21 September 2018

Grapple with the rupee & oil but don’t panic

By Ajit Ranade

The big news this week was on two key prices. One is the price of the almighty dollar, and the other is the price of petrol (or diesel). These two are the most important price signals in the economy. And both are of imported items. India has a huge shortage of oil since domestic supplies meet barely one fifth of our requirement. We also have a perennial shortage of dollars, because what we can earn through exports is not enough to meet the needs of our imports. Other countries like Thailand, China, Malaysia have surplus dollars, since their exports exceed imports. Many of these countries started on par with India in terms of their exporting prospects, some 30 years ago. So, it is not as if we could not have planned better, to be not so pressed with a dollar shortage always. Similarly, many large countries have increased their domestic oil resources through exploration and development. The USA has now become the largest producer of crude oil ahead of Saudi Arabia and even Russia. India has large untapped reserves of oil and gas, which will take years to come to market. Until then, we live with an oil and dollar shortage. Ironically, our dollar shortage arises out of oil shortage, which is why the need to import. This year the import bill on oil alone may exceed 120 billion dollars, so a slide of the rupee-dollar rate from 68 to 72 means an excess bill of Rs 48,000 crores.

The oil price is set internationally and cannot be influenced by the government. There is some leeway, in terms of a rupee payment arrangement with Iran, which can save our precious dollars. But India is being arm-twisted by the Trump administration to reduce our Iran oil imports to zero. This is even though there are no UN sanctions against Iran’s oil exports. So far, India has not been able to convince the US to grant it an exemption, so this seems to be an unworkable option. There are several demand side management measures to conserve petroleum usage, which are always welcome. For instance, oil can be substituted by ethanol. In Brazil, 50 per cent blended ethanol is used in cars. India’s cabinet has decided to increase ethanol blending in automotive fuels to 20 per cent in the next 12 years. But unlike Brazil, which is blessed with rainfall and excess land, we may have a nasty side effect. If ethanol blending leads to increase in the production of sugarcane, a water guzzling crop, it increases our water stress. Of course, if second generation bio-refineries are utilised, which use agro-waste, crop residue and wood chips, instead of sugarcane, then water stress may be less. So, ethanol blending is a partial solution.

India already has very high taxes on fossil fuels, especially petrol, diesel and coal. So, to the extent taxation can dissuade excessive consumption, the policies are well intentioned (but carbon taxation should be uniform across all fossil fuels, which it is not). In the current stage of India’s development, our oil energy usage is not likely to go down much, although energy intensity of GDP (ie calorie used per dollar of GDP) could stabilise. So, in summary, the response to rising oil prices is to take it on the chin, and hope that oil prices may come down, the Iran option might work, increase the share of renewable energy, and keep the pricing of petro products market linked.

Which brings us to the question of foreign exchange. Here too, the country is a price taker, not a price maker. It does have some influence on the exchange rate, as compared to zero influence on the international price of oil. But in the context of an open economy with global capital flows, the success in controlling one’s currency is limited. The currency is much more influenced not by trade flows (of imports and exports), but by capital flows (chasing stocks and bonds). The latter is notoriously susceptible to sentiment, and herd behaviour. The Turkey or Argentina contagion can affect all emerging market economies, including India. So far, India’s rupee was spared the harsh treatment meted out to Turkey, Brazil, Argentina and South Africa. Even then there are some tools of exchange rate management that can be used.

Further, it is easier to defend an appreciating currency than a depreciating one. The rupee slid rapidly from 68 to 72, and is in danger of sliding some more. It has lost more than most of its Asian peers, since the beginning of this year. The main worry is the widening current account deficit, which may exceed 3 per cent of GDP this year. Imports are surging and exports are not growing strongly. It is not only on account of gold or oil imports, but also electronics items and coal. Despite a negative current account (imports exceeding exports), India’s balance of payments has been positive, because the capital inflows more than compensate the current account deficit. But now, for the first time in six years, the capital account will show a negative balance of roughly 30 billion dollars. Which means our inflow of FDI, foreign loans, private equity flows and stocks and bond market inflows are not sufficient. It is for this reason that the finance minister announced a slew of measures to incentivise capital inflows.

These are seen as reformist, and should have happened anyway. That is welcome. But it is important to not send any panic signals by banning the imports of non-essential items. Who is to say what is inessential? The weaker rupee has already made imports less attractive. The depreciating currency in that sense is a self-correcting mechanism for the negative current account. Most importantly, we need to be sharply focused on exports. Why not zero GST rate them? How about a special focus on labour intensive exports such as textiles and footwear? Similarly, tourism is underperforming. For instance, out of nearly 120 million outbound Chinese tourists, not even 0.1 per cent come to India.

India’s response to both oil and exchange rate should not be panicky, because the macro situation is relatively robust, with a good stock of forex, low inflation rate and a fiscal target which is still attainable. Any knee jerk reaction will lead to investor flight, rapid fall in the rupee, and a self-fulfilling downward spiral. So, for now, grin and take it on the chin.

Ajit Ranade is an economist and Senior Fellow, Takshashila Institution.

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