The Telegraph
Thursday , January 9 , 2014
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Not the London Bridge, but the Indian rupee was falling down, falling down. Between May 20 and August 28, 2013, the rupee fell from 55.11/$ to 68.83/$, that is, by 25 per cent. The situation eased from September onwards and the rupee is now at the 62/$ — 63/$ level.

All the trouble started when for some reasons, real or flimsy — changes in the world economic situation, slowdown in industry, temporary drop in foreign exchange reserves or political instability in the recipient country — the perception of foreign investors regarding India changed for the worse, and they suddenly began withdrawing their funds. In India, some $12 billion was withdrawn between early June and late August 2013. The chief reasons were as follows. First, high current account deficit thanks to sharp duty reductions for importing luxury items like gold, personal aircraft, foreign cars and the like. Over the last five years, we imported gold worth $200 billion, which touched 845 tonnes in 2012-13, causing an outflow of $50 billion. Second, huge exposure of more than $151 billion of the European banks, which had been weakened by the long stagnation in Europe, especially in the Eurozone, to the Indian markets. This led to return flow of capital.

As the foreign exchange reserves dropped, the rupee fell and the stock prices crashed immediately. The fall in rupee raised the rate of inflation due to our high import-dependence. Soon the rates of interest had to be raised to counter inflation and speculative hoarding, especially of food grain. High inflation and high interest rates curbed the demand for personal housing and consumer durables. These also delayed industrial investments.

Much of the Western capital went to the world currency markets for betting on currency fluctuations. After the September 2008 crash, both the advanced and the developing economies injected trillions of dollars into their economies — which pulled the world out of the Great Recession. But a large chunk of it went to the world currency markets, fuelling speculation. This also explains why the post-recession recovery is so feeble. Had these funds been used for productive investments with an eye to employment generation, the world would have been a happier place to live in.

Sweet will

The danger is that the global currency market is beyond anybody’s control. Till now, the G-20 nations have failed to impose even a minimal tax on currency transactions in the global currency markets, thanks mainly to opposition from the United States of America. So speculators can target any currency they perceive to be weak even for a minor and transient reason and get away with it. And this is what they did with the rupee between May and September 2013, especially in August last. From 61.35/$ on August 16, the rupee dropped to 68.83/$ on August 28 — a drop of 12.2 per cent in just 12 days! This was a sheer speculative attack since the fundamentals of the economy hadn’t changed that quickly and it was clear by mid-August that India would get a bumper kharif crop thanks to an excellent monsoon, which also raised the hydro-power potential by filling up reservoirs, thus removing a major bottleneck for raising industrial production.

Earlier, half of the total foreign financial investment used to come through participatory notes till the Securities and Exchange Board of India clamped restrictions and framed rules to know the real identity of the investors. This sharply reduced the speculative investments. But from September last, the finance ministry has allowed the entry of foreign financial capital bypassing the Sebi. So global speculative funds can now freely enter and exit India at their own sweet will. The result is there for all to see. The stock indices just rise and fall as foreign speculative capital comes in and leaves India.