By Sujit Bhar
With US President Donald Trump’s 50 percent tariff bearing down on all Indian exports and the fast sliding overall export potential of the country in the complete failure of manufacturing capacity growth as well as in the hostility that the current dispensation has generated across regional economies, India is trying desperate measures to shore up its faltering economy.
High taxation, lack of proper market development and internal displeasure through deep racial and religious divides have collaborated to bring business to its knees. The Indian small scale industries sector, the backbone of this developing behemoth for long, was devastated by demonetisation, followed by an unplanned GST. That led to mass layoffs, the sector having traditionally borne almost 90 percent of India’s entire working population.
With little hope in sight, the Reserve Bank of India (RBI) has, recently, decided to give the rupee a bigger role, so it can travel faster through the system. It is a good thought, though somewhat impractical.
The recent RBI circular on rupee trade settlement sounds novel and interesting on paper, but a careful analysis of the issue shows that this is a case of too little too late, akin to a band-aid on a lacerated arm. Moreover, the idea of cross-border rupee settlements isn’t new and, considering the limited capital account convertibility of the rupee, the currency is not very attractive worldwide.
Frankly, cross border trade currency preferences are never created by a directive from any one country’s reserve bank. This generally emanates from the government’s ability to negotiate complex and profitable bilateral trade deals. The Reserve Bank’s directives, thereafter, create a safe passage and iron out the wrinkles.
This directive may have some limited success, that too in money movements within the borders of India.
The directive includes the following:
- Financing Acquisitions: Banks are being allowed to “finance acquisitions” by Indian corporate entities. It may be noted that Indian banks have for long financed such acquisitions, though via other routes, and this directive has only simplified the process. However, while this will lead to quick and better consolidation of finances of major companies and the resultant creation of behemoths, such South Korea-like chaebols, or large family-owned business conglomerates, are definitely not what India needs at this stage of its development. It could give already massive business houses, such as the Ambanis, the Adanis and the Tatas, unlimited power.
- Mergers and Acquisitions Activity: Also, while this could actually speed up industrial activity in a swathe of companies, it will not affect international mergers or acquisitions (M&A), where a weak rupee and a strong dollar will fail to amalgamate into any reasonable deal-brokering.
- The Non Performing Assets Issue: The third problem that could rise from this is a further spurt in Non Performing Assets (NPA). The continuous NPA write-offs that the government has been allowing banks, has not been helping the economy. A further growth in NPAs is a scary possibility.
- Credit Boost: The last point above actually leads to the other part of the RBI directive, in which the central bank is easing the flow of funds to large borrowers. This overrides the 2016 framework of restrictions on lending, and the expected initial surge in M&As while boosting credit growth could bring in major risks of default.
THE “INTERNATIONAL” RUPEE
This sounds like an impressive document till it is proven to be not so. The RBI feels that its measures to increase the usage of the rupee in international transactions will boost cross-border trade with neighbouring countries, such as Bhutan, Nepal and Sri Lanka. The idea is to lend rupees to non-residents, who would supposedly work out ways to complete the international transaction using only the rupee as a medium.
This is easier said than done. For all practical purposes, the US dollar remains the standard currency and procedure of safety and in the absence of any bilateral treaty, specifically for this purpose, this effort is more likely to fall flat on its face. Considering the ill-will that India has earned across all its neighbours, neither their governments nor their central banks would be too willing to let this pass unhindered.
THE WEAKENING RUPEE
Added to this is the fast weakening rupee. Over the past ten years, the Indian rupee has weakened from around Rs 62 per US dollar in 2014 to well over Rs 88 today. To be specific, the Indian rupee stayed weak at around 88.7 per dollar, hovering near a lifetime low (as of writing this article). That is a depreciation of over 30 percent.
Why has this happened? India runs a chronic trade deficit, bringing in far more oil, electronics, and gold than it sells abroad. Inflation in India has also been consistently higher than in the US, which chips away at the rupee’s purchasing power.
Probing international opportunities with a financial instrument so weak isn’t the most prudent move by any standards. And the RBI expects NRIs to pull this off in the absence of any hand-holding bilateral treaty. This seems a highly unlikely outcome today.
THE EXISTING EXAMPLES
There was a time when India made the bold move of buying oil from Iran (which was under US and EU sanctions at the time), using the rupee route. It went well for a short while, till Iran realised that the large accumulation of rupees in its vault was useless, because of a dearth of useful items it could purchase from India using those rupees.
Then there is Russia. Russia is a prime example (vis-à-vis India) of the trade deficit problem. Despite negotiations, the rupee-ruble trade settlement was largely stalled because Russia, exporting far more goods (primarily crude oil) to India than it imported, would have been left with a large quantity of rupees it could not easily use. Russia reportedly preferred using other currencies, such as the Chinese yuan or UAE dirham.
India’s trading partners, who had initially agreed to the rupee-trade, are now finding little use of the accumulating rupees in their accounts. The rupee being only partially convertible on the capital account imposes restrictions on the movement of money for investment purposes. Foreign entities holding a surplus of rupees cannot freely convert them into other currencies or invest them without restrictions. This makes the rupee less attractive as an international medium of exchange.
The Indian government and the RBI have historically been cautious about moving towards full capital account convertibility to insulate the economy from external shocks and volatile capital flows. This protectionist stance, however, is at odds with the goal of internationalising the currency.
Also, the current weak position of the rupee shows that even such protectionism has not been able to isolate and protect the rupee from international exchange pressures.
THE FAILURE OF MAKE IN INDIA
The rupee-trade policy could have stayed afloat, had India been able to emerge as a prime manufacturer of highly value-added goods that India’s trading partners crave for. The Indian government’s Make in India effort has, for all practical purposes, failed miserably. There is little evidence of India manufacturing any reasonable commodity that even less developed countries, such as Nepal, Bangladesh and Sri Lanka covet and are not able to source from elsewhere.
Added to that is the complicated geopolitics that has resulted in India making enemies out of almost all its neighbours, benefitting countries such as China, Taiwan, Vietnam and others. India is fast losing the respect it had gained through decades of careful negotiations and partnership. It would be difficult for India, at this point, to strategise a scenario in which India’s partners not only see a profitable trade situation, but a respectful ambience. The RBI’s initiative in this regard is bound to face resistance.
And, within this hostile geopolitical situation, India exists, sans a manufacturing capability that could benefit our neighbours, nor the heft of a currency that has international demand. The rupee accounts for only around 1.6 percent of daily global forex market turnover. For the rupee to become an invoicing currency, India’s share of global trade would need to be significantly larger, providing a natural incentive for other countries to hold rupees.
A POSSIBLE SILVER LINING
As expected, this RBI circular has failed to produce any massive shift, though there may be possibilities hiding in specific contexts, such as with countries facing dollar shortages, like Sri Lanka. The latest RBI directive, expanding the investment options for surplus vostro balances and establishing transparent reference rates for partner currencies, could help in easing the pain a bit.
The problem is that the cons outnumber the pros vastly. The RBI effort could bear some fruit within the borders of this country if regulations are brought to bear upon defaulters and corrupt practices, but beyond those borders it is a very different story. It is time the government, too, gets on board.