The Crash Of '95

On the first day of trading year Samvat 2052, the BSE bore a sombre look. No joyful brokers this year, with their families dressed in their newest and best, all determined to take the share index (sensex) up. Instead, there was some desultory trading. The chopda poojans, prayers to the account books – traditionally a community activity with much distribution of sweets – were performed quietly in the brokers’ offices. And the sensex did the unthinkable. It moved down, by 22.82 points.

To put it in context, no one had held too many hopes for Samvat 2051, but on Diwali day last year, brokers still moved the market up by 50 points. Of course, it then fell by 200 points over the next seven days, but the unspoken code of the Indian stock markets is that on New Year’s Day, the gloomiest of bears has to turn bullish, and the sensex mustmove up. Dr Singh could also have visited the Bombay commodities market, where too, pessimism reigned. Oilseed prices had shot up to an all-time high of Rs 442 per 10 kg a few days ago. On Diwali day, it traded at a slightly lower Rs 431.25 more than 25 per cent higher than the rate on Diwali 1994. Over the last few days, the price of mint gold had shot up to Rs 5,015 per 10 gm, and 0.999 fineness silver to Rs 7,569 per kg.

The crash of the rupee – 13 per cent against the US dollar in a matter of 45 days – has begun to take its toll. Three days after Diwali, a leading metals importer told Outlook: "I haven’t been to my office for six days now. There’s no point."

"What has caused concern is the speed with which the rupee has fallen, and the all-pervasive helplessness," says Hari Mundra, chief financial officer of the RPG group. "Even the RBI (Reserve Bank of India) doesn’t seem to know what to do about the falling rupee. A 13 per cent depreciation is no joke. No company earns as much net profit before tax." On October 26, forwarded premia on the dollar – index of the market’s expectations of the future value of the rupee – were at all-time highs.

The strangest aspect of the descent was that neither of the two custodians of the rupee, the Finance Ministry and the RBI, seemed overly concerned. These are the same two entities who had kept the rupee rock-steady at an artificial Rs 31.37 to a dollar. Of course, the RBI intervened periodically (see chart), and as Outlook went to press, was still doing so, but its intentions seemed to be to let the rupee fall at a predetermined pace to a pre-determined figure rather than to halt the decline.

The inescapable conclusion: what we have just seen is a devaluation of the rupee by the Government of India, except there has been no official announcement. With Lok Sabha elections looming, the Government seems to have decided that an official devaluation would be playing into the Opposition’s hands. The devaluation of a nation’s currency – whether it’s bad for the economy or not – always has a negative psychological impact (see box: ‘Devaluation, Not Depreciation).

In his four and a half years as finance minister, Singh has taken many high-risk gambles. This stealthy devaluation of the rupee is possibly the last gamble before India goes to the polls. In some ways, it is also his biggest. The Congress needs a last-minute miracle to come back to power on its own. The Narasimha Rao Government has always placed economics first on its political agenda. It is now looking for that pivotal windfall from the finance minister.

Obviously the next logical question is: how will the fall of the rupee impact the economy, and finally our lives? But before we come to that, what made the rupee so weak that the moment the Government turned its back on it, the coin sank?

To keep the rupee at Rs 31.37 per dollar, and also – we’ll come to this later – to satisfy the Government’s ravenous hunger for funds, the RBI had to increase money supply. More money chasing an uchanged amount of goods and services naturally led to inflation, which has been officially declared to be 8.12 per cent for the week ended October 7.

Late last year, inflation began to eat into the real value of the rupee, though the nominal value remained stuck at Rs 31.37 with lots of help from the RBI. Says Subodh Bhargava, CEO, Eicher Industries: "The current drop in its value is a correction that was necessary." Export competitiveness was hurting.

Meanwhile, reduced tarrifs have been inducing Indian companies to go in for more imports of raw material, components and capital goods than ever before. Between April and August this year, India’s imports rose 37 per cent over the corresponding period last year to hit $14.28 billion, while exports rose 28 per cent to reach $12.30 billion. This trend, if it continues, can only lead to a serious trade deficit predicament – much more imports than exports.

With foreign exchange reserves under pressure – they are expected to be down to $17 billion for 1995-96, it was becoming increasingly difficult for the RBI to keep the rupee buttressed. And remember, a large part of that $17 billion is "hot money" – share market investments that are theoretically one Wall Street telephone call away from disappearing from Indian shores. And not purely theoretically either: it happened in Mexico just some months ago. Singh could hardly run the risk of continued spending of his reserves to shore up the rupee.

So the rupee had to decline. Says Ramesh Chauhan, former Parle chief: "The fact that the value of the Indian rupee is falling against the dollar at a time when the greenback is losing ground against European currencies, shows the precariousness of the Indian situation." Says V Raghuraman, secretary general, Assocham: "The Government should have ensured that the fall in the rupee was gradual and not sudden to avoid the jolts that are presently being experienced in the economy."

Devaluation per se is not something negative. Says Mesco group Chairman J.K. Singh: "The Government letting devaluation happen is a healthy sign." Besides, a cheaper currency will spike up exports, and lure in more foreign investors who can now expect an even bigger bang for their buck, right?

Yes, that is precisely what the finance minister is hoping as he goes all-or-nothing in the last deal. What is terrifying is that the gamble may not work.

For one, much of the cost of production of Indian exports goes in imported raw material and components. The rupee falling by 13 per cent also increases exporters’ cost of production – though admittedly not by 13 per cent. Overall, export earnings from invisible trade – for instance, foreign tourism and NRI deposits in banks. Says Singh: "The value-addition from exports will work out to be more than the fall in the value of rupee."

But, says Saurabh Srivastava, managing director of software exporter IIS Infotech Ltd: "The initial euphoria will soon vanish once exporters realise the costs of their overseas operations have shot up with the fall of the rupee." Feels Sunder T Vachani, managing director, Weston Electroniks Ltd: "Though exporters will gain in the short-term, a falling rupee is not good in the long run." And Bansi Dhar, chairman of DCM Shriram Industries, feels: "Now that the value of the rupee has fallen, the Government should give more incentives to export-oriented industries."

As for foreign direct investors, the spectre of political uncertainty, with a coalition government the most likely possibility after the elections, is surely weighing heavily on their minds. And any significant rise in inflow from foreign institutional investors (FIIS) will depend on how fast the Government can set up a share depository, which will ensure that the shares you pay for are actually registered in your name.

The continuing Reliance duplicate-share fracas starkly highlights how creaky the share registration and delivery systems still are on Indian bourses. "Dollars brought in now will command more rupees than they did before, so more shares can be bought," says L.C. Gupta, member, SEBI. "But that is provided this is a once-and-for-all depreciation. The fear that it will depreciate more will be a deterring factor for increasing portfolio investment."

The higher costs of imports will hike costs for all major projects and hurt domestic capital formation – the investment in plant and machinery that will bear fruit in the future. This will affect not only industrial growth but also exports.

And it’s just one prong of a double whammy that has caught Indian industry right on the jaw. The other part is higher interest rates. With elections on the horizon, the Government has been focussing its economic policy on curbing inflation by getting the RBI to make sure that banks have to hike the interest rates at which they lend to industry. With money costlier, everyone would borrow less, so less money in the system; ergo, prices would fall to match the funds available. End of inflation.

On October 25, Canara Bank and Bank of Baroda became the first nationalised banks to announce a hike in interest on deposits with more than two year time periods to 12.5 per cent. Foreign banks are offering 13 or 13.5 per cent. If you as a bank are borrowing at 12.5 per cent, there is no way you are going to lend to industry, after meeting all the statutory liquidity norms laid down by the RBI at less than 18.5 per cent. This is usurious, but the banks don’t have a choice. If these measures curb inflation, they will exact a terrible price for it – a slowing down of the entire economy.

Of course, much of the inflation has been caused in the first place by the Government forcing the RBI to lend to it more than any sane levels of prudence would allow. The net increase in RBI credit to the Central Government was Rs 13,225 crore between March 31 and September 15, against a decline of Rs 6,640 crore in the corresponding period last year. Between budget 1995 and now, Singh has announced Rs 6,500 crore of non-budgeted-for expenditure. In other words, a surefire formula for inflation. And in the bargain, the Government, in its borrowing spree, is crowding out private sector borrowers. Government borrowing is depleting the economy of money that would have been utilised far more effectively and produced by industry.

And is 8.12 per cent the real inflation rate anyway? Dr Freddie Mehta, CEO, Forbes, Forbes & Campbell, verbalises the doubts all of us have about the Government’s inflation calculations: "The wholesale price index does not reflect the correct picture. Our genuine rate of inflation is in the range of 10-11 per cent." Besides, if inflation is really 8.12 per cent, how come the real interest rate is nearly 7.5 per cent higher at 15.5? Across the world, the norm is 3 or 4 per cent higher than the inflation rate.

No wonder the stock market is depressed. Reopening after the Diwali holidays, the BSE index immediately fell by 78 points as a direct result of the unofficial devaluation. Market mover Unit Trust of India (UTI) has turned bearish. Reportedly because it believes that the country’s economic fundamentals are weak and may get worse over the next six months.

Forty-three of the 91 listed mutual fund schemes have seen the returns on their net asset values dip in the last quarter. They are beginning to panic, that is, they are selling of their holdings, rather than wait and take heavier losses. Says SEBI’s Gutpa: "An unstable rupee will be a major factor in keeping the stock markets depressed."

Why does the government need so much money? Its borrowings have risen 97 per cent in just two years, from Rs 27,851 crore in 1992-93 to Rs 55,035 crore (revised estimates, not actuals, which will possibly be higher) in 1994-95. One third of all this money is direct government consumption, and the rest – loans and investments – earn far lower returns than if the same amount had been used by private industry. Says a senior manager from an FII: "The Government borrowing money against 91-day treasury bills at an astronomical 13.5 per cent is a sure indication that it’s practically bankrupt."

To add to its woes, the PSU disinvestment exercise last fortnight, targeted at raising Rs 4,000 crore for the Government, reportedly managed to raise only Rs 1,200 crore from a dispirited market. By the Government’s own estimates, its total debt and other liabilities, including external debt, are likely to be a mind-blowing Rs 691,511 crore by the end of March 1996. This is at March 1995 exchange rates. At today'’ exchange rates, it’s Rs 750,473 crore. Foreign debt alone accounts for 50 per cent of the GDP and total debt, more than 75 per cent!

Obviously, external debt-service payments have been rising. From $8.95 billion in 1993-94 to $10.5 billion in 1994-95 to an estimated $13.8 billion (Rs 48,300 crore) in 1995-96. In the meantime, between March 31 and September 15, India’s net foreign currency assets were reduced by Rs 2,575 crore, in contrast to a large increase of Rs 12,688 crore in the corresponding period last year. Obviously, the dollars we borrowed have not been put to efficient use. The conclusion staring us all in the face is that our economy is in deep trouble. Real deep trouble.

Will the devaluation gamble work? That is, will it be able to hike exports enough, restrict imports without hurting productivity or capital formation, seduce enough new foreign investment in to take care of the looming foreign debt-service crisis, and keep inflation down so you and I can live a reasonable life and assure our children of one? That’s one tall order. And given our economic management track record, which has brought the economy to the brink, and elections nearing, with the ruling party definitely not the clear front-runner, would you lay a wager that the worst is over? Says a treasury manager from a leading foreign bank: "Till mid-October, our internal projections were that the rupee might hit Rs 40 by the end of the year. But now.. well, we simply wouldn’t want to put a figure to it." Trouble is, the market operates on almost a mob psychology – once you believe the rupee will fall, you sell short and you actually make it fall, you sell short and you actually make it fall. And as the panic gathers momentum, it becomes that much more difficult for a Government to stem the tide.

Says Mehta: "Unless accompanied by tremendous productivity, devaluation is not the answer. Devaluation can be the answer in the short term. It could boost exports but with 28 million tonnes of oil imports and 3.5 million tonnes of fertilisers, it could jack up prices in the domestic markets. To counter this, in election year, the Government will fall back on subsidies."

And that could shove India percipitously into whichever circle of hell myopic politics-led economies are condemned to.

For, if all examination of the state of the Indian economy in the light of the decline of the rupee throws up one villain of the piece, it is the irresponsible and profligate politicians who run our economy. They have borrowed like there was no tomorrow. And now, suddenly, tomorrow is here.

Sandipan Deb With Oswald Pereira, Bharat Ahluwalia and Monica Raina in New Delhi and Krishna Prasad in Bombay