Economy: Crisis Comes Calling

The rupee slide--though expected--makes borrowings expensive as interest rates rise, sending industry and the markets into a tizzy.

The inevitability may have been unstated but the writing was clearly on the wall. Consider the facts: the Economic Survey estimated trade deficit to be around $6.7 billion (Rs 28,140 crore) for 1998-99. Imports in April touched $3.5 billion (Rs 14,700 crore) while exports fell alarmingly to $876 million (Rs 3679 crore). Foreign institutional investors (fiis) turned bearish and offloaded stocks worth Rs 981 crore in the past two months. In between came the threat of sanctions following Pokhran II. Then the Budget. In just five days in June, the FIIs dumped shares worth Rs 510 crore.

Impact of the Fall

Petroleum imports will hurt, it will mean a dip of Rs 3,874 crore in the Government's kitty.

Power projects will be costlier and tariffs will go up for those already in the pipeline.

Telecom projects will suffer as they are funded with offshore loans.

Capital markets will be hit as bottom lines of foreign investors will be affected. PSU disinvestment could be a non-starter.

Inflation will spiral. Consequently, the market expects interest rates to rise by about 2 per cent in the medium term.

Fertiliser imports will be costlier, which will hit farmers.

Juxtapose this with the external context: the second coming of the Asian Contagion which only last month experts had predicted would soon die. Since March 30, the Thai Baht has fallen 11.61 per cent, the Taiwanese dollar 6.19 per cent, the Singapore dollar by 7.38 per cent and Malaysian Ringgit by 8.77 per cent. The Japanese Yen slipped by a stunning 6.49 per cent vis-a-vis the dollar. And there was the looming spectre of a depreciation of the Chinese Yuan.

Simply stated, the rupee had no place to hide and slid to Rs 42.44 last Tuesday. "It was long overdue," says Surjit Bhalla, economist and member of the committee on capital account convertibility: "Unfortunately, we are devaluing from a position of weakness, we should have done it from one of strength." Equally unfortunate is that the weaknesses are many: cost of money, power, a depressed primary market, demand depression and crippling infrastructure bottlenecks. The falling rupee only adds to the woes (see box).

Harry Dhaul, chief of the Independent Power Producers' Association of India, believes that there will be an all-round rise in the tariffs of all projects in the pipeline. "Both fixed (capital equipment) and variable (fuel) costs will rise. Every project will have to be revised and each revision will mean more time and money." Those who have done their funding know this only too well. Telecom projects, for instance, are funded through offshore loans. That being the case, as Ravi Shankar, chief financial officer of BPL Telecom, points out, "it is safer to go in for rupee financing."

It is accepted that for the Indian economy to grow, additionality of resources is a must. Which means steady and growing inflow of foreign investments. More important, the ability of Indian outfits to tap the global debt market to fund projects. It is here that the rupee's fall acts as a critical two-pronged dampner: it makes borrowing more expensive as interest rates rise to match risk and it makes repayment that much more expensive.

Even those involved in the core sectors are at their wits end. Corporate houses estimate that with the rupee tumbling, capital equipment and input costs -- already hit by the customs hike -- will hurt further. Anand Mahindra, managing director M&M, puts this fear in perspective. "The breach of the Rs 40 mark was inevitable. But now this is one more uncertainty adding to the other uncertainties," he says. That goes for the agriculture sector as well. "The impact is quite disturbing," admits Uttam Gupta of the Fertiliser Association of India. "Every one rupee slide to dollar makes phosphatic fertilisers more expensive."

The pace of the rupee's slide is not conducive for foreign direct investment either and the confidence of foreign investors is bound to go on. "Take a look at the dollex (dollar denominated index) and you get the picture," says Shankar Sharma of First Global. "All investments have to be seen as risk-adjusted."

However, there's an upside to this downside. In some ways, it could be argued that the rupee's slide has achieved what was sorely missed in the budget: an incentive to export. The upside is that with oil prices lazing at a record 25-year low, the Government having saved close to $2 billion (Rs 8,400 crore) in petro-import costs, it has a real opportunity to cash in by letting the currency slide. Depreciation hawks have been campaigning with the Ministry of Finance for this as a weapon to increase the country's market share (which currently is less than one per cent) in world trade. The argument is that a booming export sector would bring in dollars, help industry get inventories off the shelves, improve profits aiding revenue growth and spur the capital market.

Easily said. But the downside of this upside is that a large part of India's exports -- except for software, commodities and agro-products -- are import intensive. Besides, there are also other increased input costs like that of transport, communication and energy. India's pathetic infrastructure -- where ships take over three weeks at times to turnaround compared to three days elsewhere -- is also an impediment to exports growth. So a good price may get orders, but can delivery be assured?

Yet, there are some corporates which believe that a dearer dollar will make them more competitive vis-a-vis imports and that a cheaper rupee will lift exports to set the balance right. S. Vasan, treasury economist, Standard Chartered Bank doesn't agree. "The lower rupee might not help exports. The fundamental factors that have impeded export expansion in the past, structural or cyclical, have not changed." What he implies is under the circumstances, it would be difficult to meet the annual export growth target of 20 per cent year-on-year.

It is not that the Government is silent about it. Even as the Reserve Bank of India (RBI) tried to stem the fall, Governor Bimal Jalan unveiled a new package that was at the same time defensive and aggressive. On the one hand, the bank sought to augment inflows by pushing through incentives for exporters including lower interest loans on incremental exports and tried to block outflows by FIIs by affording them a forex risk cover on incremental investments. At the same time, Jalan also tried to assuage the fears of the market by outlining the strength of the currency vis-a-vis the economy and stated that the policy initiative is an indication that "we are going to handle the situation. Don't act on apprehensions and fears".

The fears persist though. As Vasan points out, "the measures announced by the RBI are an indication that perhaps the rupee's adjustment is more or less complete. But much of it is intention." Others feel that given the external environment, there was little else that Jalan could have done.

Not quite that inevitable. Raghavendra Jha of the Indira Gandhi Institute of Development Research says it is a question of knowing where the currency should be pegged in the context of the trading basket. K.R. Bharat, managing director, Credit Suisse First Boston, adds that it is also an issue of improving inflows. The Government, he suggests, needs to urgently "speed up investments in infrastructure, insurance, real estate and push privatisation in both domestic and international markets. Or else the trend will be difficult to reverse." The writing, thus, is yet again on the wall. The question is whether the Government is up to it.