Monday, December 19, 2011

The Rupee Fall

The RBI is in a soup. For the past few months it has been trying to tame Inflation by increasing the repo rates (The rates at which Banks borrow from RBI) and CRR (The amount of money banks have to keep with RBI). It hoped to reduce the amount of money flowing in the economy, thus reducing demand and dousing out inflationary fires. It is well on its way to achieving this but the past few weeks have given them a new headache. The never ending troubles in the Euro Zone, and India’s insatiable demand for Oil has led to this mess. Let us simplify the situation.


(1) Troubles in Europe: Economies in Europe are toppling one after the other. The famed European Lifestyle, extravagant spending and low taxes have led to a situation wherein the government is not able to pay its dues. It started with Greece and has moved on to Spain, Italy, Portugal etc… The acronym PIGS does suit them. As an investor in global currencies, when I see that the Euro is not doing too well, I am forced to shift to other currencies. The first name that comes is the Dollar. This mad hunger for dollars has caused a shortage of dollars in the world and India, being a majorly importing country is suffering from it.

(2) Imports of Gold and Crude Oil: India being a developing country, has a huge energy bill. Since we don’t have enough to feed ourselves, we are forced to borrow. We borrowed lots of Crude at high prices which has increased the country’s debt. We have a huge dollar bill but not enough dollars to pay them. So we need more rupees to borrow dollars.

(3) High Inflation: Say there is X amount of Rupees in the economy. At times of Inflation, we are paying more for a particular product. Indians will demand for cheaper products. These products will come for other countries therefore demand for rupee falls.

Possible Solutions:

(1) We cannot really do much Europe but what we can do is make sure our Economy is performing well. For that we need to make investments in Infrastructure, Public Spending has to increase and this will attract foreign investors to India rather than other countries. To increase public spending, the public should have money to spend. The public gets money from banks who get it from RBI. If RBI keeps its rates high, then people won’t be able to borrow; so an appropriate rate cut is required without releasing too much money into the economy. Rate cuts are double edged swords, lower rates mean higher Inflation and Higher rates mean low demand.

(2) We need to attract more capital into the country from our own brethren. Increasing deposit rates of NRO, NRE accounts will make Indians earning in dollars to invest in India rather than anywhere else. This allows an injection of much needed dollars into the economy.

(3) Open up FDI in various sectors. Everyone loves to invest in a booming business and India’s growth story is well known. Putting FDI in Retail on the backburner was a bad move and in hindsight, we might just regret it.

(4) Another possible move is to put a cap on Imports. The rate at which China is sucking Gold out of the economy, there may not be much left for others. A cap on Gold imports for time being might be a good idea. Increasing our debt bills will cause an unpleasant Europe like situation. The Investments have to match up with the revenues else India could face the Payment crisis of 1991.

(5) The current policy paralysis which has hit the UPA government doesn’t augur well for the economy. Investor’s confidence depends on how well the Government performs and this could be the wakeup call for Congress to push key reforms.

I am no economist but what I have suggested are basic and logical solutions to a problem which is fairly well documented and well known. It’s not an unknown virus with strange symptoms but a disease more akin to a common cold. I believe India is in safe hands as we have the World’s best bankers (probably not the best politicians) and they know what they are doing.

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