Mr Raghuram Rajan, our new RBI governor, did a great job of reviving the economy, in a very short span of time.Indices recovering from past lows and the Rupee somewhat stabilizing for a short time. But the fact is that, no matter how hard he tries, be it tweaking rates or issuing new bank licenses, it will only buy us ample time to stay afloat when the tsunami of “QE tapering” hits. The panacea lies with the Government’s political will and intent to turn the inevitable storm to our advantage.
On august 28, 2013 the Indian Rupee touched an all time low of 68.85 to the American Dollar, on the back of Mr Ben Bernanke’s forecast of the “QE tapering” and the impending Syrian war. Equity indices in all emerging economies took a plunge. Fear and confusion permeated through the mind of investors, be it retail, institutional or foreign ,forcing them to pull out money from the Indian equities to the tune of $7.5 billion,$3 billion and $2.5 billion in June , July and August respectively. With only five months of foreign reserves left, foreign debt of almost $170 billion and a constant threat of degradation of India Government bonds to “junk” status by rating agencies, Mr Raghuram Rajan, had to use policy measures in a manner not seen in the recent past. From revising repo and MSF rates, expanding the credit window for banks to many other market liberalization strategies. He has done it all and did a commendable job, of-course with Mr Bernanke’s help, of bringing the rupee to its “fair value” i.e. around Rs 61 to the dollar.Though it has started falling again on the back of fresh fears of QE tapering. But why the struggle? I mean shouldn’t the laws of economics take care of these things. I mean shouldn’t the Indian exports benefit from the rupee devaluation? And shouldn’t imports get costlier, thus reducing the Current Account Deficit (CAD)? In fact it is happening, as exports have risen and imports have shrunk but we are yet to reap the full benefit.
Though we are recently seeing our CAD decrease as out rupee stabilized around Rs 62-63/dollar and listening to Mr Chidambaram’s optimistic speeches assuring that CAD is contained as promised earlier, but that is due to the courtesy of USA’s delayed “QE tapering” plans and its Government’s plans to give themselves a 16 day holiday package further giving rise to speculative hopes, that the tapering is not to happen any time soon. Also some help from our NRI brothers stepping up remittances and investment in real estate and the return of the foreign investors to the equity markets saved the day and the government was able to financed the CAD. But come 2014, it will again return to haunt India’s finances in a way that will completely dwarf the recent volatility seen by the Rupee. Given the fact that that a mere plan announced by Mr Bernanke to taper the QE, saw the rupee plummeting to Rs 68 to the Dollar. In fact the rupee has depreciated to a new 2 month low of 63, after hitting the 61 /dollar mark, on the back of fears of an early “tapering” by December 2013 and that oil companies have been asked to buy dollars for their imports to the tune of 8.5 billion every month, even though Mr Rajan claims that India will not see much volatility in the rupee. Imagining a situation where USA actually starts the inevitable “tapering” will see the rupee touching record lows and unimaginable volatility, unless our RBI governor Mr Rajan accumulates enough reserves or US appoints Yellen as the chairman after Ben Bernanke’s resignation in 2014, who is in no mood to taper the monthly $85 billion bond buying program.
But these are future events, are subject to speculation, posing questions such as when, by whom and in what manner the QE would be tapered. Till then it is any ones guess. But what about the present and about the things under our control? About the positives coming out of these successive events? The positives which countries like Japan and China are experiencing with every unit of devaluation of their currency, the yen and the renminbi respectively. In fact these countries are deliberately devaluing their currency by printing more money. Japan is doing a quantitative easing of its own. So why is India suffering. As always the India story is unique. India has something which none of these economies have, at least not at such a scale. It’s called the “import content of exports” .Simply put, many commodities, like mineral oil and precious metals, which India exports are basically first imported, processed and then exported. Almost about 45 per cent of our exports have imported contents. Though a fall in the rupee increases the competitiveness of our exports by making them cheap to foreign buyers (thus increasing demand, thus bringing in more dollars), it also makes the imports costlier. So a company with huge exports as part of its revenue but relies on imports for its raw materials, is not going to benefit. Not to mention the sticky inflation of around 7% adding to exporters woes, by blunting their competitiveness in the foreign market. So net result, we stand to lose or gain too little. The statistics say it all.
If statistics are anything to go by India’s exports primarily comprises of minerals and fuels like coal, oil and minerals accounting for 16.95%, followed by precious stones and gems – 15.95%, Vehicular parts and accessories accounting for 4.5%, electronic machinery-4.31%, Iron and steel – 3.76% and organic chemicals like fertilizers -3.64%.However the import components and the amount imported is quiet paradoxical to India’s export component. It comprises of minerals and fuels, precious stones (mainly gold), organic chemicals and iron and steel to the tune of 35%, 18%, 3% and 3% of total imports respectively. So it looks like if India’s exports are X it imports are 2X, for mineral oil and precious metals and approximately same in case of organic chemical and iron and steel. Wrong! , because the ratio of total imports to total exports is almost 2:1.Which means our mineral oil imports are not 2X rather 4X and the import of chemicals and iron are not same rather it is 2X (approx).
So as long as India follows a foreign trade structure like this there will be no respite from these events. It does not pay to export things which we import and that to based on the same currency, the dollar.
On the domestic front we have our fiscal deficit to worry about, as Tax collection fall short of budgeted revenue forcing the government to look for expenditure cuts quiet similar to last years Rs 80000 crores cut, leading to fears of degradation by credit agencies.How much the government cuts is to be seen, but the areas from where the cut is taken is of more importance.Reducing subsidies will be a sensible but apolitical.The inflation is also a problem as even repo hikes by RBI has failed to contain it.
So the way forward from here can be addressed by some meaningful steps.
Firstly, import substitution is needed, for which the government needs to address the problems faced by our domestic manufacturers .For instance, present onion prices are touching Rs 100 per kg. Why so? Artificial scarcity is being created by traders .So the government instead of doing their part on the domestic front, is importing cheaper onions from Egypt and China. Rather they should have taken actions against the illegal hoarding of onions by these traders. Sectors such as low-tech consumer appliances, some types of capital goods and pharmaceutical ingredients have already started to see substitution .Import substitutes are meant to generate employment by encouraging domestic production, reduce foreign exchange demand flowing from decreased imports and stimulate innovation eventually making the country self-reliant in critical areas such as food, defence and advanced technology. Rather than providing subsidies for food and diesel leading to unproductive growth, the government should look at unorthodox policies such as providing cheap finance for businesses entering new areas and there by focus on inclusive growth.
Secondly, the government should encourage exports, mainly whose costs are rupee denominated, so that we benefit from the fall of the Rupee. For example two wheeler manufacturing will massively prosper in times of devaluation as almost two-thirds of its costs are denominated in rupee terms. Hence they will be more competitive in the foreign market. Another segment benefiting is the small car manufacturers. An increasing number of car makers are making India a small-car export hub. A fifth of all small cars manufactured are already exported, and this proportion is likely to rise sharply in the coming years.
Thirdly, on the domestic front, rather than trying to choke liquidity by hiking the repo, to control the 10.09% CPI inflation, which has yielded absolutely no result till now, I think we should loosen it so that the corporates can do business thus increasing the supply and there by taming the price rise.It will also make our exports cheaper.
Lastly, and perhaps most importantly, reduce of our dependence on crude oil imports for our energy demands. This may sounds impossible to some. It was actually impossible few years ago but not anymore. Forget importing we might even be able to export it. If you are thinking shale gas, you are bang on target. According to the US Energy Information Administration, India, the world’s fourth-largest consumer of energy, could be sitting on as much as 96 trillion cubic feet (tcf) of recoverable shale gas reserves, equivalent to about 26 years of the country’s gas demand. Government has already approved the shale gas exploration policy and production can start within the next five years thus decreasing the dependence on imports (see link http://www.hindustantimes.com/India-news/NewDelhi/India-approves-policy-for-shale-gas-and-oil-exploration/Article1-1126658.aspx).Solar energy production should also be incentivised in the mean time.
As far as gold imports are concerned RBI’s gold bond scheme and higher duties did the trick for now and bought gold imports down by big margins. Also the government’s new rule to start gold mining in India is a welcome move, as dependence on imports will reduce. But hold on! We are entering the marriage seasons, November to January and could see the trend reverse. Better to keep our fingers crossed.
So to conclude, I would say that the Rupee devaluation is not as big a problem, as it is depicted to be. Rather it has become a bane due to the much larger problem of a bad export structure. The problem lays with us i.e. our government’s negligence. The delaying of the “tapering” has given us the much needed breathing space, which the RBI and the government should use to get its act together. Much has to be done by the government on the exports font that too quickly.RBI on it part has set a target of mopping up 300 billion US dollars by the end of this year to absorb the shock when the “QE tapering” starts. Recently India’s foreign exchange (forex) reserves gained 1.51 billion US dollars to touch 283 billion US dollars after central bank Governor Raghuram Rajan offered concessional dollar-swaps for lenders to spur inflows. Bank of America Merrill Lynch estimates they will reach $305 billion by the end of March.The government on the other hand is very busy with elections and is facing policy paralysis.
Though we have controlled our CAD to manageable limits, with high fiscal deficit and the inevitable US’s QE tapering in early 2014 or end of 2013 and expected bullish gold demand due to the onset of marriage season, makes the economic outlook look grim.
In such a scenario, investments will be hard to come by and could see the equity indices stay low for extended periods of time and government bond rates again going up in the coming several months. Only companies having low import component in exports and companies unaffected by such events or companies with very high economic moats like Coalgate or Nestle will fare better in such troubled times, that too for investors with a long time horizon. Other than that, India is still not attractive from an investment perspective. So buckle up as we wait for the US to execute its decision.
However, one must stay vigilant, as there is a thin silver lining amidst this gloom. This is because every economic crisis is followed by an economic boom.There have been few but strong developments which has the potential to spur growth in the coming months.A good monsoon, clearing of projects by the government, RBI’s decision to internationalize the rupee through the IMF and mulling Local Currency Trade with Japan and korea to fund CAD, all should help to oil the growth wheels of the country so that when the world comes out of this recession India can grow quickly. Thus it presents ample opportunity to add immense value to one’s wealth, provided he or she has done their homework. Equity indices and prices will correct in the short term or even become undervalued, giving way to a buying spree among long term investors, not speculators or traders. Because in the words of the world’s greatest investor, Mr Warren Buffett,
“It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”
So wait for the prices to get ‘wonderful’ and in the mean time do your research to find a ‘fair company’, so that when the the opportunity comes you can capitalize on it.
(I am not responsible for any investment decision made, based on my blog)
ANALYSTONOMICS 