India’s Problem Is Exports, Not the Rupee

August 23, 2013 • Commentary
This article appeared on Bloomberg​.com on August 23, 2013.

King Canute had it easy. Indian Finance Minister Palaniappan Chidambaram has battled currency markets for two months, trying to stem the collapse of the Indian rupee from 55 to a dollar in May to 65 this week. He has found commanding currency markets even harder than commanding the ocean waves.

He should stop trying. A weaker rupee is not inherently a terrible thing. Rather than frantically shoring up the currency, Chidambaram should target the structural impediments in the economy that have caused both Indian and foreign investors to lose faith in the once‐​glowing India story.

A falling rupee is a political, not an economic disaster. The plunge raises import prices and exacerbates inflation in the run‐​up to the next general election, just eight months away. In an attempt to support the currency, the government has increased import duties on gold and consumer durables, and has raised short‐​term interest rates to curb currency speculation.

What’s bad for electoral prospects, however, can be good for an economy running a current account deficit that’s reached 4.8 percent of GDP. A cheaper rupee will encourage exports and discourage imports. Inflation will erode some of these apparent advantages. Indeed, the rupee’s fall from 45 to 60 a dollar from 2011 to June 2013 didn’t lift exports at all: The advantages were offset by high inflation and a lousy business climate. However, exports rose 12 percent in July, suggesting that the rupee may finally have fallen enough.

Strangled Birth

The danger now is that dysfunction in the Indian economy will strangle any incipient export boom at birth. GDP growth slowed to 5 percent last year, after racing along at 8.5 percent for a decade. Industry and, until the recent uptick, exports have stagnated. Inflation has soared. The current account deficit is almost double what the Reserve Bank says is sustainable. A year ago, rating companies threatened to downgrade India to junk.

Chidambaram was recalled to the Finance Ministry to stave off that verdict. He cut the fiscal deficit from 5.8 percent of GDP to 4.9 percent, and promised a further reduction this year. He initiated reforms, including liberalized entry for retail giants such as Wal‐​Mart Stores Inc.

The hope was that fiscal discipline plus reforms would revive animal spirits among investors, and produce an economic spurt before the elections. The plan was on track until May: Inflation fell, interest rates were cut three times, and $20 billion of foreign portfolio investment flowed in. But after Fed Chairman Ben S. Bernanke said he would soon phase out quantitative easing, inducing higher interest rates, billions of dollars flooded out of emerging markets into the U.S., seeking higher yields. All emerging‐​market currencies swooned, including the rupee.

Finance Ministry officials argue that the rupee at 65 is irrational, a clear case of overshooting. They’ve forgotten two maxims of John Maynard Keynes. One is that people will ultimately do the rational thing, but only after exploring all the alternatives. The second is that markets can be irrational for longer than you can stay solvent.

India’s foreign exchange reserves are substantial at $280 billion, but foreign debts of more than $170 billion have to be rolled over in the coming year, so running down reserves is not an option. Chidambaram has sought other ways to bridge the current account deficit: quasi‐​sovereign bonds, liberalized corporate borrowing overseas and a special bond issue for overseas Indians.

But attracting dollars is not enough. Underlying the economic slowdown is a virtual investment strike by Indian businessmen, who have been put off by the terrible business climate. Corruption is a major issue. In areas such as real estate, minerals and government contracts, honest business has long been impossible. But dishonest business with bribes could be done, and kept these parts of the economy growing. Recently bribes have become more difficult, sometimes impossible, after activist judges began inquiring into scams, buttressed by a new Right to Information Act that exposed government files to public scrutiny. Result: The bureaucracy has stopped moving files.

No Enthusiasm

Many Indian businessmen say they would rather invest abroad than in India. Apollo Tyres Ltd. (APTY), India’s top tire manufacturer, has acquired Cooper Tire & Rubber Co. (CTB) in the U.S., and says its next investment priorities lie in Serbia, China and Mexico. If Chidambaram can’t get India businessmen excited, can he really enthuse foreign ones?

Sadly, last year’s reforms are not translating into large orders for equipment and machinery, the kind that would start a true industrial and export surge. Foreign investment in retail may have been liberalized, but so many conditions are attached that not one dollar has actually flowed in. The cabinet may have just cleared 1.7 trillion rupees’ worth of projects, but these haven’t produced the expected explosion of orders. In some cases, further clearances are needed from state governments. In other cases, businessmen are delaying investment until the economy picks up.

Chidambaram doesn’t have enough weapons to prop up the exchange rate. Rather, he should concentrate on converting cleared projects into actual physical investment and on converting the cheaper rupee into an export boom. If investment and exports begin to surge again, business confidence will return. That’s when the rupee will strengthen.

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