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Catching the flu
The Reserve Bank of India's package of measures to stabilise the rupee is a bowing to the inevitable. Tightening liquidity and raising interest rates are a response to currency depreciation which has been routinely tried in affected countries, the most recent example being in South-East and East Asia. The aim is to increase the attraction of rupee assets. Demand for dollars has been sought to be curtailed by the increased cost of import finance, while the supply, it is hoped, will be augmented by an inflow of dollars from exporters and from ECB and GDR holders who have kept their money abroad. However, the underlying factors on which expectations of rupee depreciation were based have not altered. These fears were that dollar supply would be considerably reduced due to the drying up of external borrowings and FII inflows as well as sluggish growth in exports. The Asian contagion is likely to adversely affect India in more ways than one -- while FII outflows continue, and our exports face more competition,
foreign direct investment too may now be directed towards the acquisition of cheap assets in the affected countries. In an admittedly apocalyptic scenario, the flight of NRE deposits is also a possibility.But not all expectations are rational. It may well be that importers are reassured enough by the RBI announcements to desist from panic covering, and exporters decide to get their dollars in. Once the rupee remains stable for some time, expectations could become self-fulfiling, and no further intervention would be needed. This is the logic of all intervention in the foreign exchange markets. Whether it will work or not is a question difficult to predict as events in the rest of Asia have so clearly shown. The RBI measures are an acknowledgment that India may well catch the Asian flu, inspite of arguments that there are clear differences between us and the rest of Asia. First, our corporates and banks are by no means so exposed to foreign debt. Next, our asset bubble collapsed years ago. Nor do we have
capital account convertibility, and our economy is far less open. True enough, but while our dependence on short-term debt is lower than in the so-called Asian tigers, our external debt as a proportion of GDP was higher than that of Korea's as at end-1996. Debt-service computed as a percentage of exports, worked out to 34.3 per cent for India in 1996, compared to 29.2 per cent for Indonesia and 11.7 per cent for Thailand. Those who compare India with China would do well to remember that China's external debt amounted to only 16.7 per cent of GDP while its debt-servicing was 9 per cent of exports. This is besides the vast difference in foreign exchange reserves, which are estimated to be around US$ 140 billion for China, besides Hong Kong's additional US$ 86 billion. Compare India's paltry US$ 24 billion, and it will be clear that we have much to learn from China. All this goes to show that there is indeed scope for worry about the impact of rupee depreciation. There is no question that the economy will pay
a price. This is exacerbated by the fact that industry is currently passing through a slowdown. Some commentators had espied recent signs of recovery, and that could well be delayed. Interest rates will increase across the board, including long-term and prime rates. The surcharge on import finance will mean that an importer whose borrowing rate is 17 per cent will actually have to pay interest at the rate of 22 per cent, which is a throwback to the darkest days of two years ago. The impact on corporate bottomlines will be drastic. Especially so since lack of demand has resulted in corporates being saddled with large inventories-steel and capital goods being prime examples. The stockmarket, already in the doldrums, will be affected. But it is also true that in the current circumstances, interest rates are not a major factor determining investment. In any case, not much investment, both domestic as well as foreign, was expected before the new government's policies become clear. Much will depend on the
stability of the new government and its attitude towards foreign investment.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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