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Turmoil on the external economic front

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Following economic statistics from PTI/RBI, 7/9/18 indicate somewhat healthy economic status. current account deficit (CAD) as a % of gross domestic product (GDP) declined marginally to 2.4% in the April June qr. of fiscal 2019 against 2.5% in the corresponding period previous year. Retail inflation has eased to 4.2% in July and wholesale inflation, to 5.1%. Private Equity/ Venture Capital exits increased to $21.9 billion this year so far from $17 billion in the whole previous year and less than $10 billion in the preceding years. Private transfer receipts, mainly, remittances by Indians employed overseas has increased by 17% compared to previous year. The net foreign direct investment at 9.7 billion dollars in the 1st qr. of 2018-19 was higher than 7.1 billion dollars in the year ago period. However, portfolio investment recorded a net outflow of $8.1 billion in Q1FY19 as compared with an inflow of $12.5 billion in the year ago period. This is of some concern.

Again, recent headline quoting SBI says-Weak Rupee to Cost India about $9.5 Billion More to Repay Short Term Foreign Debt. Notably, 85% of our exports are invoiced in the greenback despite shipping only 15% goods to the US. ET Bureau on 6/8/2018 mentioned that nearly $222 billion of short-term debt is due to mature by the end of March 2019, which is more than half of India’s foreign exchange reserves. Much of this, however, could be rolled over, although the cost of fc borrowing has now gone up. Further, the falling rupee and rising crude oil prices (about 11% so far) will combine to push up India’s annual crude oil import bill by about $26 billion in FY19 as per The Hindu.

Increasing CAD, elevated oil prices and an emerging-market sell-off have conspired to push the rupee to below 72 per dollar last week, taking its decline since the beginning of the year to almost 12 percent, the worst performer in Asia.

All this is likely to lead to even higher CAD and increasing inflation which in turn puts pressure on Re exchange rate. There is already pressure on foreign currency reserve. One of remedial measures therefore, may be turning to wealthy non-resident Indians to replenish foreign-currency reserves.

What is hurting us most is the threat of punitive sanctions against Iran, one of our biggest suppliers of crude oil, and the economic crisis in Turkey, Argentina and South Africa. Further, the strengthening economic outlook in the US has prompted the Fed to hike interest rates seven times since the end of 2015. Importantly, over the same period, it began unwinding its quantitative easing (QE) by increasingly selling treasury securities and mortgage-backed securities. This prompted investors to pull money out of emerging markets (EMs) and plough it back home.

Investors will often attempt to withdraw their money en mass if there is an overall erosion in confidence of an economy’s stability. This is when capital flight occurs. Once investors have sold their domestic-currency denominated investments, they convert those investments into foreign currency. This causes the exchange rate to get even worse, resulting in a run on the currency, which can then make it nearly impossible for the country to finance its capital spending.

The RBI raised its benchmark rate to a two-year high of 6.5 percent last month and is likely to follow through with more policy tightening in the coming months, pricing in the swap markets show. The six-member monetary policy committee will make its next rate decision on Oct. 5.

The trade war is another new weapon. India, with its past experience of relying on higher duties to curtail imports, could use it to curb the current-account deficit, as Indonesia recently did.

The RBI can even open a special swap window for oil marketing companies like it did in 2013. That would take a sizable amount of dollar demand off-market and boost the rupee.

The right level for the rupee is 68-70 per dollar, with 72 being “perhaps an outer limit or beyond the reasonable outer limit for depreciation,” Economic Affairs Secretary Subhash Chandra Garg told the Economic Times in an interview this week. It means RBI should hold it at around 72, otherwise, there may be flight panic.

The market is looking for a clear direction on the fiscal deficit as far as the rupee and the current account are concerned. The government’s commitment to maintaining macroeconomic stability — fiscal deficit and exchange rate are very major components of that — is expected to be total. Even if at some stage the oil price burden has to be shifted, something would have to be done to ensure that the fiscal deficit is not breached.

The government on Friday announced a plan to check “non-essential imports, boost exports and initiate measures to attract dollar inflows into the country. Govt. and RBI have thus started working for fiscal prudence and exchange rate stability at the earliest to prevent any flight of capital and a run on Re.

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