Rupee slide, CAD , current happenings and some unwanted advise
Rupee has depreciated above Rs 57/USD. The current account deficit (CAD) has gone above 5% of GDP during previous quarters. It had reached 6.7% for the Oct-Dec quarter last year. In simple terms, we are importing more and exporting less. The difference is being financed currently by capital inflows into markets, direct investments into India and borrowings. The investments flows in recent quarters were helpful due to the quantitative easing (QE) at US and Japan. The excess global liquidity found its way into India too, helping our cause of financing the deficit.
In coming months, the QE from the US will taper off, most likely by Dec this year. There has been indications from US Fed regarding this in the news. The expectation of this event itself has caused the USD to strengthen across the world. The effect has started playing on Rupee too.
However, that's not the only factor. Global investors have noticed the gap in our financing. Our major imports, petroleum products, are inelastic to price, subsidies being a cause of it. Also, the penchant for Gold continues unabated, irrespective of minor tweaking of taxes on Gold. Gold has proved to be an effective hedge against inflation in recent years. Also, Gold and real estates are safe parking places for black money. So you can't blame the culture if it continues to be Gold standard. Weddings continue to gorge gold and weddings won't stop because of CAD. And many analysts have ignored the consumer electronics which also add to our import bill. On the exports side, the global demand is still sluggish. US markets seemed to show improvement, but the story is still being debated. The emerging and new markets are being looked at, but they need time to develop. So overall, it doesn't seem that our exports will be able to finance our imports for some time to come. And with the capital flows tapering off, we won't be in a comfortable position.
Theoretically, what should happen is this. As CAD increases, Rupee should depreciate, making our exports competitive. Also, as rupee depreciates, imports would get costlier, thus killing demand for imported products. Over a period of time, the gap narrows and we come back to normal with no deficit (or move to surplus). That's theory. In reality, a sudden depreciation doesn't make our exports competitive. There's a lag built into it. I had blogged about that here. Also, exports are a function of global demand, which doesn't seem to improve. On the other hand, imports might be shielded by subsidies, or might be inelastic by nature/culture, and might not react to rupee depreciation. People in the field would talk about J curve and pass through effects too. Govt, in it's dim-wisdom and electoral compulsions, will keep spending more, given that it's an election year, further disturbing the economy and RBI's efforts to control inflation. And so on. To cut it short, natural economics might not work to restore balance and the situation might deteriorate from bad to worse very fast. Or is that the natural economics?
Meanwhile, I saw the jokers from Export Promotion Councils predicting an export growth of 10% or more this year. Last year, they had predicted 20% growth, while the exports actually contracted by 4.4%. Audacity of hope, I must say. Economists and your blogger are not that hopeful. Bleak times ahead.
What would I do with my money and my above predictions? I will walk the talk. When Biwi comes from US, I would advise her to keep her money in Dollars and not convert it fast. I would check if I can park my money in some mutual funds that invest judiciously in US markets. Also, buy Gold (ETFs/Physical/Funds), against national interest, for my daughter's marriage in future (she's 4 right now). I will stay away from Indian equities, as they might fall as a reaction to FII outflows. I will also stay away from any fixed deposit schemes that give me a return of less than 12% (I assume an inflation of 9% and hope to grow my money by 'around' 3%). I will also wait for the real estate to cool down before I buy any site/flat. And I will keenly follow one Mr. Murthy of Infosys fame (and first name not Phaneesh), to see when he exits, so that I go long when market over-reacts and make a killing when it corrects! I missed going short this time when market over-reacted and jumped high at his entry. It's already back to normal now.