Mumbai, Aug. 28: The UPA government and finance minister P. Chidambaram loathe Cassandras and their dire prophesies about the Indian economy.
But the Oracles were swarming the Street on Wednesday, painting gloom and doom scenarios as the rupee plunged to a 20-year low at 68.85 to the dollar.
They suggested that only a “Shock-and-Awe” strategy from the Reserve Bank of India could now save the country from floundering in the morass of its worst economic crisis since 1991.
Shock and Awe is a military doctrine prepared by US strategists Harlan K. Ullman and James P. Wade in 1996 to describe a spectacular display of military might to paralyse an adversary and sap its will to fight. It became a buzzword after the US invasion of Iraq in 2003 and its use gained currency in commercial contexts soon after.
Today, the rupee recorded its biggest single day fall of 256 paise, or 3.86 per cent. Although the RBI intervened to bring some stability to the volatile forex market, pressure built up again in the last half hour of trading, ensuring that it closed weak at 68.80.
BNP Paribas economist Richard Iley said: “With little genuine support from the ministry of finance, the RBI has been left trying to frame monetary policy across too many dimensions and fundamentally backing the ‘wrong horse’.”
“The recent liquidity squeeze (referring to the capital controls slapped on August 14 and the decision to float cash management bills to suck money out of the system) is the wrong solution to the wrong problem and risks proving entirely counter-productive,” Iley wrote in a note.
“The RBI has unwittingly created the worst of all possible worlds: a monetary tightening that has not failed to staunch the selling pressure on the rupee but rather has intensified it.”
The verdict on the Street on Wednesday was that the rupee could hurtle past 70 to the dollar unless the RBI policymakers delivered a “full-bloodied and decisive policy tightening that breaks the expectations loop”.
There are two developments on the horizon that will now shape the course of the rupee in the immediate term.
On Friday, the Central Statistical Organisation will release the first quarter GDP growth figure which isn’t expected to dispel the gloom.
Chidambaram has already played down expectations by suggesting that GDP growth in the first quarter would be “flat” but rise in subsequent quarters.
Market economists challenge that assumption. BNP has now trimmed its GDP growth forecast for the current fiscal to 3.7 per cent from its earlier projection of 5.2 per cent way below the RBI’s forecast of 5.5 per cent.
On August 9, Morgan Stanley chief economist Chetan Ahya warned that India was in real danger of slipping back to a Hindu rate of growth that characterised the pre-liberalisation era. Ahya said India’s GDP growth could plummet to an abysmal 3.5 to 4 per cent if the weak growth trend persists over the next four to five quarters, which more or less ties in with Iley’s forecast.
The RBI headquarters on Mint Street will see a change of guard on September 5 when Raghuram Rajan takes over as the central bank’s governor.
Nobody is realistically expecting Rajan, a highly acclaimed MIT-educated economist, to pull off a “Jedi-mind trick” like the one that European Central Bank governor and fellow MIT-ian Mario Draghi hatched last year to yank Europe back from the brink of a bond crisis that had erupted in Greece and Portugal.
Rajan has a tricky inheritance and will have to wrestle with the RBI’s conflicting policy objectives: first stabilise the rupee, then squelch inflation and also ignite growth in a faltering economy.
But the bigger problem that Chidambaram and Rajan will have to grapple with is over the twin deficits fiscal and the current account deficit (CAD) which have now started to feed off each other, tipping the economy down a vicious spiral.
With foreign investors pulling money out of Indian markets and oil importers scrambling to scoop up dollars, the rupee has gone into a tailspin. Oil prices have surged past $117 to the barrel, forcing oil importers to pay more for oil and that can only widen the current account deficit. Last year, it had ballooned to $ 88.2 billion. This year, it is projected at $ 70 billion but many believe it will be slightly higher.
The thumb rule is that a one rupee move in the Rupee-US dollar exchange rate adds Rs 8,000 crore to the fuel subsidy bill, which has been projected at Rs 65,000 crore this year. Experts believe that the oil subsidy bill will swell to Rs 1.4 lakh crore, more than twice the budget projection.
A rising oil subsidy will throw the fiscal deficit out of whack. The budget arithmetic has already been thrown into a wrench because of the additional spending on food subsidy to support the Food Security Bill this year.
If the government isn’t able to raise the prices of diesel and urea because of the compulsions of an election year, the overall subsidy bill could top Rs 3 lakh crore against the budget assumption of Rs 2.2 lakh crore.
Chidambaram said in Parliament yesterday that the fiscal deficit would be capped at 4.8 per cent.
Many believe that this is not possible. “Chidambaram’s target
looks increasingly unobtainable. Without remedial action, a 6 per cent (fiscal) deficit looks possible,” said the BNP Paribas note.
The last-gasp resort to save the rupee would be to go in for an IMF loan as India did in 1991. There has been some desultory talk on the subject on the Street.
“Loan from the IMF would be a last resort. But there is a reputation issue here, considering that India is not really in a desperate situation as in 1991. Also for a nation that is to be a global economic leader in the years to come, going to the IMF may not send the right signals to the world,” said Madan Sabnavis, chief economist at CARE Ratings.
Sabnavis felt the more likely option would be to go in for a currency swap arrangement with another central bank. India already has one with the Bank of Japan. Late today, the RBI opened a currency swap window to meet the daily dollar requirements of three state-owned oil marketing companies.