The RBI determined to tank our economy just to keep up its pride in the Rupee, but acts of machismo will not save us from the precipice.
There is a man like that here inIndia too. He is somewhat lucky in that his office is less public than that of the American president's, and so he may yet escape widespread hate. RBI Governor Duvvuri Subba Rao is polite to a fault. Earlier this month, traveling in the same flight with him I was amazed at his insistence in carrying his own bag, sitting in an Economy class seat and creating the least fuss even as the sarkari airline staff buzzed around genuflecting. To know Subba is to like him. The five-year term of Governor D Subba Rao is drawing to a close, and his legacy looks all set to be pretty disappointing. Even these last few weeks are not holding much hope.The first part of Subba's term saw him being silly enough to believe whatever Finance Minister Pranab Mukherjee and his team told him. In the latter half, chastened by experience, he compounded those mistakes by stubbornly refusing to believe whatever Finance Minister P Chidambaram and his team told him. Thus, in the initial years he kept dropping interest rates and loosening monetary policy while inflation attacked the Indian economy and became entrenched. The finance ministry kept making false promises to him that he kept listening to. Very surprising, given that Subba himself had spent his lifetime there.
When Subba first took charge, Pranab Mukherjee was busy with political coalition management and apparently had little time for the finance ministry job. His two gravest errors were to keep domestic oil prices disconnected with rising global prices and look the other way as gold imports spiraled out of control. All this, alongside the financial upheavals in the US, landed India with 'imported inflation'. For reasons best known to them, Pranab & Co. managed to convince Subba that this was all short term. But 2012 was not 1982, when Mukherjee was previously the finance minister. Days turned to weeks, weeks to months, and months to years. Oil prices didn't come down and blew a large hole in India's fiscal deficit. Gold buying became a fetish and India led the world in its worst excesses in the metal in the last three-four years.By the time the economy came to a halt and Pranab had to be kicked upstairs and Chidambaram brought in for the rescue, Subba was a changed man. No amount of persuasion by the new finance minister could now make him reverse the tightening in the face of falling inflation and plunging growth. Chidambaram reversed his predecessor's policies on fiscal deficit, brought oil prices to market levels, clamped down on reckless gold imports – but Subba was so chastened after the first ride that this time around he ignored all the steps the new finance minister took.
The economy has been in free fall and crying for a sharp reduction in interest rates. Subba's supporters may argue that he did decrease interest rates in the last few quarters, but alas, those rate cuts were too small and too spread out to make any difference. He has been so slow and doubtful about the need to cut rates that the market have never quite trusted him. So measly and slow were the rate cuts that most bank loan borrowers did not get any benefit, since money market liquidity remained tight and the banks simply refused to cut rates significantly. Now, alarmed by the Rupee's slide, Subba has overreacted. This month he cut the money supply to banks by putting limits on the RBI money normally available to them (and keeps the economy 'greased'). He also sharply increased the rates at which this money would be available to banks. As a result, gilt yields shot up to 8 percent. This created such a scare in the markets that there were huge redemptions and mutual funds could not redeem their customers. In order to not have the markets run aground, the RBI was forced to open a new window to lend money to mutual funds so that redemptions could proceed smoothly. This is a rare act – last done at the height of the 2008 global crisis. This time around the world was not in crisis; we had simply invented one for ourselves.
If you thought that this chastened the RBI or its governor, you were wrong. On Tuesday, Subba further halved the money available to banks. Gilt yields shot across 8.5 percent – meaning that the cost of borrowing funds increased in the last month from 7.25 percent to 8.5 percent – a 17 percent increase, which is a sharp rise in such a short duration, all accompanied by the sucking up of liquidity in the money markets. In simple English, it has become that much costlier to borrow. The RBI has not formally increased rates, but the markets have seen this as an increase in interest rates through the back door. No grease in the wheels equals jammed wheels and the vehicle coming to a halt.
Apart from the huge redemptions from mutual funds, there has been a blood bath in the bond markets. Equities have crashed, especially banks, stocks and companies that the market likes to call rate-sensitives (a polite word for those companies that have borrowed beyond their means and can't pay back even their interest). What hundreds of shady promoters and dubious companies did to retail investors in the equity markets, Subba managed to do it single-handedly for debt markets – make them lose faith. The finance minister keeps pleading with investors to see avenues beyond gold. Having burnt their investments in equity shares earlier, the only silver lining for retail investors in mutual funds were debt schemes. Those have been burned too. So where does that leave investment options other than stupid, stupid gold? If there are any answers, Subba has not been forthcoming.
Why has all this happened?
All this has been done, off course, to prop up the Rupee. But the moot question is, does the economy need high interest rates or does it need to get back traction? The even bigger question is, do we run the economy on the basis of our pride (and Rs 56 to US $1) or do we make imports less attractive and exports more competitive? Between the politics of pride-size and the economics of rupee-size, the country is being taken to the cleaners. Not that Subba's defense of the Rupee has found no admirers. The economist of a large public sector bank gushed how the knight in shining armour has come to the Rupee's rescue. This, even as her own bank's gilt portfolio lost a few hundred crore and its shares tumbled. Worse is yet to come as higher interest rates lead to more bank loans going bad, and their non performing assets increase to a point that they become threatening to their balance sheets. Elsewhere, an anchor on a business news TV channel screamed that the RBI should clamp down hard and blow the lights out of exporters. Those who earn dollars should be brought to their knees and made to remit dollars inwards so that our middle class, weaned on a steady diet of oil subsidies and unrestricted gold buying, can continue with its binge. That would be the mark of a true man, we are led to believe. The figure of Rs 56 has appeal beyond Ahmedabad and is now lashing the shores of Mint Street. How foolish it was for all of us to believe that Mumbai was a safe harbour for ships to dock in peace. Except that the Rupee has refused to rise. Much like the reviled US president who imagined weapons of mass destruction that didn't exist, our Don Quixotic Governor, too, has charged at windmills. The imaginary speculators whose sails the RBI sought to cut didn't seem the ones who were speculating against the Rupee. Instead, again following the cowboy figure's example, there was more collateral damage.
If you assumed that the act of throwing the baby with the bath water would have satisfied our Rupee rescue team, perish the thought. A week down the line, they found that their efforts were not paying off. Not in Rupees, surely. So what did they do next? They tried one more shock to the baby. The central bank tried to cut off liquidity completely. Instead of realizing their mistake, they repeated it. Bank shares tanked further. Bond yields jumped to 8.5 percent. Perhaps RBI thought they are making speculation so much costlier that it would drive away speculative positions. But why were they not also considering that in addition to the speculators, there are also millions of borrowers who take loans for homes, cars, education, businesses? Were they cutting their nose to spite the face? The TV anchors lost no time in telling us that the Rupee strengthened by 1 percent or so (after destroying 10 percent of bond holdings of banks and retail mutual fund investors). As usual, they were way off the mark because the Rupee rise of 1 percent was a classic case of Forex For Dummies – the dollar decline of a percent was not on account of the Rupee strengthening, but a general correction in Dollar against all currencies. Even after the RBI's deadly blows to money markets, the Rupee continued to grovel at near lifetime lows against the euro, the pound, etc. If the first move to choke the economy was a farce, the second one is turning out to a tragedy. Even the reticent SBI chief raised his hands to express his disappointment over the back door interest rate hike that was choking liquidity of the money markets. Let's look back at the global crisis of 2008. The problem was not the fall in the prices of homes in the US, it was the money markets grinding to a halt. And the Fed responded by quantitative easing. In India, the central bank is doing the reverse – quantitative tightening. This would have been the right approach only if the Indian economy was overheated. However, the truth is just the reverse – growth has been steadily decelerating and threatening to fall off the cliff. Just like the first half of his tenure, Subba has been behind the curve. Why this obsession with the Rupee? What's so holy about Rs 56 to a dollar? If you lived in the USA, in the last five years your bank FD would have grown by 10 percent. And if you lived in India, the bank deposit would have grown by 50 percent (FD rates of 8-9% p.a.).
So why would your money grow by 9 percent every year and that of the American Joe by only 1 percent? The 8 percent gap is on account of inflation. So does Subba think the Indian depositor should get rewarded nine times better than the American depositor? If the answer is no, and each country's interest rates factor their inflation rate, then the Rupee is bound to depreciate against the Dollar by 8 percent or so every year.
Thus, over the last five years the true worth of the Rupee should have moved down from 44 to 66. Truth be told, the Rupee should've been forced into a further decline. Don't believe me? Just ask the Japanese prime minister. He is doing exactly the opposite of Subba. And winning.
Faced with a sluggish economy, Japanese PM Shinzo Abe is pumping billions into the economy – unlike Subba who is decreasing liquidity. Abe is deliberately weakening the Yen so that exports can go up. Subba, on the other hand, is trying to artificially strengthen his currency and choking growth. This year, he has pushed the Yen from 80 to a dollar to 100 a dollar – a 25 percent depreciation. And here we are, despairing if the dollar moves to Rs 60. This has started paying off for Japan: the export boost has led the economy to start growing (4 percent in the first quarter). Abe's ruling party won the upper house elections last week.
Isn't it funny that the world's third largest economy is busy weakening its currency to make its exports competitive, but a struggling economy like India is busy with false pride in wanting a higher currency value? Ofcourse, there are factors such as current account deficit, trade imbalances, gold outflows, FDI inflows, etc. that cause short-term blips and occasionally sustained biases in currency pricing. So far, over the last few years they've occurred on the side of favoring the Rupee. But how long can the party go on and on? And party for whom? Who benefits from an overpriced Rupee? A downward correction of the Rupee is actually good for the Indian economy. It will make our exports more competitive and importing useless gold more prohibitive. Will the likeable Subba go down in history as someone whose obsession over false pride in the Rupee took his country down a path of economic peril? Even in his last few weeks in office, Subba has played George Bush. Extremely likeable man with an extremely disappointing tenure. He has a few weeks to correct the epitaph.
All this has been done, off course, to prop up the Rupee. But the moot question is, does the economy need high interest rates or does it need to get back traction? The even bigger question is, do we run the economy on the basis of our pride (and Rs 56 to US $1) or do we make imports less attractive and exports more competitive? Between the politics of pride-size and the economics of rupee-size, the country is being taken to the cleaners. Not that Subba's defense of the Rupee has found no admirers. The economist of a large public sector bank gushed how the knight in shining armour has come to the Rupee's rescue. This, even as her own bank's gilt portfolio lost a few hundred crore and its shares tumbled. Worse is yet to come as higher interest rates lead to more bank loans going bad, and their non performing assets increase to a point that they become threatening to their balance sheets. Elsewhere, an anchor on a business news TV channel screamed that the RBI should clamp down hard and blow the lights out of exporters. Those who earn dollars should be brought to their knees and made to remit dollars inwards so that our middle class, weaned on a steady diet of oil subsidies and unrestricted gold buying, can continue with its binge. That would be the mark of a true man, we are led to believe. The figure of Rs 56 has appeal beyond Ahmedabad and is now lashing the shores of Mint Street. How foolish it was for all of us to believe that Mumbai was a safe harbour for ships to dock in peace. Except that the Rupee has refused to rise. Much like the reviled US president who imagined weapons of mass destruction that didn't exist, our Don Quixotic Governor, too, has charged at windmills. The imaginary speculators whose sails the RBI sought to cut didn't seem the ones who were speculating against the Rupee. Instead, again following the cowboy figure's example, there was more collateral damage.
If you assumed that the act of throwing the baby with the bath water would have satisfied our Rupee rescue team, perish the thought. A week down the line, they found that their efforts were not paying off. Not in Rupees, surely. So what did they do next? They tried one more shock to the baby. The central bank tried to cut off liquidity completely. Instead of realizing their mistake, they repeated it. Bank shares tanked further. Bond yields jumped to 8.5 percent. Perhaps RBI thought they are making speculation so much costlier that it would drive away speculative positions. But why were they not also considering that in addition to the speculators, there are also millions of borrowers who take loans for homes, cars, education, businesses? Were they cutting their nose to spite the face? The TV anchors lost no time in telling us that the Rupee strengthened by 1 percent or so (after destroying 10 percent of bond holdings of banks and retail mutual fund investors). As usual, they were way off the mark because the Rupee rise of 1 percent was a classic case of Forex For Dummies – the dollar decline of a percent was not on account of the Rupee strengthening, but a general correction in Dollar against all currencies. Even after the RBI's deadly blows to money markets, the Rupee continued to grovel at near lifetime lows against the euro, the pound, etc. If the first move to choke the economy was a farce, the second one is turning out to a tragedy. Even the reticent SBI chief raised his hands to express his disappointment over the back door interest rate hike that was choking liquidity of the money markets. Let's look back at the global crisis of 2008. The problem was not the fall in the prices of homes in the US, it was the money markets grinding to a halt. And the Fed responded by quantitative easing. In India, the central bank is doing the reverse – quantitative tightening. This would have been the right approach only if the Indian economy was overheated. However, the truth is just the reverse – growth has been steadily decelerating and threatening to fall off the cliff. Just like the first half of his tenure, Subba has been behind the curve. Why this obsession with the Rupee? What's so holy about Rs 56 to a dollar? If you lived in the USA, in the last five years your bank FD would have grown by 10 percent. And if you lived in India, the bank deposit would have grown by 50 percent (FD rates of 8-9% p.a.).
So why would your money grow by 9 percent every year and that of the American Joe by only 1 percent? The 8 percent gap is on account of inflation. So does Subba think the Indian depositor should get rewarded nine times better than the American depositor? If the answer is no, and each country's interest rates factor their inflation rate, then the Rupee is bound to depreciate against the Dollar by 8 percent or so every year.
Thus, over the last five years the true worth of the Rupee should have moved down from 44 to 66. Truth be told, the Rupee should've been forced into a further decline. Don't believe me? Just ask the Japanese prime minister. He is doing exactly the opposite of Subba. And winning.
Faced with a sluggish economy, Japanese PM Shinzo Abe is pumping billions into the economy – unlike Subba who is decreasing liquidity. Abe is deliberately weakening the Yen so that exports can go up. Subba, on the other hand, is trying to artificially strengthen his currency and choking growth. This year, he has pushed the Yen from 80 to a dollar to 100 a dollar – a 25 percent depreciation. And here we are, despairing if the dollar moves to Rs 60. This has started paying off for Japan: the export boost has led the economy to start growing (4 percent in the first quarter). Abe's ruling party won the upper house elections last week.
Isn't it funny that the world's third largest economy is busy weakening its currency to make its exports competitive, but a struggling economy like India is busy with false pride in wanting a higher currency value? Ofcourse, there are factors such as current account deficit, trade imbalances, gold outflows, FDI inflows, etc. that cause short-term blips and occasionally sustained biases in currency pricing. So far, over the last few years they've occurred on the side of favoring the Rupee. But how long can the party go on and on? And party for whom? Who benefits from an overpriced Rupee? A downward correction of the Rupee is actually good for the Indian economy. It will make our exports more competitive and importing useless gold more prohibitive. Will the likeable Subba go down in history as someone whose obsession over false pride in the Rupee took his country down a path of economic peril? Even in his last few weeks in office, Subba has played George Bush. Extremely likeable man with an extremely disappointing tenure. He has a few weeks to correct the epitaph.
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