Is The Indian Economy Collapsing? - Facts & Infographic
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India's currency woes have their origins in a number of factors. Leading them is the country's burgeoning current account deficit (CAD). The deficit is a major cause of the sharp plunge of the value of the Indian currency, the Rupee (INR) as seen in the past month.This deficit is a buildup due to a consistently larger import bill topping the country’s export earnings. A deficit which is continuously challenged and widening puts a strain on the nation's foreign exchange reserves. A widening CAD means that year on year India is required to pay more than it earns by way of foreign exchange, primarily the USD. This hikes up the demand for the USD, thereby increasing its value vis-à-vis the domestic currency, the INR. The USD is often used as the benchmark currency across the world. A decrease in value against the USD is known as devaluation.
An increasing CAD also leads investors to doubt the country’s ability to foot its own import bill and indicates that a loan may become necessary. India has the world's third-largest current account deficit. The trade deficit is quickly approaching $90 billion. In March 2013 the current account deficit hit a record low of 4.8% of the national GDP. This rise from 1% of GDP in FY07 to 4.8% in FY13 has taken a deadly toll on India's sagging economy. Goldman Sachs, however, expects India's deficit scenario to improve and to stabilize at 4.2% in FY14 and improve to 3.4% in FY15.The slowdown in India's growth rate, caused by the plunging value of the domestic currency, is currently at the lowest levels in the past decade. The global bank has also cut India's GDP growth rate forecast to 4% from 6% for the current financial year, anticipating difficulties in keeping the rupee buoyant. It is anticipated that inflation will reach a staggering 7% by FY14.
A steep plunge in the value of the rupee means that imported goods and services will now be more expensive. Devaluation of the rupee also negatively impacts the inflation of the economy. Since the INR now has less purchasing power, domestic goods and services also tend to become more expensive. Apart from luxuries, even essential commodities such as food, medicines, and oil become more expensive.
The Fall Of The Rupee
In the past year, the Indian national currency, the rupee has lost over 20% of its value. It is now among the worst-performing currencies in the world. Throughout August 2013 Indians watched in horror as the domestic currency plummeted to record low levels against the US Dollar. By August 28, 2013, the INR was at the nadir of its decline and traded at 68.825 against the dollar.
The tumble of the rupee started somewhere in mid-May 2013 till when it was trading between 52 and 55 to the USD. While a widening CAD (current account deficit) was cited as a major cause of the decline. The declining value of the rupee has been shown to have caused much harm to the national economy and much stress to financial managers across all sectors. With corrective measures having been taken by the Reserve Bank of India (RBI), the central bank of the country, economists believe that the INR has lost much of its volatility but is still unlikely to reach previous levels till India decides to trim its CAD.
The fall of the rupee is likely to have triggered off a contraction in the national economy with the HSBC index of purchasing managers’ sentiment falling from 50.1 in July to to 48.5 in August. A reading below 50 indicates a contraction in economic activity and a decline in new trade and exports.
The corporate sector of India, however, continues to show immense confidence in the Indian economy. According to the results of the Economic Times CEO Confidence Survey, more than 40% respondents were assured of growth and the revival of the rupee.
While most analysts and experts believe that the rupee is likely to recover, the process itself is expected to be long-drawn. “The recovery is likely to prove protracted as confidence will only return reluctantly, and the structural reforms will only pass through to growth very slowly,” said Leif Eskesen, HSBC’s chief economist for India and Southeast Asia.
While exporters and export houses could benefit from the fall of the rupee in the short run, the depreciation is unlikely to cause any long term benefits. This is because manufacturing/operational costs of exporters will increase in sync with the inflation.To combat the free-fall of the rupee, however, the government needs to concentrate on increasing exports and liberalization of export policies.
Gold imports are among the biggest contributors to India’s trade deficit and cause a hefty foreign exchange drain on the nation. India is the world’s largest buyer of gold. Buying gold is an integral part of the Indian culture. About 52% of the gold produced in the world goes into making Jewelry, about 12% is to meet industrial needs, about 18% is in the form of holdings such as gold ETFs (exchange-traded funds), and about 18% is held by central banks worldwide. Of the 52% that goes into jewelry making, the majority of the consumption is by India. A middle class Indian household is likely to buy between Rs 15 and 80 lakhs worth of gold jewelry in a lifetime.
In 2012, India imported a record 860tonnes of gold. The country has 31,000 tonnes of commercially available gold – estimated to be worth $1.4 trillion (at end-August 2013 prices).In the second quarter of 2013 (April – June), gold imports by India more than doubled following a slide in prices, increasing the demand for gold coins and bars. According to statistics from the World Gold Council, gold imports between April and June 2013 were at about 338 metric tonnes, a remarkable increase over the import of 153 tonnes for the same period in the previous year.
Mid-August 2013, India tried to curb the insatiable demand and ever-increasing import of gold by placing a blanketban on imports of coins and medallions. Bullion import duty was increased to a record 10% and the Economic Affairs Secretary, Arvind Mayaram, said that all imports of gold would require a license from the Foreign Trade Office. It is however likely, that imports and consumption will both skyrocket again in October - November, the festive season for the Hindus which is considered very auspicious for buying gold and other precious metals.
The RBI holds huge gold reserves (557.7 tonnes in end August 2013) as the fund requisite to redeem promises to pay depositors, note holders, and control fluidity of the currency market. The RBI is now considering directing banks to buy gold directly from the Indian public to regulate rupee fluctuations.
Oil And Oil Imports
The ever-increasing costs of crude oil has been the bane of the Indian economy since over 80% of the country's oil and oil products requirement is imported from outside the country. Besides with a population of over 1.27 billion, the demand for oil and oil products have only been increasing exponentially each year. India’s dollar and forex drain is led by oil imports to feed its growing industries, automobiles, and domestic requirements. Last year, India’s oil imports were worth $144.29 billion.
Across global markets the trade of oil is conducted in dollars. With any increase in the demand for oil in India or with the increase in global oil prices, the strain on India's forex reserves is immense. This automatically leads to a dip in the Indian currency against the US Dollar.
The prospect of a US-led military action in Syria caused a major jump in global oil prices; it also triggered higher inflation worsening of India's trade deficit. While it is uncertain if India will ever be able to trim its oil requirements, the situation is by no means beyond repair.
India now plans to increase crude oil imports from Iran. This could save the country about $8.5 billion in foreign exchange.The proposal is currently being considered by Prime Minister Manmohan Singh. Sanctions imposed on Iran by the US administration and the European Union had prompted India to cut down oil imports from Iran by 26.5% during 2012-13.In 2012-13, India imported only 13.1 million tonnes of crude, against a 18.1 million tonne import in 2011-12. What is significant here is that India pays Tehran in INR through a nationalized bank in Kolkata for its oil imports. The likely $8.5 billion savings on foreign exchange if the proposal gets through the PM's office is likely to prop up the rupee and decrease the trade deficit considerably.
Faltering Stock Markets
Investor confidence has been badly shaken by the downslide of the rupee and by the slowdown of the economy. Between June and August 2013, international investors have withdrawn over $12 billion worth of shares and debt from the Indian economy.
The American central bank, the Federal Reserve of the United States, in an effort to boost domestic growth and increase liquidity in the American markets embarked on a policy of Quantitative Easing by directing liquidity into Asian markets. In India, this hiked stock and asset prices of every class.The Federal Reserve’s decision to scale back such stimulus measures with the improvement of the domestic economy and expectations that September could see some such withdrawals have seen a major pull back by global investors.While this has uniformly hurt the currencies and stock markets of India, Indonesia, Philippines, and Thailand, since May 2013, India has suffered rather severely.
On August 1, 2013, news filtered in confirming the downgrading of Indian stocks by Goldman Sachs. The economy was regarded as extremely vulnerable and the stocks deemed "underweight". Goldman Sachs expects corporate earnings in the country to grow at 5% for the current fiscal year and 11% for the next year. These concerns have further dissuaded foreign investments. “We lower our NIFTY 12-month target to 6200, implying 7 per cent upside in local FX with potential downside risks from rupee weakness”, said Goldman.Some major FIIs have recently withdrawn their promised investments adding to the woes of the Indian economy. ArcelorMittal and Posco decided to pull out their projects from India.Posco shelved plans of a proposed steel plant worth INR 30,000 crore that was meant to be put up in the Indian state of Karnataka. ArcelorMittal also abandoned a steel plant project, this time in the eastern state of Odisha. This plant was worth INR 52,000 crore. Most of the withdrawals have cited bureaucracy and administrative delays as the reason. India must remain nimble and react quickly to woo back investors who now seem to prefer dynamic and more welcoming markets such as Singapore for the inflow of foreign investments to stay healthy, say economists.
Pre Elections Slowdown
Pre-election economic slowdown is a common feature seen in the Indian political economy. With the general elections coming up in 2014, the nation has been plunged into uncertainty over the deeply divided political leadership. While the current UPA government has been largely unsuccessful in stimulating growth and preventing inflation, the lack of a cohesive and strong opposition has been a matter of worry for international investors and observers.
Indian Finance Minister, Mr. P Chidambaram does not see reason for panic behind the tumble of the rupee. He said, "A number of steps have been taken to moderate demand of non-essential imports ... enhance capital flows to augment supply of foreign exchange and curb speculation in the foreign exchange market to stem the rupee depreciation."
In an address to the lower house of the Indian parliament on September 5, 2013, the Indian Finance Minister said that the Rupee would correct itself and bounce back. While the dip is certainly cause for concern, the government had taken corrective steps to check slide. While the economy was indeed going through a period of stress, it was not indicative of a collapse.
The opposition, however, holds radically different views. The Congress-led UPA government was slammed by major opposition leaders for their inability to focus on and rescue the failing economy. Gujarat Chief Minister Mr. NarendraModi said “The country is disappointed today because the government is neither concerned about the economy nor the falling rupee. It is only worried about saving its chair”.
India’s economic future could largely depend on the outcome of the 2014 elections and the initiation of robust financial and trade policies by the next cabinet.
RBI Changes And Positive Measures
To halt the fall of the rupee and to heal the widening CAD, the RBI has taken a number of corrective measures. This includes imposition of restrictions on the amount of money that can be sent out of the country by both companies and individuals.The RBI has also asked other banks to buy back gold from the public and has increased the interest rate at which it lends money to other banks, putting a cap on their daily borrowings.In August 2013, the central bank announced the auction INR 22,000 crores worth of government cash management bills each week. The duration of this auction was not announced by the RBI, though.
On September 4, 2013, Mr. RaghuramRajan took over as the new Governor of the RBI. Mr. Rajan faces a tough challenge as the head of the Indian central bank – as the person responsible for formulating and implementing policies related to the Indian banking system and advising the Indian government with regard to its economic policies. MrRajan, however, has immense faith in the health of the Indian economy. He said that the Indian economy was "fundamentally sound" and has a "bright future".
Laying down fresh regulations to revive the rupee value, MrRajan announced that banks that receive dollars from Indians living abroad would be able to exchange those dollars for rupees from the RBI. Thus the banks would have rupee funds enhancing liquidity, and the banks could also swap them back to dollars at the central bank. This is likely to increase USD holdings with the RBI, leading to a reduction in value. It is anticipated that Mr. Rajan will bring in more regulations to heal the INR value and CAD woes.