Double Trouble

To maintain forex stability at the time of QE withdrawal and maturation of external debt is going to be a tough call for Government.

Reserve Bank of India recently reported that India’s external debt i.e. loans borrowed from foreign lenders has reached to as much as 21.2% of the GDP ($390bn) as of March end. The news has come in the backdrop of depreciating rupee which has already crossed the psychological 60 due to dearth of dollars in the country and might even go up given the series of internal and external structural challenges. Though the recent Current Account Deficit data standing at 3.6% of GDP for Jan-Mar quarter as compared to 6.7% of the previous quarter has rekindled the hope of strengthening rupee but rising external debt and their soon-to-come maturation period certainly spills water on this hope as repayment of these debts has to be made in dollars, thus causing upward pressure on rupee.

External debt mainly consists of External Commercial Borrowings (ECBs), NRI deposits and short-term credit. Worryingly, the share of short-term debt stands at 44.2% of the total debt which has to be repaid in the next one year. By the same time American Federal Reserve will also be tapering off quantitative easing (QE) as announced by Fed Chief Ben Bernanke few days ago. During American recession, under its QE policy, Fed was pumping $85 bn dollars in the economy on monthly basis which is going to be rolled back as American economy is back on the recovery path. India being the biggest beneficiary of American QE will now turn out to be the biggest loser as its major source of capital inflows i.e. Foreign Institutional Investment (FII) is likely to be ended by mid 2014. In fact, impact of this announcement is already palpable given the free fall of rupee for the past few weeks as many foreign investors have been selling out their bonds and stocks from Indian market. To maintain forex stability at the time of QE withdrawal and maturation of external debt is going to be a tough call for Government.

While Govt. has no say in decreasing or increasing FIIs inflow but it must try to control external borrowings. Cheaper foreign money prompts India Inc to borrow funds from other countries while lending rates in India are skyrocketing with no sign of coming down due to high inflation. Although external borrowings has a positive side too as it stimulates dollar inflow in the economy but relying on ECBs, short-term credit or NRI deposits etc. for forex stability is dangerous due to its being highly volatile. Now that the value of rupee against dollar has been sharply falling, it might lead Indian companies to pay their foreign debts sooner than later as their repayment amount in dollar terms is piling up due to exchange rate vulnerability towards rupee. Their dollar-demand for repayment will further cause rupee to weaken against dollar. Considering this, RBI along with Finance Ministry would better adopt measures to maintain internal stability rather than becoming victim to external sector vulnerability. Yet RBI recently eased ECB norms in order to attract dollar-inflows. It can be temporarily acceptable for short-term boost to rupee but certainly not a viable option given the risk factor associated with it.

India’s heavy dependence on imports is the root cause of its weak currency which is also the bedrock of rising inflation i.e. the prime cause of economic slowdown. India stands at fifth position among countries having largest coal reserves yet it is one of the biggest importer of coal due to poor coal-mining in the country. Also more than 80% of India’s oil demand is met via imports. It is also the biggest importer of gold which had raised India’s CAD to unprecedented level. However, gold import could be curbed by bumping up import duty on the same but it is difficult to divert people’s attention from this yellow metal for its being a sure hedge against inflation. Stringent measures have to be taken by Finance Ministry and RBI to mitigate India’s heavy reliance on imports as direct and indirect impact of rising commodity prices and services chargers not only surge inflation but also raise production cost thus making export products costlier leading India to lose in competitive export market from other countries offering cheaper products.

India is stuck in a gruesome vicious cycle. Solution of one problem works as the catalyst for another. In this backdrop, finding a balanced solution and thus shifting to virtuous cycle is a herculean task for Government. Tough times for Indian economy and the lesson must be learnt that heavy dependence on precarious global economy while being in throes of weak domestic economy is not prudent. A robust, domestically sustained economy can only bear the brunt of sudden emergence of internal and external turbulence.