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Decline and fall of the Rupee

This must stun most. Our trade deficit with China for 2012-13 is expected to be in excess of $40 billion. Remember, we do not import either gold or crude from China. Nor do we import arms or hi-tech products. Apparently, the import deficit with China is reflective of all that is wrong with Indian economy. Welcome to India under UPA!

But what do we import from China so as to run such gargantuan trade deficits? Nothing big or spectacular. What is galling is that most of these items could be manufactured or produced in India. Yet we import.

It is pertinent to note that in 2011-12, we imported Rs 100,911 crore (say $20 billion) of 'sensitive' items from various countries as compared to Rs 70,656 crores in 2010-11 — a spectacular rise of 43 per cent! Remember, this includes mundane items like milk and milk products, fruits, vegetables, pulses, edible oils, rubber, spices, toys and other sundry items that could easily be produced or manufactured in India.

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The figures for 2012-13 are awaited. But let me assure you this will not be encouraging.

Yet, all this does not form part of the popular narrative on trade deficit, the resultant current account deficit and the consequential Rupee depreciation. Interestingly, most in the Finance Ministry seems to be completely ignorant of these facts. What else would explain his passionate plea of the Finance Minister last week to Indians from desisting buying gold to tackle our current account deficit?

Needless to emphasise, self-styled economists within the establishment somewhere down the line hold surging gold imports as the villain when it comes to current account deficits. Professor R Vaidyanathan of Indian Institute of Management, Bangalore puts the matter rather humorously when he says that even as such lecturing goes on by sarkari experts, ladies in their own household would well be shopping for gold!

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In a way the professor is right. Even as the Finance Minister, made his plea gold imports surged to about 150 tonnes per month on an average in the first two months of this fiscal when was 75 tons per month the previous fiscal.

Surely this near doubling of gold imports in recent months despite the sharp fall in international prices has flummoxed our economists who expected Indians to refrain from purchasing gold even as renowned international experts predicted its collapse. What is not understood by most is that the lady in every Indian household sees this drop in gold prices as value purchase, while our economists fail to do so.

Why? Read on.

Interest rate mis-pricing?
Thanks to demographic dividend and lack of state-sponsored social security, our savings rate is one of the highest in the world. That implies we are dependent on the private financial sector for parking our investment. Nevertheless, thanks to our mismanagement of this sector by the UPA, there are very little avenues to invest our savings within India with scope for assured yet reasonable returns. This requires some explanation.

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Despite the hoopla surrounding the capital markets, the fact remains Rs 5,904 crore got invested in IPOs in 2011-12 and Rs 6,043 crore in the first nine months of the fiscal 2012-13. (Source: Economic Survey 2012-13 Page 120)

What may be interesting to note is that shares and debentures accounted for 8.3 per cent of total financial savings in the 1980s. Their share increased to nearly 13 per cent in the 1990s before declining to 4.8 per cent in the 2000s.

And this pattern extends to the whole of the financial sector. Thanks to successive scams, the average Indian investor is completely cynical about this sector and its functioning. It is in this connection I must confess that even as a chartered accountant, I have very little faith in the system of accounts, accounting standards and audits not to speak of regulators like Institute of Chartered Accountants of India, IRDA, RBI, PFRDA and SEBI.

Government helpless as Rupee plummets
That explains why financial sector in India is virtually irrelevant to our savings. Interestingly, as the Government clamours for more financial sector reforms the Indian households have been extremely chary of the same. What else would explain the decline of the share of financial savings vis-à-vis physical savings in recent years?

Financial savings, it may be noted, take the form of bank deposits, life insurance funds, pension and provident funds besides investment in capital markets. Financial savings accounted for around 55 per cent of total household savings during the 1990s. This declined to 47 per cent in the previous decade and it was a mere 36 per cent in 2011-12.

Of course, investment into bank deposits has been another traditional avenue. But thanks to the myopic policy of the UPA Government and mispricing of the interest rate regime (where interest rates are lower than inflation) for the past few years, Indians have been shying away from investing even into banks.

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In fact, household financial savings were lower by nearly Rs 90,000 crore in 2011-12 vis-à-vis 2010-11 (Source: Economic Survey 2012-13 Page 15). And it is this money that gets invested as gold and real estate — assets that economists within the establishment term as unproductive and yet are found lucrative by the ordinary Indians! Paradoxical isn't it?

Interestingly, in a country where locals are reluctant to invest in the domestic economy (and that is why they are investing in gold), it is trite argument that foreigners would rush to invest into India. And that is what the Government wants us to believe would be the solution to tackle the present economic crisis.

What about Chinese toys?
Naturally that takes us to trade deficit with China yet again. Thanks to a decade of misgovernance and policy paralysis at the Centre, production of even ordinary items like toys, has been stymied within India. That has compelled Indians to import when these items could be ordinarily produced or manufactured in India.

But that begs the question — why are Indians unable to compete with Chinese imports even within India? I guess even if the Rupee depreciates to about 70 to a dollar, Chinese imports may well and truly continue to be competitive even within India! That in essence is the built of inefficiency of the past decade under Manmohan Singh.

What is indeed appalling is that the economic managers of the UPA believe that at prevailing exchange rates of Rs 60 to a dollar Indians can compete with the Chinese outside India. How foolish!

More importantly, the mandarins in North Block assume that foreign investment flows will somehow stabilise the Rupee, forgetting for the moment that investment is a function of confidence. Elementary economics tells us — foreign investment follows the domestic.

Where is the question of foreign investment when domestic investors are rushing to park their money in gold — in effect invest outside India? More importantly, isn't it funny that we are importing in excess of $50 billion of gold every year while simultaneously pleading with foreigners to invest a few billions?

As India continues to maintain gargantuan current deficit — buying gold becomes a self fulfilling prophecy — a situation where the investor is rewarded simply by a depreciating rupee. This depreciation virtually turns gold into a risk free investment as it more than compensates for the fall of international gold prices.

Put pithily an average Indian has ultimately turned out to be much smarter than the collective intelligence of our establishment and gained by betting on its inability to deliver. By simply refusing to invest in financial products Indians seem to be rewarded. In this two way bet – one on gold and another on the foolishness of the Government – the average Indian seems to have triumphed.

Needless to emphasise there are two limbs in tackling the current account deficit. One, improve governance. That could possibly have the calculated effect of reducing imports from China as well as imports of sensitive items. That can happen only when we produce, produce in abundance and produce competitively.

And the key to that is improving governance — an area where the track record of the UPA is appalling.

The other one is to provide viable lucrative alternative investment channels for domestic savings. To effectuate that idea, India has to increase, not decrease, interest rates. This repeated clamour for reduction of interest rates by corporates is sheer nonsense. By artificially depressing interest rates, savings are getting diverted into gold.

And what the corporates gain by lower interest rates, the country loses through a depreciating Rupee. Surely, corporate India cannot plead for this interest subsidy endlessly. It is time that the Government revisits the root assumption of our economic policies.

Can the UPA Government address this challenge by making investments in India attractive for Indians? If its track record is any indication, it may not. Given its management bandwidth it cannot. Given its thinking it will not.

PS: Chinese toys are my new economic barometer. Take a walk to the neighborhood store and figure out whether Manmohanomics is dead or alive.

Last modified on Sunday, 07 July 2013 07:36

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