India’s currency and external sector in a worrying zone


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Over the past few weeks, the Reserve Bank of India (RBI) has fought a losing battle to maintain the rupiah’s exchange rate as foreign portfolio investors (REITs) have continued to sell in equity markets. REITs have sold shares of mainly blue-chip Indian companies and pulled a whopping Rs 2.3 lakh crore (nearly $30 billion) out of the Indian market since January. This created strong downward pressure on the value of the rupee.

The rupiah continued to hit new lows, falling below Rs 79 to the dollar, even as the RBI tried to stabilize the currency by selling dollars from India’s foreign exchange reserves. In just a fortnight, the RBI spent $10 billion. India’s foreign exchange reserves have shrunk by $50 billion from their peak of $642 billion in October 2021.

India, being a huge energy importer, further faces the prospect of a peak current account deficit (CAD) of 3.5% of GDP estimated by most analysts. In absolute terms, India should have a CAD of over $100 billion. The challenge is to offset this enlargement of the CAD by capital flows. This year, capital inflows (both FDI and FDI) are extremely weak. A lukewarm response to the sale of LIC shares also made it clear that foreign institutions were not showing interest in India’s highly profitable PSU assets.

Foreign investors will tend to hold off on their investment decision until the rupiah decline/devaluation is completely over and a new equilibrium is found. What is the new level of the rupiah after the Ukrainian war, in the context of soaring energy and food prices on a global scale? This is what most global investors are trying to figure out. Japanese investment research firm Nomura pegs India’s exchange rate at Rs 82 to the dollar. The Ministry of Finance quietly let it be known last week that Rs 80 to the dollar would seem reasonable given the global economic backdrop.

In a CNBC interview, Chief Economic Advisor Ananth Nageswaran has admitted that India could see a negative balance of payments of between $30 billion and $40 billion in 2022-23. He quickly added that this should not be of concern as such an amount can be taken from foreign exchange reserves. There is another somewhat alarming report in the Economic period based on RBI data, $267 billion of India’s external debt is due to be repaid over the next nine months. This constitutes about 44% of India’s foreign exchange reserves. Could this become another vulnerability under conditions of global monetary tightening?

While Nageswaran argues there should be no cause for alarm, some of the government’s actions seem to suggest a great deal of anxiety.

Last week, the Ministry of Finance imposed a hefty one-off tax – nearly $40 a barrel – on domestic crude producers like ONGC and Oil India Ltd. It also imposed a reasonable export tax of Rs 13 per liter of diesel, gasoline and ATF exported. This mainly affects Reliance Industries which exports more than 90% of its refined products. RIL made super profits for several months by importing much cheaper and discounted Russian crude and simply exporting products, mainly diesel, to the EU and the US. According to some experts, RIL was making a profit of over $35 a barrel. According to JP Morgan, the profit margin could fall by $12 to $13 a barrel after the government imposed the export tax. RIL always makes a good profit on its exports.

The government also imposed a higher duty on gold imports in hopes of reducing imports and saving valuable foreign currency.

The problem is that these are just piecemeal decisions to control the DAC. Some measures, such as the imposition of restrictions on food, steel and oil exports, aim to control domestic inflation, but also end up reducing export earnings at a time when the vulnerability of the external sector is s increases. Thus, between controlling domestic inflation and stabilizing the external sector, the Center finds itself with a Hobson choice. This is precisely why the macroeconomic management of contradictory forces is not at all easy. The more governments tinker and tweak at the micro policy level, the more uncertain and difficult the task of macro management becomes. This is currently happening in India.

The money collected through the tax on oil company windfalls will go some way to filling the growing budget gap. But this is not enough as the overall overspending beyond what is budgeted can reach Rs 3.5 to 4 lakh crore even after all the exceptional taxes levied by the government are taken into account. The growing fiscal challenge amid deteriorating global economic conditions cannot be understated.

Prime Minister Narendra Modi’s promise of more comprehensive welfarism through generous labharti the programs are also adding to budget pressures as India goes from election to election with more social commitments amid dismal job prospects.

At the macro level, the world will be watching closely how India manages its two deficits – budget deficit and CAD. Ultimately, the macro management of these two parameters will determine the stability of the exchange rate, inflation and growth. Short-term tinkering won’t help beyond a point.

Shirlene J. Manley