Short term measures to stem the Rupee slide won’t work

by Manshu on June 14, 2013

in Uncategorized

I’ve wrote about the Rupee fall yesterday, and I also described the factors causing the Rupee fall more than a year ago. I think the factors listed in that post are still valid, but due to the political process, and short term thinking, not much is being done about it.

There have been some short term measures that have been taken to reduce the Rupee slide and in this post I’m going to talk about two such measures and say why I feel they are counter productive.

Gold Imports

The government is citing gold imports as a big reason for the trade deficit and indeed it is the second biggest import item after crude oil.

Anything that leads to outflow of USD causes the Rupee to depreciate and the government has zeroed in on gold imports as one item where they want to discourage Indians from buying gold and draining forex as a result. They have increased the duty on gold to 8% to achieve this.

I think this is not going to achieve anything and may just work to counter what they are trying to do. We’re in a situation where the US listed Gold ETF GLD is down about 18% YTD (Year to Date), while India listed GOLDBEES is down only 9% in that time frame.

What is the difference due to?

Due to exchange rate depreciation and taxes, and that’s a problem right now.

People aren’t buying gold because the prices are low, people are buying because it is getting higher. The higher it goes, the more people make in notional gains in their gold investments, and increasing taxes isn’t going to do anything to dampen that. Gold demand has gone from consumption led to investment led, and higher prices will only fuel this.

The other aspect of this is where do people invest if not in gold?

The stock market is going nowhere, fixed deposits give negative real returns, debt mutual funds are doing well but for how long? And to add to all that, the Rupee is rapidly losing its value due to high inflation.

To me, the two big factors that are driving gold demand are the rise in gold prices, and lack of alternative investments and raising duty on gold addresses neither. It is better to go back to the lower duty that used to prevail earlier.

Allowing foreign investors to buy government debt

The Finance Minister has recently talked about allowing foreign institutional investors to own $30 billion of government debt, this limit was $5 billion and SEBI has increased the limit to $30 billion now. 

I’m not too sanguine about the efficacy of this step either.

You are allowing FIIs to buy but then are also assuming that they won’t sell during times of stress. How does that make any sense?

It is great that the limit is increased and there will be more participation from FIIs but that in itself won’t do anything to reduce the ease on the Rupee. Is it realistic to think that when there is strain on the Rupee which is usually due to structural problems, FIIs will be queuing up to buy government debt?

I feel that this step can also backfire as the FIIs who do own Indian debt may sell off along with other investors and accelerate Rupee slide when the wave comes next time.

Conclusion

I think we’re mired in short term thinking and the short term measures aren’t doing any good. They may give some immediate relief but that may just be making the situation worse because it takes away the focus from more long term measures that will reverse this trend of continuous depreciation.

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