The past few weeks have been difficult for India as it struggles to stabilize its currency, the rupee, which has depreciated somewhat sharply against the U.S. dollar. The rupee has generally trended down over the past three years due to underlying fundamentals, but a widely anticipated tapering of stimulus by the U.S. Federal Reserve seems to have accelerated its fall. The currency movement has greatly impacted investor nerves and led them to increasingly question India’s balance-of-payments (BOP). However, fears of a potential BOP crisis may be overblown.
One of the key measures that determines the vulnerability of an economy to such a crisis is the external debt-to-GDP ratio. For India, that metric is nowhere close to the level of the early 1990s when the country needed to be rescued by the International Monetary Fund after finding itself on the verge of defaulting on its sovereign debt. Another reassuring factor is the country has foreign exchange reserves of nearly US$300 billion—although only enough to support up to seven months of imports.
Nonetheless, the falling rupee is a challenge to the economy, and policymakers can use this as a clarion call to bring in much-needed reforms. The Indian economy’s challenge has long been to attract sufficient foreign capital to fund domestic growth. On a sustainable basis, the flow of capital can occur either through a robust export industry or through foreign direct investment (FDI) in long-term projects. Reforms are critical to achieving either of these improvements.
However, we are concerned that policymakers are drawing the wrong conclusions about the current state of the rupee. Recent measures announced by the Indian government and the Reserve Bank of India (RBI) suggest that policymakers are viewing the rupee movements as a short-term issue while paying less attention to some of the structural problems confronting the economy. Hence the measures seem to focus on reducing the country’s need for U.S. dollars by restricting or raising the cost of “non-essential” imports such as LCD televisions or gold. Furthermore, in recent days, the RBI has placed some restrictions on the ability of its residents to move capital overseas. The efficacy of such measures is questionable.
The government may be aiming to plug the gap in funding India’s current account deficit by increasing reliance on shorter-term sources of funding, including external debt. While these measures may work in the interim, there must be a concerted effort to attract more sustainable sources of capital that can be achieved by easing the cost of doing business, and by improving domestic business competitiveness. Unfortunately, the country’s attempts to improve competiveness in recent years have been half-hearted. Last year’s much-heralded decision to open FDI in retail, for example, amounted to very little due to certain constraints placed on foreign companies seeking to invest in India.
The silver lining to all this is if recent events can become the impetus for Indian policymakers to pay attention to longer-term objectives of improving competition and productivity within the country. In the past, economic stresses have enabled progressive elements within the country to move forward with reforms. We continue to believe that the underlying attraction to investing in India remains intact, and may get a boost with a more thoughtful framework for economic reform.
Sharat Shroff, CFA
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