro banking and the agro-based economic framework, where more than 70 percent of the population of this country is housed; (i) RBIs performance being tamed by the brilliant presence of strong political leaders like Shri P Chidambaram,  Manmohan Singh and Shri Pranab Mukherjee in a UPA Government during times of the world’s worst financial turmoil having its seeds in the West with oil bubble, natural and man-made tsunamis and NPA accumulation by banks between 2004-2007 bringing its heat further to the Asian region after 2008 until today.

In my opinion, there has been no valid reason for the rupee to fall. There are all necessary positive signs in India – given the recession that hit the global village – to enable the economic growth and the rupee to appreciate at new levels which have not been observed since the 1991 fall when the rupee was fluctuating between Rs. 11 – Rs 13 for one US dollar.

India at its independence in 1947 had an exchange rate of Rs. 0.50 for aUS$ (i.e. 2 USD for 1 rupee) when we were by 98 percent an importing country, had almost no industrial or economic growth and no strengths to match any developed nation. Statistically simulated empirical evidence shows that the recent single rupee fall means sending the nation, its people and economic developments clearly backward.

The Indian Rupee (INR) in the last 40 years has been slowly, steadily and strongly emerging as a reserve currency in various countries neighboring to India (in South Asia, in East Asia, in the Arabic region and in Africa). In the Arabic region, the INR was floated with a different colour of currency note in the 1970s. The new governor of the central bank, professor Raghuram Rajan, outlined on September 5, 2013, also highlights that the Indian INR ought to be recognized as an international currency.

The RBI has been able to curtail the Money Supply (M3) growth to 13 percent as against 17-22 percent (between 2005-2008). In the last one year the M3 has again gone up by 17 percent and hopefully given the new policy framework adopted by Governor Prof. Raghuram Rajan of having a multi-facet monetary targeting policy with special focus on an inflation target, would help the RBI bring the M3 back to a 13 percent level. The multi-objective and multi-instruments approach followed by the RBI in formulating the monetary policy has helped in interpreting developments in the financial system and taking prompt corrective action. Also the measures such as putting in place robust systems for reducing counterparty risk in OTC transactions through CCP arrangements and regulation of shadow banking institutions to address the interconnectedness issues have helped in containing the impact of the crisis.

The high savings rate of 33 percent has also been a positive anchor to the economic downturn and the threats of rising unemployment and large number of Indian workforce retrenched and returning back home between 1995 (from the U.S.); 1997-99 (from South East Asia), 2001-03 (from the U.S.), 2008-12 (from Europe and the U.S.). It should be kept in mind that India has a shadow economy as strong as the normal economy, which provides for a buffer for any kind of recession with actual savings rate and GDP growth being substantially higher than the official figures. The FDI flows in 2011-12 and 2012-13 have seen a big jolt due to the bleak economic scenario globally, however, given the trends observed in the increase in FX reserves it is expected to improve in 2013-14.

The Government of India needs to re-consider its FX reserve policy both from the perspective of putting the excessive reserve to productive use and by allowing the exchange rate to float freely and to appreciate – given strong currents of depreciation of the US dollar, the euro and the GBP, which are the major currencies in the basket of currencies in accordance with trade balances.

Governor Rajan having served as Advisor to the Prime Minister and as a Chief Economic Advisor to the government would entail smooth functioning. I strongly feel that the symbiotic relationship which Rajan has with President Shri Pranab Mukherjee, Prime Minister Manmohan Singh and Finance Minister Shri P Chadambaram is unique and would serve to be of advantage for the Indian Economy and international confidence inIndia.

References

  1. Agarwal, Aman, (2007), “Global Dis-Equilibrium, Growth and Europe”, Plenary Keynote Address at the Economia Reale Conference at Sala delle Colonne (Italian Parliament),19th September 2007. Audio of the Speech online at Italian Media Channels (Radio RadicaleItaly www.radioradicale.it/scheda/235385 and Sherpa TV Italy) & at IIF (www.iif.edu).
  2. Agarwal, Aman; (2003); “US Federal Reserve Policy, RBI Policy and Indian Economy” Lok Sabha TV (Parliament of India TV Channel) in Public Forum Program on Saturday, September 21st, 2013 at 7:00 PM – 8:00 PM.
  3. Agarwal, Aman; (2013); “Challenges before RBI Governor Raghuram Rajan” Lok Sabha TV (Parliament of India TV Channel) in Insight Program on Friday, September 6th, 2013 at 1:00 PM – 2:00 PM.
  4. Agarwal, J.D. and Aman Agarwal, (2004), “International Money Laundering in the Banking Sector, Finance India, Vol XVIII No 2, June 2004; Reprinted with permission in The ICFAI Journal of Banking Law, Vol. II No. 4, October 2004, the journal of ICFAI University, Hyderabad. Invited to deliver as the Keynote Address at the Asia Pacific Banker’s Congress 2004 inManila,PHILIPPINES on 26th March 2004. (25-26th March 2004)
  5. Agarwal, J.D. and Aman Agarwal; (2009);”Building Nations Future in times of Recession and Global Dis-Equilibriums“, Invited to be delivered as Plenary Keynote Address at the Parliament of Finland (EDUSKUNTA) at the Finland Parliament Committee of the Future’s Conference on “Future of Nation Building” at The Parliament, Helsinki, FINLAND (July 6th, 2009)
  6. Agarwal, J.D., (2004), “Volatility of International Financial Markets: Regulation and Financial Supervision” delivered as Keynote Address at the 4th International Conference in Finance organized by Faculty of Administration & Economics, University of Santiago de Chile, CHILE on 7th January 2004; Finance India Vol. XVIII No. 1, March 2004.
  7. Agarwal, J.D.; (2013); “The Indian Economy & the Rupee Depreciation”, Lok Sabha TV (Parliament ofIndia TV Channel) in Insight Program on August 2013 at 1:00 PM – 2:00 PM.
  8. Agarwal, J.D.; Manju Agarwal and Aman Agarwal; (2013); “Fall of Rupee & its Impact on Indian Economy: The Dancing Baby Elephant“, Invited to be delivered as Guest of Honour Plenary Address at the 2nd VDMA German Mechanical Engineering Summit 2013 at Taj Vivanta, Bangalore, India [30th September 2013]
  9. Bernanke, Ben S., (2008), “The Euro at Ten : Lessons and Challenges”, at the 5th ECB Central Banking Conference, Frankfurt, Germany, November 14th, 2008
  10. Everingham, Neil C.; and David A. Anderson; (2011); “The Dollar’s Vulnerability and the Threat to National Security”, Strategic Insights, Vol. 10, No. 1, Spring 2011
  11. Fromlet, Hubert, (2008), “Financial Literacy and its Benefits on a Household, Corporate and Macroeconomic Level“, Working Paper, Baltic Business School, Kalmar/Sweden, & Blekinge Institute of Technology, Ronneby/Sweden, April 2008.
  12. Kalam, Abdul A.P.J and A Sivathanu Pillai, (2004), “Envisioning an Empowered Nation : Technology for Societal Transformation”, Tata McGraw-Hill Publishing Company Ltd,Delhi
  13. Miller, Merton H., (1990), “Leverage”, Nobel Prize Lecture, December 7, 1990


 

 

 

 

 

 

 

Aman Agarwal
Professor of finance, vice chairman of the Indian Institute of Finance (IIF) and Executive Editor of “Finance India”, Delhi

 

 

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Det här inlägget postades den November 6th, 2013, 09:40 och fylls under India

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