Isn't it strange that as global currency markets shiver over the intense Eagle-Bear cold war, the India Rupee is appreciating? The rupee has gained six per cent since August 29, 2013 against the dollar, when it bottomed out. Then the Reserve Bank of India (RBI) and the finance minister P Chidambaram and the mandarins in North Block had then attributed the fall to "speculation." Very little has changed other than the hot air from the mandarins in North Block.
Curiously, this round of rupee appreciation appears to have accelerated in the second half of January despite adverse economic fundamentals. In January this year the depreciation pressure on the rupee was high, especially since the key economic parameters, inflation, current account and capital flows - influencing exchange rates have remained in the danger zone. Consumer inflation as measured by the consumer price for labour remains in double digits. An inflation differential of one per cent between the $ and the rupee has an 800 basis points impact on exchange rates. With dollar zone consumer inflation at 1.6 per cent, the differential would mean 6.7 per cent currency depreciation.
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| Soaring prices drive Indians to the sea |
The second indicator, the current account deficit appears to have shown some improvement. The current account deficit for the December quarter of this financial year was 0.9 per cent of the Gross Domestic Product. This was largely due to the improved exports. Merchandise exports rose 7.5 per cent to $80 billion for the third quarter of this year. About 70 per cent of merchandise exports are to Europe, Americas and China. As for services exports, particularly software and IT services, Europe and the Americas have not shown any increase in imports. In fact, imports into both these regions have shown little improvement. U S imports from all over the world increased by only $3.5 billion in the last quarter of 2013. In the case off Europe, there is little or no increase in imports of goods and services from India. (See here and here). So where has the improved export earnings come from? Certainly not from Africa or Indonesia!
One pointer is that the 70 and 80s trends are reversing. During the 70s and 80s it was imports that were over invoiced. It is exports that are being over invoiced to facilitate money laundering. Increase in gold imports was precisely intended to facilitate that move. This is because increased duties make gold imports through trade channels unattractive. Instead, gold through non-trade channels or criminal channels are encouraged! The duty hikes have pushed up gold smuggling from zero to 200 tonnes in just one year! The second pointer is the boom in the equity markets.
That cash is entering the equity markets, when global financial markets are faced with uncertainty over the Russian-US standoff, is interesting. The Bombay Stock exchange index has just set a record 22000 points. Obviouly equity markets are hardly reflective of the economic or political fundamentals, especially in an environment where barely 1 per cent of the population invest in equities and over 400 million still continue to scrounge for a living.
But then equity markets in India are another vehicle for laundering cash. Curiously this rise in Indian equity markets have coincided with the downturn in the real estate markets of Ukraine, Latvia, Estonia and other European countries where some of India's well healed have park their wealth, beyond survelliance. Preferred assets of these Indians being real estate or farm land in Eastern Europe. See here .
But the Putin Obama standoff has resulted in that Indian cash making haste back home. Therefore it is hardly surprising that even at a point of time of global uncertainty the rupee should be appreciating. By no stretch of imagination is the Rupee a "safe haven currency."
It is this inflow of foreign currency that triggered the Rupee's rise. But the inflows have some benefits. The appreciation in exchange rate helps the Chidambaram to camouflage the inflationary impact as the government prepares for the 2014 general elections.
For election expenditure however, what is required is rupee liquidity or cash. This is particularly so in an election year, when most transactions by political party candidates are made in cash. This includes bribing Indian voters a practice that has been refined by India's political establishment and tacitly supported by government.
That cash is in demand was also apparent from currency with the public. There has been a reserve money expansion on account of the inflows. This is partly due to the RBI's purchase of foreign currency from the banks or banks entering into swap arrangements with the central banks for credit. After all Indian banks need rupee liquidity to lend and not dollars. Even if the dollars are parked into Indian bank deposits through non-resident deposits, the withdrawals are made in rupees. Each of these operations leads to demand for rupee liquidity.
The impact is that there has been big increase in currency with the public by almost Rs 1.13 trillion (Rs 1.13 lakh crore) since the beginning of this financial year (April one, 2013). Currency in circulation has also increased by Rs 1.2 lakh crore. This was also part of the reason for the Reserve Bank of India putting on hold the policy of withdrawing currency notes issued before 2005 from circulation, where the year of print does not appear. If the notes had been withdrawn, then cash in the system would have shrunk and election funders would not have been in a position to account for the large amounts of cash for conversion.
Once the elections are completed, the illusion exchange rate appreciation evaporates and high prices of essential goods will once again overwhelm Indians.
The fundamentals of a bubble economy kick in, translating into another steep collapse of the currency, hike in prices and tariffs of essential services. Indians will be returned to the time tested standard monotone, "The economic fundamentals are sound and the inflationary pain was necessary and would translate into long term benefits." But then in the long term we are all dead. Isn't that what the economist, John Maynard Keynes said.
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