The golden age

With export prospects dim, time for the RBI to step in to strengthen the rupee to cap the rising imports of the yellow metal

By Mohan Sule

The heat and dust raised by Union Budget 2016-17 is settling down, with the market giving its approval after some hesitation. There is a consensus that the allocation for rural and infrastructure segments will act as a trigger for growth. The focus on the farmer, however, was not at the expense of the investor. The favorable capital gains taxation structure remains intact. A cause of cheer is the resolve to stick to the income-expenditure deficit target for the next fiscal. The implication is that the government will not crowd out private players from the debt market, thereby easing pressure on interest rates. The combo of low cost of money and increase in consumption is surely appetizing. The feeling of relief does not take into account that, besides fiscal deficit, a big difference between the value of imports and exports can influence the availability of money. The current account deficit (Cad) increased to 1.6% of GDP from 0.2% in the six months to September 2015. The euphoria over the expected rate cut, howsoever small, clouds the potency of currency volatility in torpedoing the feel-good factor. Exports in dollars slumped 24% late last calendar year. A crisis was averted as the value of imports, too, was down a third. The oil import bill fell by over half in the year to February 2016, with crude prices down nearly one-third in the period. Though the share of oil in the dollar import bill nearly halved in the nine months to January 2016, that of gold rose, peaking at 15% in August 2015. The price in rupees per 10 gm has risen 13% in the year to March 2016.

The liquidity injection by the European Central Bank and Bank of Japan and loosening of statutory liquidity ratio by the People’s Bank of China are devaluing currencies, prompting investors to seek refuge in gold. The nearly 10% depreciation of the Indian rupee over two years has also resulted in higher domestic gold prices. A weak currency has the might to ignite inflation and prod the central bank to increase interest rates. Economists might be delighted at the narrowing of the Cad, which declined 8.3% in the December 2015 quarter. Yet, just like fiscal deficit, a widening gap suggests a humming economy. An emerging market imports more than it exports to meet growing domestic demand. Also, the age-old concept of self-reliance has been junked, with the world integrating and capital moving to areas offering higher yields. Besides, the global slowdown led by the US initially and by the euro zone and China and Japan of late has brought into focus the dangers of relying on exports for growth. The excess capacities set up to cater to the overseas markets are turning idle and leading to layoffs in China. Wages and recruitment stagnated in the tech sector in India following the 2008 liquidity crunch. What is worrying is exports are not spurting despite the depreciation of the rupee. Apart from the sluggishness in the euro region, China and Japan, the US market’s fragile recovery is complicating the problem.

The unpopular step of hiking excise duty on fuel even as international crude was falling has discouraged copious consumption and added revenues to the treasury. Once the economy gathers speed and oil prices begin to heat up, these duties can gradually be reduced as the void can be filled by buoyant corporate taxes. The market, in fact, should hope for a rate hike by the US Federal Reserve. The fear of the flight of foreign portfolio investors from India accelerating should not cloud the reality that their investment is temporary. From a high soon after Narendra Modi’s victory in May 2014, the inflows fell 70% beginning of 2016 but turned net positive before and after the budget. What is important is foreign direct investment, which touched the highest-ever level since 2000-01 of over US$ 4 billion in the 10 months of 2015-16, probably due to the Make-in-India initiative.The slowdown in the global economy, thus, is proving to be a window of opportunity for India. At the same time, gold has to be made unattractive.Gold sovereign bonds address the urban buyers. Rural consumers view gold as a hedge against bad times. With the budget focused on the agriculture sector, usage of gold is bound to go up. Prices, too, will spurt if the rupee goes down further. The Fed has indicated it might ramp up interest rates twice in the current calendar year. An uptick in economic activity might lead to diversion of some gains into gold. The rupee has to strengthen for gold prices to cool to discourage hoarding. Export prospects, however, are dim. The acquisition of teflon-like characteristics ensures the US dollar remains strong. As such, there might not be much downside of losing the competitive edge even if the Reserve Bank of India steps in to shore up the Indian currency by using some of its record reserves to nip gold imports.