Rupee is dancing to more tunes this year

Rupee is dancing to more tunes this year

Context

Menacing threats include rupee overvaluation, rising CAD, a retreat in capital flows and macroeconomic populism 

What has happened?

The Indian currency has been facing some selling pressure for the last 4-5 weeks, chiefly on the back of rising crude price. The rupee fell against the U.S. dollar by a little over 2.5% in April, and 4.3% since the beginning of the year, making it the worst-performing Asian currency.

U.S. dollar recovering

• And this has come at a time when the U.S. dollar seems to be on a cyclical recovery path against other major currencies on the relative strength of the U.S. economy.
• On all such occasions in the past, the rupee as well as the capital account of the country’s Balance of Payments came under pressure.

Real effective exchange rate gone up

The real effective exchange rate of the rupee has gone up by about 4.73% since 2015-16, but it remained flat in 2017-18, although the nominal effective exchange rate of the U.S. dollar fell by about 9% during that period. 

High inflation in coming months

• RBI expects CPI inflation to lie between 4.4%-5.1% during the current fiscal year, with higher inflation expected in the first half. For the purpose of this estimate, RBI has assumed an average oil price of $68 per barrel
• If global prices turn out to be higher than this, then the inflation will be higher
• With the benchmark Brent having already touched a high of $75 per barrel, the possibility of inflation crossing 5% in the coming months is high.

India’s inability to gain market share in a global business   

“Make in India” not making enough

Despite the claims of ‘Make in India’, India does not yet figure among the top ten exporters of manufactured goods. China now exports manufactured goods worth $2 trillion (almost equal to India’s GDP) and its share of global exports of manufactured goods increased from 4.7% in 2000 to 17.9% in 2016.

Lackluster exports

• While the country’s imports relative to its GDP is now much lower than the peak level reached in 2012-13, the performance of exports continues to be lacklustre.
• In the financial year 2013-14, exports were 17.2% of GDP and by the financial year 2016-17, the ratio fell to 12.4% of GDP
• In the traditional areas of exports, such as garments and textiles, where India was second only to China, the country now occupies third position in textiles and fifth position in garments.

Garment exports lagging behind

• In 2000 the share of clothing exports as a percentage of total global clothing exports of Bangladesh, Vietnam and India was 2.6%, 0.9% and 3% respectively
• By 2016, while India’s share of global clothing exports has increased marginally to 4%, Bangladesh has improved its share to 6.4% and Vietnam’s share is a stellar 5.5%.

A silver lining in exports: ITES

• Indian IT services companies, which followed a low-cost global delivery model with success in the past, have not succeeded so far in graduating to the new world of artificial intelligence, machine learning and robotics
• Growing trade protectionism in the West will certainly slow down the growth of exports of IT and IT-enabled services, unless Indian companies move up the value chain.

Gold Import rising

India’s gold import, which was $56 billion in 2011-12, declined 52% to $27 billion in 2016-17. However, a rising trend of gold import is now being seen, with the import in 2017 at 855 tonnes — a 67% rise over the previous year

Rapid increase in import of electronics goods

• Rapid growth in imports of electronic goods, which was $3.4 billion in 2011-12 and $42 billion in 2016-17 — a massive 12-fold increase in five years
• There is a distinct possibility that imports of electronic imports, mostly from China, will surpass oil imports in the near future

Rupee overvaluation

The rising trend of import of gold and white goods could very well be a manifestation of the rupee’s overvaluation

Decline in FDI

The FDI and portfolio flows in the first nine months of 2017-18 remained robust. But, a decline in portfolios flows is taking place now, as evidenced by an outflow of $2 billion in April

Disagreements with IMF?

• Curiously, India’s annual Article IV consultation with the IMF staff, which usually takes place in February, has not yet happened this year.
• As per its office in India, the earliest it is going to happen is in July, 2018.
• One wonders if the delay is due to any disagreement between Indian authorities and IMF staff on macro issues.

Conclusion

Higher oil prices mean tough choices, especially on the fiscal front. In fact, there are no easy options left on any of the major macroeconomic policy front in the lead-up to the next general elections.