Insights from street children

A brief pause (or an interminable wait during peak hours) at a traffic light is a sure invitation to beggars and vendors in Indian cities. But this editorial from the Economist seem to have spun an insightful theory – how to contain the huge forex inflows into India – based on it. Excerpts -

“INDIA, it is fair to say, is not yet reconciled to the new-found strength of its currency. One poor wretch, pressed against the car window at a Delhi traffic light, tries to change a dollar bill she presumably cadged off a tourist. She wants 50 rupees for it. Alas, the dollar now fetches less than 40 rupees.

This vigour is due to a strong inflow of foreign capital, some of it enticed by India's promise, the rest disillusioned by the rich world's financial troubles. The net inflow amounted to almost $45 billion in the year to March, compared with $23.4 billion a year earlier.

The migration of capital from the rich world to the poorer one is a sign of a bleaker season to come in the world's biggest markets. This would, then, seem an inauspicious moment for India to bet its future on export-led growth. If it cannot resist the inflow of foreign capital, it should try instead to make room for it—by observing fiscal restraint—and to make the most of it—by investing it wisely. India may then have an economy worthy of a more expensive rupee; and its children may have better things to do than hang around at traffic lights trying to change a buck.”

Well said, The Economist…

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What drives the US dollar down ?

If not as stressed as India’s IT vendors and exporters, I am a little hassled. What drives the US dollar down so much?

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Ok. There you have a steep oil price, a weak economy and an anxious credit market - all helped dump the dollar. But America's growth prospects are not so poor and the subprime-mortgage market not so woeful—at least, not yet—that they can fully explain the dollar's recent sickliness. My basic understanding of economics tells me a currency of a country that has an adverse balance of trade will be weak.

But a closer look suggests that currency markets, rightly or wrongly, are blithe about trade imbalances. Some of the countries whose currencies have gained most at the dollar's expense, like Britain, Australia and New Zealand, have large external deficits and debts too. Australia's current-account shortfall has been more persistent than America's and, as a result, its net overseas debt last year was 60% of its GDP, compared with 19% for America. New Zealand's debt ratio is larger still at 90% of GDP. Meanwhile the currency of the world's largest creditor nation, Japan, continues to languish—even against the dollar.

If anxiety about global imbalances is not driving currency markets, perhaps the dollar might rally once America's economy is back on its feet. It has, after all, fallen a long way already: on the Fed's broad trade-weighted index, the greenback is down 22% since its peak in 2002. According to the purchasing-power parities calculated by the OECD, the dollar is undervalued by 15% against the euro, 18% against the Australian dollar and 21% against the pound. Such divergences from fair value might not prove sustainable, particularly for the countries that have external financing gaps of their own to fill.

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Flood relief

External Commercial Borrowings (ECB) by M&A bug bitten Indian businesses have been partly responsible for the dollar deluge that drove up the Rupee to phenomenal 6% in a short period of 6 months.

To induce growth, RBI had earlier raised overseas borrowing and investment limits earlier. Now it’s altering its stance, giving in to the persuasion from domestic businesses that suffer the surging Rupee. The overall goal is to prevent the external borrowing window from weakening the financial discipline in India’s economy.

The government has announced fresh restrictions on external commercial borrowings (ECBs), capping the Companies to raise only up to $20 million abroad for rupee expenditure and only with prior RBI approval. Exemption shall only be for expenditure in foreign currency. For the rest, they will have to look for local financing. The funds raised abroad will have to be parked overseas till the actual requirement in India.

Despite Finance Minister’s warning, the effect was this.

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Samurai runs the Yen

Despite Japan's 2.6 percent growth and its trade surplus, the Yen is down 6.4 percent versus the dollar during the past 12 months. By contrast, the Thai baht is up 20 percent; the Philippine peso is up 14 percent; the Indian rupee is up 13.8 percent; and the ringgit is up 5.7 percent.

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Isn’t that strange? The common economic sense is that the currency of a country that has a trade surplus should be stronger than those having a deficit – unless it’s artificially kept depressed by its government like China does. Hence the global pressure on china to let Yuan fly loose. In that commotion, not many noticed what Japan has been upto.

William Pesek in his Bloomberg column, has explained it as he sees it.

"Anytime the Yen does rise, Japanese officials begin talking about “unnatural moves'' in markets. Then comes the “watching trends closely'' warning: In other words, “back off'' to anyone tempted to buy the Yen. Having raised verbal intervention to an art form, Japan no longer needs to intervene.

China, of course, does -- as evidenced by its more than $1.3 trillion of currency reserves. The difference is that China makes no bones about its desire for a competitive exchange rate; Japan disingenuously claims it lets market forces set the yen's value. If that's the case, Tokyo should just shut up and prove it. Then, China would have fewer excuses to hold down its own currency."

Dr.Y.V.Reddy can sure take a leaf – my IT portfolio could look a lot better.

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Plunge Protection Team for Indian markets ?

Contrast the underlying philosophy behind Government’s fiscal policy and RBI’s monetary measures, the clock is stuck at 10 past 10. Finance ministry wants the reforms to continue on the liberalization plank. Liberal SEZ, more FDI, lifting of investment caps, more resources freed towards industrial progress. All these boost forex inflow, enthuse the stock markets that have soared to dizzying levels. With SEBI also considering letting in big ticket investors like Hedge Funds have a direct exposure to Indian equities, barring short term blips, the long term India story is in tact and the buoyancy is likely to persist.

Not all are happy about it. The RBI and its Governor Dr.Y.V.Reddy are a worried lot for one. So far RBI has managed recessionary phases and forex crisis of different kinds over the decades. They are now facing a new kind of problem they’ve often not met with before – Forex reserves are building up at a faster clip than they can count, much less manage. With $ 203 billion as on April 20, 2007 as per latest available RBI statement, they’d better figure a way out to deal with it soon.

The normally intrepid Guv is close to pressing the panic button or is near as he can get, as he continues to let the Rupee appreciate against the US dollar, much to the chagrin of businesses with huge $ billings like IT, Healthcare and Telecom. Though he has also left all key rates unchanged and announced steps that would pave the way for lower interest rates on home loans in its annual credit policy - aimed at sustaining growth without fuelling inflation, it’s totally clueless where it comes to dealing with the mounting forex reserves.

Financial assets if badly managed can often spell disaster for any economy. Compare the 9.5% returns earned by GIC of Singapore as against India’s paltry 3.5%. Isn’t it time that we look at other economies that are handling the situation efficiently and adopt the best practices that worked well with them ?

I am not a fan of regulatory overkill. But if there’s a certainty of idea vaccum at the top, I’d better tweak my belief system than to let my tiny net worth erode. How about a working group on financial markets on the lines of Plunge Protection Team – may not be a panacea, but could well be a dry run to test internal efficacies in an emergency.

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What do you think ?

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