What is your view on the collapse of the rupee?
This collapse is the result of two components: a reversal of the U.S. monetary policy last May, and a significant weakening of the Indian economy. Beyond the slowdown, India suffers from two severe imbalances: a fiscal deficit and a deficit in the balance of payment.
Amid fears on the part of investors to see a crisis appear and worsen like that of 1991, the country has faced a significant swinging back of the capital flows which were heavily worn on emerging markets in 2010-2011, to dollar assets, both currency and U.S. stocks.
To halt the decline, government and monetary authorities tried to intervene. How would you make measures?
These measures make sense, particularly the interest rate policy and the tax on gold, which is the main outflow of foreign exchange to date. Of the estimated 5% GDP current account deficit, gold purchases account for 2% to 2.5%. However, these measures have failed to stop the attacks against the rupee, or the correction of the Indian stock market. That said, it seems that these actions has been sufficient for the moment to contain the outflow of foreign exchange reserves. These were $ 297 billion in late 2010, $ 296 billion in December 2012 and were estimated at $ 270 billion as of August 10, 2013. I guess the RBI keep them for the “last battle” against speculation. This piece of information is crucial, because in 1991, India found itself with foreign exchange reserves of only few weeks of imports.
Many criticize the Central Bank, indicating that it has reversed its position several times. Having started to take restrictive measures, it then took expansive actions for instance.
It is always easy to criticize a central bank. The problem is that India’s central bank is faced with several dilemmas. There are first pressures from government officials to revive the economy through lower interest rates and therefore more accommodating monetary policy. Especially since a major constraint is the high indebtedness of Indian economic agents, especially large business groups, resulting in a rise of non-performing assets in the portfolios of banks and their degradation by the rating agencies. This was particularly the case for three major institutions including the State Bank of India.
On the other hand, to balance its current account deficit, India must strive to attract international investors. This implies a necessary reduction of inflation, today around 10%, who appreciate the real exchange rate of the rupee, and reduce the rate of return on investments in rupees.
Central Bank uses a pragmatic policy that tends to use all the tools available to implement a small expansive monetary policy and at the same time some restrictive actions wherever necessary. Which is discretionary in nature and a little erratic by definition.
Policy of the Central Bank is, according to you, thoughtful and coherent?
I think so. Evidenced by the recent interview given by Subir Gokarn, the former Deputy Governor of the Central Bank in the French newspaper Le Monde. He too emphasized the pragmatic nature of the monetary politicy in a country facing internal and external dilemmas. To me, the Indian Central bank is credible and the imminent arrival of the new governor, R. Rajan, will reinforce its credibility.
Which leeway is there for the Central Bank?
Its margin is reduced as regarding the decline of the rupee. The central bank should raise interest rates, which has the effect of squeezing the domestic economy. Rates are already put together more than 10%. The other consequence is mechanically to increase the cost of funding the fiscal deficit through debt service already at the forefront of budget expenditures. Here we find the twin deficits syndrome of the group of emerging countries weakened by the tapering of the U.S. monetary policy.
How do you see the sequence of events for this great country ?
India will struggle to recover an economic blow due to its current account deficit and given the weakness of the recovery in developed countries. Because there are no really strong markets today, the international environment is less buoyant. India therefore needs a large inflow of dollars to finance its imports. Everything is question of credibility. The battle is not lost at all.
Regarding the rupee, it is necessary to bear in mind that the Indian currency has not depreciated suddenly but simply had to adjust after a long period of appreciation in real terms. Since 2005, if one relies on the nominal exchange rate, the rupee was at 45 to the dollar. End of 2012, she was 53. It has therefore depreciated in nominal terms 10% for 7 years. Meanwhile inflation of minimum 5-7% per year trimmed the competitiveness of the Indian economy. So there was a real need for adjustment. At 65 rupees per dollar now, which represent a nominal depreciation of 25%, India still has not restored its price competitiveness gap. It would therefore be objectively justified to see the rupee depreciate further.
Which number do you locate the equilibrium level of the rupee?
Close to 70 per dollar. However, the market is never able to achieve a balance and tends to go upward or downward with excesses.
It is difficult to improve the attractiveness of India to encourage financial investors and direct investors to redirect the country?
Regarding financial investors, the level of the Sensex was propelled to unprecedented levels in 2010-2011, beyond 20,000 points, an excessive level. The index back down to 17 000 to 17 500 points makes sense. To me, the equilibrium level is around 15,000 points based on the real profitability of the Indian corporates. Regarding direct investors, we are now in an election period. A number of very politically sensitive reforms have either not been adopted or were but with severe restrictions, such as the liberalization of investment in retail.
We can expect a lull once investors see more clearly the change of direction of the Fed. Lifting the uncertainty that dominates could give market operators a renewed appetite for risk assets, including emerging assets. If the Indian crisis deepens, its resolution will depend heavily on the mobilization of International institutions.
The monetary policy coordination issue at the global level -the G20- was abandoned for three years. This has resulted in a return to the dominance of private financial markets. After the Fed announced its intention to initiate a process of normalizing monetary policy (the so-called “tapering”), investors reallocated their funds into dollar assets on a large scale. If the G20 does not take urgent steps to inject dollars in vulnerable emerging countries like India, Brazil and Indonesia through the IMF or whatever may be the channel, the speculation may lead to a severe disruption of these essential economies and prevent a strong global recovery. For a country like India, if the outflows proved to be more frequent and larger, reserves of 250 billion could melt in the space of a month.
India is already currently in crisis?
It has fallen into crisis since early this summer. The risk that the crisis will become similar to the crisis of the current account in 1991 cannot be ruled out. Could there be a crisis similar to the Asian crisis of 1997? There does not seem to me. The 1997 crisis was above all a crisis of the whole of Asia. We had, in a short time, contagion initially experienced by Thailand, due to macroeconomic imbalances and institutional turmoil in the region. Since the crisis, Asian countries have made it a point of honor not to expose the fragility of their balance of payments and governance has really improved, not necessarily in India by the way. They then have accumulated substantial foreign exchange reserves.
Yet destabilizing countries like India (third world GDP in purchasing power parity), Brazil and Indonesia, if the crisis deepen, could have very damaging consequences for the world, especially developed countries where the recovery is not yet firmly established. We would end up for the first time in a world configuration where all the major areas of the planet are slowing down. The prospect is worrying and economies such as China may suffer severely. This would be a bad news for everybody, including India.