The last few weeks have seen the onset of a currency crisis in India. The Rupee has fallen to a new low against the US Dollar pretty much daily, as the Reserve Bank of India and the Indian government have struggled to resist this new trend. This morning the Rupee has fallen to yet another new all-time low of 62.46 versus the US Dollar. If we look back, we see this all in fact began at the start of May when the Rupee stood at 53.82. But over the next three and a half months the Rupee has fallen by 8.6%.
If you wish for an image to go with the currency fall it is perhaps the sinking of the Indian submarine INS Sindhurakshak which exploded and sank last Wednesday. The only good thing about that was it was not the nuclear powered submarine that the Indian Navy now possesses.
Putting events another way the news has even hit twitter as the #Rupee is trending.
One of the issues often debated around Quantitative Easing if its effect on currencies and the reason for this is that whilst the theory seems clear, the practice as ever, has been much more complex.
There are usually so many often contradictory events taking place that any measurement gets drowned in economic noise. However if we look at the timing of the Indian Rupees decline, we have to ask ourselves whether it is more than a coincidence that this coincided with the first mention of a reduction in the US’s Quantitative Easing programme?
If we follow that thread we see that such taper talk has led the US 10-year Treasury Bond yield to rise from 1.63 to 2.84% as I type this. So for once we have perhaps an apparent success for conventional economic theory as the US dollar has risen in response. Although we note that this has been against just talk or “open mouth operations” and that it has been against emerging and developing nations as the Euro and UK pound for example have not fallen.
So whilst India is to some extent a victim of overseas events this is by no means the entire story or the trade weighted US Dollar Index would have risen more generally, rather than being not far off the same. Although we do return to an emerging country problem as the Dollar Index does not include them.
What are India’s specific problems?
Rather like her past Imperialist ruler India has run a persistent trade deficit with a cause I discussed on the QFinance blog back on the 27th of February.
India has been running a considerable trade deficit which has been exacerbated by the way that the oil price has risen and also by the way the Rupee has weakened against the US Dollar.
A trade deficit driven by oil imports is the driver and it was also showing signs of getting worse.
In the first half of the year it was 4.7% of her economy’s size and the forecast for it is not hopeful according to the RBI’s Governor ( who is likely to be a professional optimist in such matters…)…..The second half is likely to be higher and this year’s currency account deficit is likely to be significantly higher than last year’s current account deficit.
Recently I have returned to the issue of trade deficits, currency values and economic performance and I looked at the UK’s position on the 9th of this month. However India is now clearly on the economic front-line.
Official policy has failed
On the same February 27th blog I pointed out that in my opinion the Reserve Bank of India was making a mistake by pressing the stimulus button.
If we add economic growth to the inflation rate we see that at somewhere between 16 and 17% a central bank would normally be pressing the brake and not the accelerator and some would be stamping on the brakes hard!
Secondly if you add in the promises of further action the RBI has taken quite a gamble here but if it fails it will be the Indian population who will feel the pain.
One more time we find ourselves reviewing a situation where a central bank has posed as Superman and ended up looking much more like Clark Kent. In fact in the case of the RBI the analogy is unfair on Clark Kent! This sadly does not seem to deter those who call for ever more central planning and involvement.
If we stick with the issue of the price level and inflation then India Statistics tells us this.
Provisional annual inflation rate based on all India general CPI (Combined) for July 2013 on point to point basis (July 2013 over July 2012) is 9.64%
As we wonder exactly how those in India can compensate for this and recall that the poorest will find this hardest, we have the grim realisation that the currency fall will add to this. The latest Wholesale Price numbers for July shed further light on this.
The index for ‘Food Articles’ group rose by 3.4 percent to 237.7 (provisional) from 229.8 (provisional) for the previous month
A factor in this has been a surge in the price of an Indian staple the humble onion which rose by 31% in a month and is 145% higher than a year ago.
As we look around the products which are essentials we also note this.
Fuel & Power (Weight 14.91%)
The index for this major group rose by 3.0 percent to 199.8 (provisional) from 194.0 (provisional) for the previous month
Accordingly we see that there are already substantial price pressures at the beginning of the price and inflation chain.
The dash for growth seems to have failed
If we look at industrial production we see some more signs of the mire into which the Indian economy has plunged.
The General Index for the month of June 2013 stands at 164.3 (2004-5=100), which is 2.2% lower as compared to the level in the month of June 2012.
The Official Response
Currency crises are a time where both governments and central banks deploy ”open-mouth operations” which may satisfy a feeling that they need to do something but in practice they invariably make things worse. Actual measures to improve things would have to have been already deployed.
The RBI deployed these last Wednesday.
RBI announces measures to rationalise Foreign Exchange Outflows by Resident Indians
Of course such measures invariably only encourages those who can move their money to do so quickly -in case the capital controls spread to them too- and the initial effect is for the currency to fall even faster. So far this has been the Indian experience.
Other financial markets
Currency crises are usually accompanied by falling stock markets and government bond prices and this is true for India right now. The Sensex equity index is no longer joining in the global equity market rises and is now down 4.5% in 2013 at 18,320. The benchmark ten-year bond yield is just below 9%.
If we review what India can do then there are two factors at play. If we look at past currency crises we see that there is no magic solution and that plans for genuine reform are much more likely to have an impact than headline grabbing. As India has a limited supply of foreign exchange reserves any intervention is risky. Also as is the way of things markets are adapting as shown below.
Mumbai:Axis Bank Ltd on Monday said it has raised its minimum lending rate, or base rate, by 25 basis points to 10.25% with immediate effect.
So the first tactic should be to follow the advice printed in big friendly words in the Hitchhikers Guide to the Galaxy.
If we move to the consequences of this then I worry very much about the impact of this on the poorest in India. They are the least able to protect themselves against the rises in price of essentials such as food and fuel. Indeed I am reminded of the way that such rises played a part in the so-called Arab Spring.
Also there is the issue of gold where Indian’s have for many years been investors or hoarders depending on how you review it. Longer-term holders have been having what one might call a stormer as Rupee falls have been added to gold price rises. They will not have enjoyed the decline towards US $1200 per troy ounce in late June but now it is US $1372 and the Rupee has plunged too. So gold investors in India may be amongst the few who can take a sanguine view of the current crisis.
Also more will be tempted into gold and other stores of value which of course only makes the overall underlying situation worse.
Cricket fans of which there are an enormous number in India are already wondering if the Rupee will bring up a century against the UK pound as it moves through the nervous nineties to 98.
This tweet from @shuvankr illustrates how currency crises spread around the economy.