It is no secret that with India’s foreign currency reserves plunging over the past several months, RBI has been—appropriately, in my view— “…closely and continuously monitoring the liquidity conditions in the forex market and has stepped in as needed in all its segments to alleviate dollar tightness…”
Last Friday, they increased the import duties on gold and imposed an export tax on petroleum products; there was an immediate reaction with the rupee climbing back above 79, but it was, unsurprisingly, short-lived. It is clear that, while our current account deficit is rising, this is not the primary cause of the panic in the market. Foreign portfolio investors have been fleeing Indian markets, as, indeed, other emerging markets, in droves. Notably, the outflows are not so much from the debt segment, which would point to rising US rates as the proximate driver, but from equity, or risk, investments.
So, even though India’s economy is reasonably sound, as RBI so painstakingly articulated in its announcement, that is hardly the issue. Global investors, having already lost around 20% of their equity value and concerned that there could well be more to come, are retrenching investments willy-nilly from everywhere.
Thus, the moves made by RBI to pull in dollars are, to my mind, unlikely to have a major impact. With global markets going into a downturn, it is hard to see a wider ECB window generating a whole lot of enthusiasm. Permitting banks to provide much juicier returns on NRE deposits could have some impact in the immediate term; no doubt, RBI had done some sniffing around before making this move. However, the universe of non-resident investors would be nowhere near large enough to plug the kind of haemorrhaging we have been seeing, and which is likely to continue till the global risk-off wind dies down.
The two key drivers of this are, of course, fear of US inflation leading to substantially higher interest rates which would undermine equity values, and oil prices, which had climbed sharply both further pushing inflation and putting pressure on company profits. The good news, if it can be called that, is it is beginning to appear as if there may be a hiatus in these variables—US economic growth is slowing sharply and there are some analysts who believe the Fed may not have to push rates as high as had been feared; and, in a lovely sympathy move, oil has suddenly come down sharply reiterating the slow growth fear. If this continues, sabke muh mein ghee shakkar (everyone benefits).
But, and that is the tragedy, there is no certainty of this. The Fed, having thoughtlessly burned its inflation-fighting credibility, would be hard-pressed to respond to signals of slowing growth till the inflation horse is safely back in the stable, and nobody really knows how to identify that event. In other words, even if things are getting better, the Fed cannot chance that they turn bad again—this is, in fact, the real reason to “take the punch bowl away just as the party is starting”, which is Monetary Policy 101. If you fail to do that, as most of the past Fed chairs have, you are doomed to push the economy and markets lower than they need to be.
Thus, it is hard to see when the pressure on the rupee will ease, despite RBI’s best efforts. In a recent report, I had suggested they raise rates out of turn again, but, again, it seems that it would be, at best, a very short-term breather. I would imagine RBI has thought about some more draconian changes in the event of the pressure remaining, or, worse, increasing.
The reserves fell by $6.5 billion in June; they have fallen around $600 million in the first two days of July. It was a mercy that the Dow, after falling sharply at the opening on July 5 (after a holiday weekend) recovered to close just a bit better; and today Dow futures are up. But these are short-term movements—we could well be seeing the beginning of a bear market rally.
One day at a time.
(The author is CEO, Mecklai Financial http://www.mecklai.com)