Why choking growth will not help save the rupee
India is in a vicious cycle where falling growth is hurting the Indian Rupee that in turn is forcing anti growth policies from policy makers leading to more pressure on the currency to depreciate. Is there a way out of this mess or is time the only healer? The latter seems to be the more plausible answer but pain caused by the current economic conditions will be high.
India's GDP growth forecasts are being revised downwards across think tanks. Private economists are projecting growth at below decade low growth rate of 5 percent seen in fiscal 2012-13 while the RBI and government have lowered projections by around 200bps to 300bps to 5.5 percent and 6 percent levels respectively. The outlook for growth is weak as RBI is tightening monetary conditions to fend off INR speculation while the government is fiscally constrained to spend.
The Indian Rupee (INR) is deeply impacted by the falling growth prospects of the economy. India is seen as one of the high growth economies in the world and a growth slowdown can impact capital flows negatively. Weak capital flows lead to worries of financing a high CAD (Current Account Deficit) leading to more pressure on the INR. Policy makers actions to stem currency weakness leads to more growth pangs for the economy leading to fresh worries on capital flows that in turn leads to INR fall. A vicious cycle that has no end in sight.
The INR that touched all time lows of Rs 61.81 to the USD in the first week of August 2013 is compelling the RBI to tighten system liquidity to stave off currency speculation. RBI's liquidity tightening policies has driven up yields across yield curves and has inverted the yield curves. Inverted yield curves have short maturity bond yields higher than long maturity bond yields and the reason for the inversion is due to the cost of liquidity becoming tight in the system.
The rise in yields at the short end of the curve is impacting the cost of funds for the banking system. Banks have been forced to park 4 percent of their NDTL (Net Demand and Time Liabilities) with the RBI at zero interest rates on a daily basis. Banks access to the RBI repo window for funds is restricted to 0.5 percent of their NDTL and banks are forced to borrow from the RBI at MSF (Marginal Standing Facility) rate of 10.25 percent. Banks are raising lending rates to pass on the higher cost of funds to borrowers.
Borrowing costs for corporates are high due to the stress levels in bank loans. SBI's gross and net NPA (Non Performing Assets) stood at 5.56 percent and 2.83 percent respectively in first quarter of fiscal 2013-14 compared to 4.99 percent and 2.22 percent respectively seen in the same period last year. Economic growth at decade low levels of 5 percent is placing pressure on debt servicing by indebted corporates.
The economy is slowing down sharply. IIP (Index of Industrial Production) growth was negative 1.1 percent for the first quarter of fiscal 2013-14. Vehicle sales are falling with sales down year on year for the first four months of the fiscal. Tax collection at 10 percent levels for the April-July 2013 period is well below the budgeted growth of 17.5 percent for the full year. Bank credit has grown by just around 1 percent in the April-July period.
The government is under pressure to contain fiscal deficit as it is seen as one of the primary factors for a weak INR. Fiscal deficit is budgeted at 4.8 percent of GDP for this fiscal against levels of 4.9 percent of GDP seen in the last fiscal. The weak economy is slowing down revenue growth and the government has to curb expenditure to keep its fiscal deficit in check.
The government and the RBI are trying hard to bring down the Current Account Deficit (CAD) that was at record highs of 4.8 percent of GDP in fiscal 2012-13. The government has raised duties on non essential imports such as gold and silver while RBI has made financing of non essential imports costlier. The weak CAD is seen as the primary cause for the INR weakness.
Exports have grown by less than 1 percent in the first four months of fiscal 2013-14 despite a weak INR that is down by over 11 percent in the same period. Weak global economy is leading to anemic export growth. Imports are up by just 2.6 percent indicating weak domestic demand.