Mumbai: The Indian rupee has wobbled with metronomic regularity every five year—you could describe it as a five-year itch. The sharp decline of the Indian currency against the US dollar in recent weeks is part of that pattern. The current rupee trouble was preceded by similar episodes in September 2008 (after the collapse of Lehman Brothers) and August 2013 (after the US announced its intention to gradually withdraw from quantitative easing).
How bad is the recent decline?
The Indian rupee sits somewhere in the middle of the list of emerging market currencies that have been walloped, as the US increases interest rates to cool down an economy that runs the risk of overheating.
The rupee has neither showed the stability of the Mexican peso or the Thai baht nor has it been hammered like the Argentine peso or the Turkish lira.
This is in sharp contrast to the situation five years ago.
India then found itself in the ‘Fragile Five’ club of the emerging markets that were most susceptible to a global shock. Keeping it company were Turkey, South Africa, Brazil, and Indonesia.
India is today in a better place than it was in 2013, if one takes a look at the standard measures of macroeconomic stability—inflation, current account deficit and fiscal deficit.
Two successive Indian governments did well to focus on macro stability after the July 2013 shock, undoubtedly helped by the sharp decline in global oil prices after the second half of 2014.
However, inflation has been climbing in recent months, while the current account deficit has widened.
India could end the fiscal year with a current account deficit of $70 billion. This gap will either need to be funded with capital inflows or drawing down the foreign exchange reserves with the Reserve Bank of India.
Foreign investors have been pulling money out of the Indian financial markets. The Indian central bank said last week that net portfolio outflows in the first quarter of fiscal year 2019 were $8.1 billion. An increase in foreign direct investment, or FDI, as well as deposits made by non-resident Indians, or NRIs, have been stabilizing factors.
The key question is whether India can pull in $70 billion of foreign exchange this year to cover its anticipated current account deficit. India will likely end the year with a balance of payments deficit.
It will be tough, but there is no need to panic. India is not on the edge of any cliff. This is not 2013 redux. Yet, policymakers as well as investors need to keep a close eye on whether higher global oil prices lead to a sharper deterioration in the trade balance and if global capital flows are disrupted in case the US Federal Reserve increases interest rates faster than expected.
Optimists believe that India could actually benefit in the next run on emerging markets since it is a relatively stable economy where growth is picking up. More cautious souls say that it would be prudent to float a special bond for overseas Indians as insurance, as was done in 1997 and 2013.
A lot will also depend on how much dry gunpowder RBI has to fight the next battle.
The three most common ways to assess whether a central bank has enough foreign currency reserves to sail through a storm are as follows:
First, how many months of imports are covered by the stock of reserves? Second, are there enough dollars in kitty to pay off foreign exchange debt that is due over the next 12 months? Third, is the current stock of foreign exchange reserves in excess of the annual current account deficit plus foreign debt that has to be repaid over the next 12 months?
India is reasonably well-placed in terms of all three requirements. The import cover is in excess of nine months; foreign exchange reserves are nearly twice the external debt that has to be repaid over the next year; and residual short-term debt plus the expected current account deficit are more than covered by the dollars in the RBI kitty. India is not as comfortably placed to deal with a run on the rupee as it was in 2008, but it is in a far better position than it was in 2013.
The recent deterioration in the macro fundamentals will not help the rupee in case there is an emerging markets contagion. Prudence now requires a combination of tighter fiscal policy, higher interest rates and a cheaper rupee. The challenge will be to stick to such a path even as the next national election approaches.
Niranjan Rajadhyaksha is research director and senior fellow at the Mumbai-based IDFC Institute.