Rupee breaches 67: Four myths about India and the politics of pessimism

Why this panic about the rupee decline, asked Paul Krugman on 20 August, a day when the currency hit 64.13 forcing the RBI to intervene to pull it back to 63.25 levels at the close.

His contention was that a panic was unwarranted now as India's dollar denominated debt situation is not like the Asian crisis countries of 1997-1998 or Argentina in 2001 and the fall in the rupee was in line with the emerging market currencies.

"Now, the depreciation of the rupee will presumably lead to a spike in inflation - but it should be temporary. So at first examination this doesn't look like as big a deal as some headlines are suggesting. What am I missing?," he said in his blog.

But then the rupee's record low was 64.13, a level which now looks like a strong one. The rupee has fallen 65 and 66 in a matter of 7-8 days and looks set to reach 70 faster than expected.

The Indian rupee breached the 67-mark in early trade Wednesday, hitting a record low of 67.98 against the dollar in a couple of minutes of trade.

Rupee woes. AFP

Rupee woes. AFP

The reasons for the rupee falling to newer lows are the same as then. The only change is in the level of pessimism about the economy, which is aggravating day by day.

An example is the passage of the Food Security Bill and the general media reaction to it. Almost all the reports have attributed the rupee's fall yesterday to the bill. Most of them said the markets were worried that the bill would be a bigger drag on the government's fiscals, already stressed because of a heavier fuel subsidy.

But the fact of the matter is that the rupee's fall yesterday was not an isolated one. In fact, the Indonesian rupiah also fell to record lows along with other emerging market currencies. The fall was largely because of an increase in crude oil prices because of the geopolitical tensions arising from Syrian crisis and a likely intervention by the US.

As far as the rupee is concerned, dollar demand from importers, a usual factor that impacts the forex during month ends, added to the worries. The demand had a larger impact as there were no inflows this time round.

Moreover, many economists are of the view that the Food Security Bill is already factored in by the market. Samiran Chakraborty of Standard Chartered told CNBC-TV18 that the bill is unlikely to have a major impact on this year's fiscal deficit as the expense on this count has already been factored in.

The finance minister too reiterated this at a press conference yesterday. But nobody was in a mood to listen and kept tom-tomming the bill as the reason for the fall, eclipsing all other factors.

Food Bill is just a case in point. The dominant discourse about the economy has become pessimistic due to the apprehension that the Congress may return to power riding the Food Bill. This has resulted in creation of myths about the Indian economy, isolating the country from the global developments.

A research report by Ambit yesterday quashing four myths about the Indian economy assumes significance in this context.

According to Ambit, the zeitgeist now is that India is in the grip of a downward spiral. This line of thought is reinforcing four popular myths about the Indian economy, the report says.

The myths are:

(1) India is in the midst of a 'structural' slowdown

(2) India's macroeconomic woes emanate from inadequate savings

(3) Wage growth across the country has slowed drastically

(4) India's GDP growth is the primary driver of equity returns

On the first myth, the brokerage cites the World Bank's Country Policy & Institutional Assessment to drive home the point that India, which now is in a 'cyclical' economic downturn after a long period of above-trend growth, has broadly maintained its positioning in all structural parameters.

"The key variable that has changed vs the pre-CY07 era is that the global business cycle has turned downwards, thereby affecting a host of Indian macro variables even though the structural features of the Indian economy, for better and for worse, remain intact," it says.

According to the report the same set of structural fundamentals, which are now spreading pessimism about the economy, were used until a few years ago "to justify the unfettered optimism" about India.

The pressure on fiscal policy and current account is because of the global downturn, which adversely impacted the revenue flow to the government and exports.

"India's current account deficit came under pressure once the global business cycle turned in CY07 mainly because India's exports growth, which is a function of global GDP growth rates, came under pressure even as imports growth remained resilient," it said.

On the second myth, the brokerage says India has a better savings rate compared with its emerging market peers. In 2012, India's per capita income was at $1,491 and gross national savings ratio 30%. Other countries with similar per capita income level had a savings ratio of 2 percent.

"This statistic in turn points to India's substantially higher propensity to save as compared to its EM peers," it said. For the brokerage the big problem with the Indian households savings is that 64 percent of them is in physical assets. However, India's import demand for gold today is lower than what it was during the 2005-07, a fact that undermines the finance minister's attack on gold imports.

The average gold imports to current account deficit ratio was at 229% over FY05-07 vs a significantly less 61% in FY13. What this means is that as Ambit says India's disproportionately high demand for physical savings is a structural problem, but the problem has not worsened in recent years.

So the main culprit behind the worsening CAD is decline in merchandise exports to -1 percent in FY13 as against the average rate of growth of 24 percent over FY04-07. The reason for this decline is the decline in global growth rates.

It also attacks the perception that India's consumption is higher than investment. The country's consumption (as a percentage of GDP) has been trending lower as the country gets richer whereas India's investment (as a percentage of GDP) has been trending higher. This trend is in keeping with the third world countries, it says.

On wage growth, the report says it is a myth that there is a positive correlation between jobs growth and GDP growth. During the 2001-05, 60 million jobs were created in India, when the GDP growth was about 6 percent. In the subsequent years when the economic growth was about 9 percent, only 1 million jobs were created. In 2010-12, 14 million jobs were created and the growth during these years decelerated to about 6.2 percent.

True, the white collar job market was in a slump during these two years, but there was an unprecedented 15 percent rise in wages in the blue collar jobs.

It also says the perception that MGNREGA has resulted in a labour shortage in the rural areas is wrong. This is because the man days in the scheme that guarantees 100 days of job to a household annually has steadily declined over the years.

"Average days of employment provided per household in India has been declining systematically from 54 days in FY10 to 36 days in FY13, suggesting that the take up for this programme is declining," it said.

It says there are two reasons for the labour shortage that the rural area is witnessing:

1) India's traditional labour-supplier states have emerged as centres of high growth in India

2) the rising demand for education has meant that more individuals, particularly from the lower income segments, are choosing to be a part of the formal education system.

As far as the fourth myth is concerned, the brokerage says "theoretically, GDP growth and equity returns should not have a correlation simply because the microeconomic analogue of GDP is sales and not corporate profits (whereas stockmarkets are driven by profits)".

This is not to suggest that there are no problems with India. There are. And they are definitely major ones. But to say that it would have been all hunky dory had the Opposition been in power during these years is baseless. They also would have had to deal with the same unfriendly global situation.

The excessive pessimism has now become a rallying point for all those who oppose the Congress. Everything that the government and the RBI do is being opposed with a cynical mindset. With the election approaching, we can only expect this attitude to heighten.

This will not do any good for the economy or the country. The sooner the pessimists, including those who are in a hurry to anoint Narendra Modi the prime minister, realise this, the better.