Why Rupee Falls
Present fall of the rupee
is due to the use of money received from foreign investment for consumption. Manmohan Singh has hugely increased government consumption in the last ten years. Schemes like MNREGA, loan waiver and now Right to Food have been implemented. Salaries and perks of government servants have been raised after the Sixth Pay Commission. And, of course, there is huge leakage of government money through corruption.
The culprit is not foreign investment but use of the money received. Consumption is being financed by debt.
But this cannot go on indefinitely. There comes a tipping point. A drunkard can drink and put up a brave face that he in his senses is but a tipping point comes when he collapses. That tipping point for the rupee came last month; and with the announcement of passage of the Food Security Act which would impose an additional burden of 130k crore on the Government this turned into a mayhem. Foreign investors realized that the debt burden on the Government is increasing. Investment in infrastructure is lagging. Politicians and bureaucrats are extracting huge monies through corruption. Cost of production in India is going up. India is losing competitiveness in the global market. They decided to go negative on India and started to withdraw their monies. Result has been decline in the rupee. It is as simple as that. And it makes little sense for the crisis managers to burn mid-night oil as to how to chase the wild goose.
The Government appears to have foreseen this. Efforts were made to ensure that the tap of foreign investment did not go dry. The Government can do little for attracting Foreign Institutional Investment in the share markets. This is driven by assessments by the investors. Thus the Government embarked on a plan to open up Foreign Direct Investment. Thinking was that opening FDI will instill confidence among foreign investors that Indian economy is globally competitive and that, in turn, will persuade the Institutional Investors to remain positive on India. Thus the Government increased the caps on FDI in various sectors. Previously more than 25 percent FDI in defense sector was not permitted. Now this is allowed up to 49 percent on case-to-case basis. The cap has been increased from 74 to 100 percent in telecom sector; and from 25 to 49 percent in the insurance sector.
This policy did not succeed though. First reason is that it takes time for FDI to materialize. An international telecom company would first commission a market survey, make a project report, tie up with banks and obtain necessary licenses before money would start pouring in. This would take at least 2-3 years. Second, the burden of profit repatriations is rapidly increasing. Amount remitted by foreign investors was 4 billion dollars in 2010. It increased to 8 billion dollars in 2011 and further to 12 billion dollars in 2012. Outflow on this account is likely to increase rapidly in the coming years as foreign investors start repatriating the profits in larger amounts. This outflow will nullify the positive impact of increased inflows. Third problem is that FDI is coming more for acquisition of existing Indian companies and not for the establishment of Greenfield projects. The impact of this FDI on the Indian economy will depend upon how the Indian seller uses his money. For example a Japanese investor has bought out Ranbaxy. Owners of Ranbaxy got money for selling their stake. Now the impact of the FDI will be positive if the Indian seller invests the money received in some new project in India. The impact will be zero if the Indian seller sends out the money out of India and invests abroad. The increase in caps on FDI did not help Singh, Chidambaram and Aluwahlia revive the economy for these reasons.
Lesson is that borrowing should be used for productive investment. Highest priority should be given to investment in research, infrastructure and regulation. The Government may borrow large amounts for these investments but this will not cause any damage because the returns from these investments will generate revenue to repay these borrowings. Middle priority should be given to people-oriented consumption schemes like loan waiver, MNREGA and Right to Food. These schemes help increase the productive capacity of the people though these are consumption oriented. Last priority is of salaries paid to government servants and leakages through corruption. The fact that the rupee has collapsed means that the unproductive- consumption by the government has increased. Controlling this alone will help rejuvenate the economy and save the rupee.
Vol. 46, No. 11, Sep 22 - 28, 2013
Your Comment if any