Capital outflows have put pressure on the rupee | Photo Credit: GODS_AND_KINGS
India’s external account is more robust than in mid-2013, but there’s no room for complacency
The two basic elements that shaped India’s rupee, external account and inflation crisis of mid-2013 are very much in our midst today — namely, the hardening of US interest rates and elevated crude oil prices, at well over $100 a barrel. India, whose petroleum imports account for a fifth or more of its total import bill at prices of over $80 a barrel, inevitably runs into external account turbulence when energy prices rise. An increase in crude prices widens the current account deficit and weakens the rupee, while a spike in US interest rates encourages capital outflows and hurts the rupee further. A crisis can set in, if not properly managed. This nearly happened in 2013, when the rupee fell from about 56 to the US dollar at the end of May to nearly 69 three months later, a fall of nearly 25 per cent, while the CAD touched 4.8 per cent of GDP in FY14. The Reserve Bank of India, between September 2013 and January 2014, raised the repo rate by 75 basis points to 8 per cent to stem the slide. The FCNR(B) deposits, announced in September 2013 raised $30 billion, and that helped stabilise the rupee. But today, India is in a much better situation, even as its rupee and the CAD are coming under a bit of pressure.
The rupee has fallen by about 6 per cent since end-January, but has since then recovered. As the Economic Survey 2021-22 notes, India’s reserves can cover about 14 months’ imports, against 7.8 months in FY 14 (the taper tantrum year), even though forex reserves have fallen from $633 billion as on December 31, 2021 to below $600 billion today. In absolute terms, they are double the levels of FY 2014. The external debt to GDP ratio remains unchanged at about 20 per cent. Yet, there can be no room for complacency. With the US treasury yield rising by over 80 per cent from 1.72 per cent on March 1 this year to 3 per cent now, capital outflows arising out of interest arbitrage could pick up. As the RBI Annual Report for FY14 shows, an interest rate differential of about 6.5 percentage points helped, among other factors, to bring down the rupee value from 68 to a dollar in September 2013 to 60 to a dollar in July 2014. Today, the interest rate differential is just over 4 percentage points, a level that can be sustained if the CAD is kept in check, thereby necessitating lower capital inflows to keep the external account in balance. However, the CAD is expected to end up at $100 billion in FY23 (about 3 per cent of GDP), translating into a merchandise trade deficit of about $280 billion, against $192 billion in FY22. While more rate hikes seem hard to avoid, other steps can be taken to contain capital outflows. Realistically speaking, lowering the trade deficit through lower imports seems impossible in the short run.
The Centre should seek to step up FDI flows by removing bottlenecks to investment. It can go slow on signing more free trade pacts, so that it can raise tariffs on non-essential imports if required. Countertrade deals can be explored. Above all, managing the currency is also a confidence game; the RBI should be firm in its actions and communication while managing the rupee.
Published on May 11, 2022