Bankers expect India’s widening current account deficit to partly take care of the inflows
Reports from news agencies suggest the G-20 draft communiqué will take a stand against any move by governments to help their exporters by measures such as preventing appreciation or putting capital controls, as also ensuring market-determined exchange rates.
While the rupee has gained 5.8 per cent since the beginning of September, a question posed by economists and analysts is whether India is adequately prepared, with the right tools, to take part in the ‘currency war’?
At the heart of the problem is the weakening of the dollar and an expected second round of Quantitative Easing, often referred to as QE2, that could strengthen currencies around the globe. More so of currencies from the emerging market economies, with their growth drawing more funds from advanced countries seeking higher returns.
Inflow surge
The investment in Indian stocks of $23.8 billion (Rs 1.05 lakh crore) by foreign institutional investors this year so far, up from $17.5 billion in 2009, and of $10 billion (Rs 44,300 crore) in bonds, is the highest since these were allowed in 1992. Companies, taking advantage of cheaper overseas rates, have gone in for $15.4 billion (Rs 68,200 crore) external commercial borrowings (ECBs) so far this year, compared with $16.7 billion in 2009.
Strangely, though, foreign direct investment has been only $13.9 billion (Rs 61,550 crore) so far, compared with $26.8 billion in 2009.
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More inflows are expected from other initial share sales after the resounding success of Coal India’s, which attracted $40 billion (Rs 1.8 lakh crore) in applications, 12 times the Rs 15,400-crore sought to be raised. More public sector companies are planning to take advantage of the rush. The government has raised the PSU disinvestment target to Rs 59,000 crore from the earlier Rs 40,000 crore in the year to March.
A surge in flows has lifted the rupee by 4.6 per cent in 2010 (January till now), almost in line with the 4.7 per cent in calendar 2009. But it is the sudden strengthening of 5.8 per cent since September that’s causing disquiet among some exporters, economists and policy makers.
“We have to take a consensus view if appreciation is beneficial or not and export is just one aspect,” said Ajay Sahai, director general and chief executive officer of Federation of Indian Exporters Organisation (FIEO). “An appreciating currency also makes imports cheaper, hurting domestic manufacturers. We are worried for our future competitiveness and orders.”
He recommends considering options such as curbing ECBs by companies, shifting demand from local dollar deposits, limiting FII investments for 180 days or more, and imposition of a Tobin tax (a tax on all spot conversions of one currency into another).
While Prime Minister Manmohan Singh in June-end ruled out imposing a Tobin tax, saying inflows from abroad were manageable, much water has flown under the Yamuna since then. Inflows have been particularly high in the past two months. India is witnessing inflows from FIIs, ECBs and FDI.
| MONEY MOVEMENT MONTH-WISE INVESTMENT ($ MILLION) | |||
| Month | FDI | ECB/ FCCB | FIIs in equity |
| January | 2,042 | 1,320 | -231 |
| February | 1,717 | 2,192 | 464 |
| March | 1,209 | 4,322 | 4,135 |
| April | 2,179 | 2,818 | 2,220 |
| May | 2,213 | 696 | -1,989 |
| June | 1,380 | 1,791 | 2,099 |
| July | 1,785 | 1,165 | 3,777 |
| August | 1,330 | 1,089 | 2,404 |
| September | NA | NA | 6,373 |
| October | NA | NA | 4,521* |
| Source: RBI | * Till Oct 20 Source: Sebi | ||
| Compiled by Bs Research Bureau | |||
A Tobin tax is typically levied to discourage short-term currency flows, with an aim to reduce sharp volatility in currencies. Short-term currency movements operate on narrow margins and a tax will thereby reduce their profitability, the argument goes. The idea was propounded by Noble Prize-winning economist James Tobin.
The case against curbs
Bankers say over a period of time, such taxes get distributed among the various stakeholders involved and may not necessarily curb large inflows. The efficacy of such taxes is yet to be established, some say. Likewise, curbing ECBs could be denying local companies fine rates, argue some bankers. India’s foreign currency is rated BBB- by Standard & Poor’s, the lowest in investment grade. Reliance Industries Ltd raised its 30-year bonds at a yield lower than US companies with comparable rating, according to Bloomberg. Indian companies have raised $6 billion in overseas bond sales this year so far, compared with $1.79 billion in 2009, it said. Almost all leading banks including the State Bank of India, ICICI Bank, Axis Bank, Bank of India and IDBI Bank have sold bonds this year. Many are preparing for a second round of fund raising.
Bankers expect India’s widening current account deficit to partly take care of the inflows. India’s current account deficit widened almost three times in the quarter to June 30 and could increase further if commodities such as crude oil become more expensive. Then, a smaller than expected second Quantitative Easing could change the scenario and might not strengthen emerging market currencies as much, thereby nudging some funds to flow out of emerging economies, including India, said another treasury head. In such a scenario, any attempt to shut or slow overseas inflows could create a situation much worse than a surplus would, cautioned a senior banker. A sudden dip in foreign reserves, coupled with a trend of restricted investments into the country, could trigger a ripple effect that might see more outflows, he said. This is a scenario a country such as India must avoid, especially when it’s in a growth phase and needs critical growth capital.
Then again, over the medium and long term, India is seeking between $500 billion to $1 trillion to boost its infrastructure to facilitate double-digit economic growth. Much of this money is to come from abroad. “Any attempt to peg the currency at an artificial level could be like playing with fire,” said a senior banker with a South Africa-headquartered bank. “Stopping inflows should not even be considered as an option. One has to see that India is importing growth capital and not hot money.” India could deal with a strengthening currency by selective intervention and pushing inflows, by the central bank ‘selling’ these now and ‘buying’ at a later date. This could take care of any sudden rush, he said.