Aweek, it is said, is a long time in politics. So it is for the economy. Even as the politicos were busy with the floor test in Karnataka, high-frequency indicators in the economy were testing new floor levels.
This week the rupee tested the `68 mark for the dollar—for sure this level has been crossed before, but what is significant is the belief that the slide will persist.
It has slipped from around `65 in January, and market forecasts estimate the value of the dollar in the coming weeks could rise to around `70 and even more. Crude oil prices, specifically Brent, have crossed the $80 per barrel mark. Unsurprisingly, the bond markets reacted to reflect the consequences. The benchmark for a 10-year bond yield touched 7.73 per cent—propelled by expectations of higher interest rates and higher borrowing by the government at the Centre.
This government came to power when crude oil prices were over $104 and the macros were in disarray. The fortuitous sharp fall in crude oil prices post-November 2014 delivered a lucky break and over `2.5 lakh crore a year in cash flow—in savings and revenues.The favourable factors that enabled repair of the fiscal math, created revenues and sustained consumption have flipped. In May 2018, global and local factors have triggered a spectre of headwinds. The Indian economy faces a triple whammy—of higher cost of dollar, higher import bill and higher cost of capital given the vulnerability and probability of higher current account and fiscal deficit ratios.
To appreciate the situation it is necessary to locate the causality which influences the visible consequences. At the global level, there is the unmistakable phenomenon of flight of capital as the risk matrix shifts to more attractive avenues and safety. The yield on 10-year US Treasury bonds hit a new high this week since 2011, at 3.12 per cent, and the 30-year bond topped 3.2 per cent, which was the highest since 2014.
The flight to safety phenomenon is reflected in the RBI's data on India's reserves too. On April 13, as per Reserve Bank of India, the total stock of foreign currency reserves was $400 billion. In four weeks, on May 18, foreign currency reserves had dipped by over $7 billion to $ 392.4 billion—and total forex reserves inclusive of gold and SDR, in the same period, slid from $426 billion to $417 billion.
Through April and thus far in May, foreign portfolio investors have sold Indian paper, both equity and debt, estimated at over $5 billion. This trend is expected to persist till a new equilibrium is arrived at and will affect both the bond markets and the equity markets in India and elsewhere in the emerging markets. Specific to India, the risks are embedded in the volume and build-up of carry trades—the opportunity to borrow from low-interest geographies and invest in higher-interest geographies— which is estimated to be over $100 billion. Then there are unhedged corporate borrowings and obligations which include leveraged deposits.
The fear of a further slide of the rupee is propelled by speculation around rising crude prices. The thesis of shale output intervening at the price line of around $65 per barrel hasn’t quite played out for various reasons. The geopolitical quagmire around the Iran nuclear deal and the threat of sanctions is yet to play out and could worsen the supply-demand matrix and pricing. This has led some experts to forecast crude prices touching $100 per barrel. Whether that happens or not, the average price India pays for its oil imports has already crossed the budgeted estimate.
The Indian crude basket cost is over $75 per barrel, up from around $47.5 last fiscal. The Ministry of Finance estimates that higher prices could push up the import bill by between $25 billion and $50 billion, depending on where crude oil prices are headed.
Aggravating the global factors are local factors. India has mostly missed the global surge in trade over the past 18 months. Its exports have grown slower than those of most other emerging economies. And its imports have risen in non-oil, non-gold and gem-jewellery sectors—imports from China have shot up from $17 billion in 2006-07 to $61 billion in 2016-17--widening the gap between its dollar earnings and dollar obligations.
Notwithstanding the promise of the insolvency process and recoveries, India is yet to emerge out of the twin balance sheets problems—quarterly results of nationalised banks have thrown up higher provisions and NPAs. Add to this the wave of sop politics sweeping the economic landscape. The cost of the many loan waivers that have been promised and delivered, estimated currently at around `1.5 lakh crore, will weigh on the balance sheets of the states. And there are the polls in the three big states yet to unveil their sop boxes, and the general elections.
The good news is that growth in consumption and demand has picked up in the economy. These are yet green shoots and are vulnerable to inflation caused by higher fuel costs and input costs driven by the fall in the value of the rupee. Forecasters expect the Reserve Bank of India to hike interest rates by as much as 50 basis points in the coming months.
For growth to be followed by investments, consumption needs to be sustained. Essentially this demands measures to curtail profligacy and enhance spend efficiency. The CAG reports quantify a peculiarity called “persistent savings”—under-utilisation across ministries. A quarterly review and audit of allocation and spending will enable efficiency and reallocation of scarce resources to critical sectors. There is also a need to accelerate disinvestment, and monetization of unused and surplus land could release resources. It may also be a good idea to revisit the floating of a sovereign bond to international investors to raise resources and confidence in the rupee.The triple whammy faced by the economy calls for attention, action and some out-of-the-box measures.
Author of Aadhaar: A Biometric History of India’s 12 Digit Revolution,and Accidental India