Rupee stable against dollar on account of high forex reserves

Any capital flight, partly triggered by MAT disputes, could well lead to a balance of payment crisis

After reading the recent comments of the Finance Minister in a speech to the Enforcement Directorate staff (Business Standard, May 1, 2015), one was reminded of US Treasury Secretaries of yesteryears proclaiming their “strong dollar” currency policy. In that country, while the Federal Reserve is responsible for price stability and full employment -- the latter interpreted very flexibly -- the Treasury is responsible for exchange rate policy, despite the connection between the exchange rate and employment. The “strong dollar” commitment of course never deterred the Treasury from calling other major economies to let their currencies appreciate. To quote only two examples, recall the Plaza Agreement (of 1985) and the pressure on China in recent years to let its currency appreciate. As if appreciation of trading partners’ currencies is not weakening one’s own, and vice versa!

For politicians and policy makers to fool others in public statements is fine, but one wonders whether our Finance Minister is fooling himself in believing in the virtues of a “stable rupee” – if only in nominal terms, and that too only against the dollar! It has appreciated against other major currencies, even in nominal terms, let alone real, ie inflation adjusted, terms.
Surely he should be aware of the ground realities:

• The merchandise trade deficit ($150 bn) has gone up marginally in FY 2014-15 despite a sharp fall in oil price, our single largest import item. Exports fell 21% in March, year or year. Ominously, crude oil prices have gone up to $68. And, reserves go up when the Reserve Bank of India buys dollars, to avoid appreciation – the FM seems to have reversed the cause/effect relationship!
  

 

The gap between India’s foreign currency assets and liabilities is more than $350 billion; in other words, in foreign currency terms our net worth is hugely in the red.

• Any capital flight, partly triggered by the MAT (minimum alternate tax) disputes, could well lead to a balance of payment crisis -- the “Minsky moment” can never be exactly predicted. And, foreign portfolio investors seem to be reducing their India exposures.

Surely, over-valuation of the rupee in real effective terms by 25% has something to do with all the three issues above; and continued nominal stability in dollar terms may become increasingly risky. It is also worth emphasising that external deficits represent an equivalent loss of output and employment (“Trade figures raise fears of contraction in US economy”, Financial Times front page headline, May 6, 2015); that no Asian economy has grown fast except on the foundation of a sharp rise in export-based manufacturing – and surpluses on current account.
 

Surely, the central bank is aware of all the above issues. Dr Raghuram Rajan, in his book Fault Lines found a strong correlation between growth and how investment is financed: “the more foreign financing it uses, the more slowly it grows”. Again, there are enough examples of the dangers of using the external value of the domestic currency, measured by the exchange rate, to influence the domestic value, measured by inflation. To quote two examples, Mexico and Argentina tried this in the 1990s and faced crises respectively in 1994-1995 and 2000-01. It is often dangerous to rely on the belief that This Time is Different, the title of a famous book by Kenneth Rogoff and Carmen Reinhart, about “eight centuries of financial folly.”
 
The Reserve Bank’s core purposes, as proclaimed on its website, are:
“To foster monetary and financial stability conducive to sustainable economic growth….
“To foster confidence in the internal and external value of the rupee….”
 
One wonders to what extent its exchange rate policy of the last seven years is conducive to serve the core objective of economic growth. Or does it believe that the growth needed to create enough jobs, given our demographics, is not “sustainable”? Or, are the core purposes to be regarded as pious intentions of statements, with little relevance to policies?
 
Coming back to the question of MAT, surely the high level commission should have gone into the issue before the demands were made and publicised? And, the recent assurance of “no coercive action” – does it mean that FPIs are expected to pay MAT voluntarily?

THe author can be contacted at avrajwade@gmail.com