Dear FM, Seventh Pay Commission will only help you lose votes

The Indian rupee is still on life support. The only reason that it strengthened by 9.5 percent from lows of 68.80 to 62.20 against the dollar is profit taking by short sellers at lower levels, the US Federal Reserve postponing bond purchase withdrawal and the RBI taking measures to increase dollar inflows.

A sudden shock in the global markets can easily take rupee can easily go back to its lows. This could be either the Fed cutting its asset purchase programme faster than expected or geopolitical tensions in the Middle East spiking oil prices globally.

[caption id=“attachment_1135315” align=“alignright” width=“380”] Reuters[/caption]

The rupee has a strong reason to move down again now and this is purely domestic. Foreign investors and NRIs have a reason to believe that India’s reforms will progress and lower fiscal and current account deficits. The belief stems from the fact that the government has gone on record in global investor forums saying its will bring about more structural reforms. The Indian government is desperate to get FII and FDI flows into the country to keep the rupee from falling off the cliff.

The two recent announcements by the government are definitely a cause for concern for the rupee, though. One is the announcement that there will be no sharper diesel price increase (oil companies are already increasing their diesel prices by 50 paise/L every month) and petrol prices could be brought down and the second is the formation of the 7th pay commission.

The rupee is down over 50 percent against the dollar over the last six years primarily due to the implementation of the 6th Pay Commission recommendations and also because of lack of pass through of rising global crude oil prices to the end user.

India’s fiscal deficit touched a 14-year high of 6.46 percent in 2009-10 on implementation of the 6th pay commission. Fuel, food and fertiliser subsidies took up fiscal deficit to levels of 5.75 percent in 2011-12 from levels of 4.79 percent seen in 2010-11. Fuel subsidies have also impacted the current account deficit that touched all-time highs of 4.8 percent of GDP in 2012-13, as fuel consumption was not rationalised.

The government has added fresh worries to both domestic and foreign investors alike on the 7th pay commission formation and lack of pass through of global oil prices to the end user. Markets could start factoring in higher deficits going forward and that would mean fresh pressure on the rupee.

The rupee falling on the back of the government going back on its commitment to reforms cannot be saved. Neither the RBI nor the US Federal Reserve can save the rupee. The government may find itself fighting the rupee fall going into the 2014 assembly elections.

The UPA should realise that the rupee is the barometer of its performance and if the currency is at record lows going into polls, even the most loyal voters will ditch it. The earlier it stops its poll gimmicks and start taking the right economic decisions, the better.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.