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By Minhaz Merchant, Chairman, Merchant Media
On a cool late winter evening 20 years ago, India's finance minister pulled a rabbit out of the hat. Dr Manmohan Singh was delivering his second Union Budget on February 29, 1992. The first had been an interim Budget on July 24, 1991, to stitch together an economy battered by near-financial bankruptcy with 67 tonnes of treasury gold mortgaged by the Indian government to the Bank of England and the Union Bank of Switzerland under the stern gaze of the International Monetary Fund.
The rabbit Dr Singh pulled out that evening was the Liberalised Exchange Rate Management System (Lerms) that created a dual exchange rate for the rupee. The reformist finance minister, demonstrating early signs of the gentle political guile that would stand him in good stead as prime minister in UPA-I and UPA-II, dubbed it "a partial float of the rupee". He was being economical with the truth. The partial float of the rupee was a fig leaf for one of the steepest controlled rupee devaluations in Indian history. On July 1, 1991, the exchange rate was 18 to the dollar. By March 1993, the exchange rate had plunged to 32 to a dollar - a decline of 77% in a little over 18 months.
The 'partial float' of the rupee led eventually to current account convertibility but not to the full capital account convertibility the finance minister had promised. Despite the Tarapore Committee and others backing the idea (with riders), the rupee 20 years later remains partially convertible on the capital account with the Reserve Bank of India ( RBI) allowing Indians to remit only up to $200,000 a year for capital investments abroad.
Dr Singh's leap year Budget on February 29, 1992, did not celebrate its 20th anniversary this year. The five state assembly elections have pushed the Budget into March, much to beleaguered Union finance minister Pranab Mukherjee's relief.
He gets an additional fortnight to balance the nation's books and use creative accounting to keep the central fiscal deficit from spiralling into dangerous territory - roughly defined as anything above 6% of GDP.
Since Dr Singh's interim Budget of July 1991 and his magical leap year Budget of February 1992, the rupee has depreciated by nearly 100% in 20 years (from 25.95 in February 1992 to just under 50 today). That's a compounded annual depreciation of 3.6%. On the face of it, that doesn't seem too steep. But a constantly weakening rupee pushes up the cost of imports, widens the trade and current account deficits, raises the external debt burden (currently over $320 billion), makes petroproducts more expensive and fuels inflation.
Votaries of a weak rupee point to the example of China which - to the rest of the world's annoyance - has deliberately kept the yuan undervalued, forcing US legislators to consider officially declaring Beijing a 'currency manipulator'. The comparison with India though is not valid. China is the manufacturing workshop of the world. Exports comprise around 32% of its GDP. Last year, it displaced Germany as the world's largest exporter (with annual exports of $2 trillion). In contrast, exports account for only 18% of India's GDP. A weak rupee does not help the other 82% of India's economy. Quite the contrary: a current account deficit arising from an import bill of $460 billion (over 25% of Indian GDP) erodes the currency, pushes up inflation and lowers competitiveness.
A stronger rupee will not only trim our trade and current account deficits and temper inflation, it will attract more FDI and FII. Today, foreign investors factor in a historical 4% annual depreciation of the rupee when computing their return on investment. Were the rupee to strengthen, dollar returns would rise concomitantly. Average central bank lending rates in the west and Japan are 0.25-3%. In India, the RBI's repo rate, at which it lends funds to banks, has averaged 7.00-8.50% in the recent past. The gap mirrors precisely the historical annual depreciation of the rupee against the dollar. A stronger rupee would reduce that gap and bring India in line with advanced economies.
Wouldn't Indian services - especially IT software - suffer if the rupee hardens? Service exports sell increasingly on quality, not price. Many (especially refined petroproducts and polished diamonds) have high import content. Besides, services include sectors such as foreign tourism that benefit from a stronger rupee. The biggest long-term beneficiaries of a stronger rupee would be India's manufacturing productivity.
Cheaper imports would allow companies to ramp up foreign technology and build infrastructural and manufacturing assets. These, in turn, would lead to a spike in competitiveness, boosting exports based on quality, not marked-down prices. This would create a virtuous cycle of high productivity and quality allied with low inflation and deficits.
So what should be the value of a more muscular rupee? The Economist's latest Big Mac Index shows that the rupee is undervalued vis-A -vis the US dollar by 61% while the yuan is undervalued by 41%. While The Economist's Big Mac Index has, over the years, been a surprisingly accurate indicator of exchange rate trends, discounting The Economist's index for India's low-cost economy, the rupee is probably currently undervalued against the dollar by about 25%. A fair value of the rupee would, therefore, be just under 40 to a dollar. Our former finance minister, now prime minister, who 20 years ago said 25 to a dollar was fair value for the rupee in pre-reform India, might well agree.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
By Minhaz Merchant, Chairman, Merchant Media
On a cool late winter evening 20 years ago, India's finance minister pulled a rabbit out of the hat. Dr Manmohan Singh was delivering his second Union Budget on February 29, 1992. The first had been an interim Budget on July 24, 1991, to stitch together an economy battered by near-financial bankruptcy with 67 tonnes of treasury gold mortgaged by the Indian government to the Bank of England and the Union Bank of Switzerland under the stern gaze of the International Monetary Fund.
The rabbit Dr Singh pulled out that evening was the Liberalised Exchange Rate Management System (Lerms) that created a dual exchange rate for the rupee. The reformist finance minister, demonstrating early signs of the gentle political guile that would stand him in good stead as prime minister in UPA-I and UPA-II, dubbed it "a partial float of the rupee". He was being economical with the truth. The partial float of the rupee was a fig leaf for one of the steepest controlled rupee devaluations in Indian history. On July 1, 1991, the exchange rate was 18 to the dollar. By March 1993, the exchange rate had plunged to 32 to a dollar - a decline of 77% in a little over 18 months.
The 'partial float' of the rupee led eventually to current account convertibility but not to the full capital account convertibility the finance minister had promised. Despite the Tarapore Committee and others backing the idea (with riders), the rupee 20 years later remains partially convertible on the capital account with the Reserve Bank of India ( RBI) allowing Indians to remit only up to $200,000 a year for capital investments abroad.
Dr Singh's leap year Budget on February 29, 1992, did not celebrate its 20th anniversary this year. The five state assembly elections have pushed the Budget into March, much to beleaguered Union finance minister Pranab Mukherjee's relief.
He gets an additional fortnight to balance the nation's books and use creative accounting to keep the central fiscal deficit from spiralling into dangerous territory - roughly defined as anything above 6% of GDP.
Since Dr Singh's interim Budget of July 1991 and his magical leap year Budget of February 1992, the rupee has depreciated by nearly 100% in 20 years (from 25.95 in February 1992 to just under 50 today). That's a compounded annual depreciation of 3.6%. On the face of it, that doesn't seem too steep. But a constantly weakening rupee pushes up the cost of imports, widens the trade and current account deficits, raises the external debt burden (currently over $320 billion), makes petroproducts more expensive and fuels inflation.
Votaries of a weak rupee point to the example of China which - to the rest of the world's annoyance - has deliberately kept the yuan undervalued, forcing US legislators to consider officially declaring Beijing a 'currency manipulator'. The comparison with India though is not valid. China is the manufacturing workshop of the world. Exports comprise around 32% of its GDP. Last year, it displaced Germany as the world's largest exporter (with annual exports of $2 trillion). In contrast, exports account for only 18% of India's GDP. A weak rupee does not help the other 82% of India's economy. Quite the contrary: a current account deficit arising from an import bill of $460 billion (over 25% of Indian GDP) erodes the currency, pushes up inflation and lowers competitiveness.
A stronger rupee will not only trim our trade and current account deficits and temper inflation, it will attract more FDI and FII. Today, foreign investors factor in a historical 4% annual depreciation of the rupee when computing their return on investment. Were the rupee to strengthen, dollar returns would rise concomitantly. Average central bank lending rates in the west and Japan are 0.25-3%. In India, the RBI's repo rate, at which it lends funds to banks, has averaged 7.00-8.50% in the recent past. The gap mirrors precisely the historical annual depreciation of the rupee against the dollar. A stronger rupee would reduce that gap and bring India in line with advanced economies.
Wouldn't Indian services - especially IT software - suffer if the rupee hardens? Service exports sell increasingly on quality, not price. Many (especially refined petroproducts and polished diamonds) have high import content. Besides, services include sectors such as foreign tourism that benefit from a stronger rupee. The biggest long-term beneficiaries of a stronger rupee would be India's manufacturing productivity.
Cheaper imports would allow companies to ramp up foreign technology and build infrastructural and manufacturing assets. These, in turn, would lead to a spike in competitiveness, boosting exports based on quality, not marked-down prices. This would create a virtuous cycle of high productivity and quality allied with low inflation and deficits.
So what should be the value of a more muscular rupee? The Economist's latest Big Mac Index shows that the rupee is undervalued vis-A -vis the US dollar by 61% while the yuan is undervalued by 41%. While The Economist's Big Mac Index has, over the years, been a surprisingly accurate indicator of exchange rate trends, discounting The Economist's index for India's low-cost economy, the rupee is probably currently undervalued against the dollar by about 25%. A fair value of the rupee would, therefore, be just under 40 to a dollar. Our former finance minister, now prime minister, who 20 years ago said 25 to a dollar was fair value for the rupee in pre-reform India, might well agree.
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