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Management of Foreign Exchange-cause for concern
Parveen Kant / Avneesh Matta
In normal circumstances, with the growth in the economy, appreciating currency and the consequent increase in reserves is a signs of a healthy economy. But at present juncture some specific conditions prevailing in India, points out towards some serious concerns in the matter. These factors require immediate intervention and government attention.
Rising Rupee has become the cause of immense worry amongst all, especially small and medium exporters and others in the manufacturing sector. Rupee which used to sail around Rs. 45-46 to a US Dollar is now at around Rs. 39.50. This has all happened in a year's time span. It is not only that the rupee is appreciating; it is the dollar, which is weakening. Depreciation of Dollar has its own pitfalls so far as our country is concerned.
Causes of Concerns
Normally trade deficit leads to depreciation in the currency thereby helping in balancing the international trade of the country by increasing the exports. However, despite the persistent trade deficit our currency is appreciating which is due to huge inflows of foreign exchange and therefore it is not leading to improvement in the balance of trade situation.
Secondly, if this inflow was of good quality and not consisting of so called hot money, which is primarily short term in nature, this would not have been that harmful.
Thirdly, if the foreign exchange reserves created out of this inflow had been properly deployed and invested in acquiring proper assets abroad and not in purchasing treasury bonds in US, the adverse situation arising out of increasing reserves could have been avoided.
Fourthly this inflow and investment in real estate is leading to inflation in land prices which is causing trouble for industries and housing sector
Finally many of the PE funds are by way of replacement capital through mergers and acquisition and not as direct investments to create fresh assets and for new green field projects.
Maximum inflow has come when the rupee was lying low during the couple of years. Now that the Rupee has gained ground, any remittance out of the country will unduly enrich the foreigners, who may not sincerely be interested in the development of our country.
Just parking of funds by overseas investors is giving good returns to them. India has given 48% return in one year in US $ terms.
FII investment is creating extreme volatility in markets, which is harmful to economy and spoiling investors' confidence.
If these issues are properly tackled by the government, our manufacturing sector will also be in a better situation and inflated asset value syndrome could be avoided.
Direction of International Trade
As per the figures released by the government for Balance of Trade of the country during April to December 2007, exports stood at US $ 111 billion as against imports of US $ 169 billion. Out of the total imports non oil imports grew at US $ 120 billion and oil imports stood at US$ 49 billion. During this period of nine months, non oil imports rose far more higher by 3-3% as compared to the same nine months of 2006. Oil imports rose by 11.68%, which may be considered normal.
The alarming 33% rise in non oil imports points towards an alarming trend i.e. in spite of the strengthening of Rupee which should lead to fall in value of imports, the imports are increasing. This is the result of local manufacture becoming traders, for whom it is profitable to close their industries and become importers.
Another factor which requires attention is that the asset inflation has led to a situation where industrial houses find it beneficial to turn into real estate developers. Glaring example is of Escorts, which is a manufacturing concern and recently it has announced, starting real estate development activity. Ultimately by change in the composition and character of manufacturing sector this phenomenon will also have a negative impact on employment.
Exports during first nine months of current fiscal grew at 7.7% as against around 25% growth during the same period last year. On a conservative estimate with strong rupee it is likely to fall further for the whole year, which is a very bad trend for our economy.
How much is good reserve is a difficult question to answer. The foreign currency reserves must be sufficient to meet our import demand as well as must ensure to take care of crisis in case of sudden withdrawal of foreign investors from our markets.
Some other reasons for this unhealthy trend are that the components of reserves are not earned but are a liability and the Balance of trade is negative, which should in normal circumstances weaken the currency. But due to speculative hot money, it is other way round, i.e, Rupee is appreciating. Estimated Trade deficit is pegged at US $ 94 billion for 2007-08.
Composition of current trade wherein, Imports of capital goods forms a very low portion in our international trade and most of the imports are of consumable goods. And our manufacturing sector's contribution to GDP is very low, it is only 16%; therefore value addition in product does not lead to significant increase in GDP these two factors also lead to aggravating the problems.
Tools of Exchange Management
Deployment of reserves is not proper, China has taken the policy of investing in Natural Resources of the other countries, like, oil, iron ore etc.
RBI is investing in purchasing foreign government's treasury bonds, which can depreciate and is harmful.
We should not keep our reserves only in Dollars but in other currencies as well.
Arbitrage in interest rate is also leading to speculation, which again is distorting the currency rate. US interest rates are far lower than ours. We need to manage interest rates.
Verify the source of foreign funds to check quality of inflows: compliance and data reporting under FEMA by the bankers and rigorous inspection of bankers is warranted.
Redemption of high cost foreign debts.
Attempt to stop under invoicing of imports.
The government has announced the creation of a sovereign fund of US$ 5 billion; these steps should be expedited and should have been taken long back.
Calls for Tobin Tax should be viewed seriously.
A very recent survey by FICCI has come out with revealing realities:
98% of companies surveyed said appreciative rupee was hitting their performance.
42% companies say their exports would decline over six months.
40% reported a decrease in order book position year on year.
Co authors
CA Gopal K Agarwal (National Convener, Chartered Accountants Cell, BJP)
Email: gopal.agarwal@hotmail.com
CA Praveen Kant
CA Avneesh Matta
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