Why the rupee's ride may only get rougher from now on

The trade figures for April-December 2011 tell us why the rupee is not going to have it easy in 2012. In fact, the ride could get rougher.

This is the macro picture: during the nine-month period, the trade gap bloated to $133.3 billion and could end the year at $ 155-160 billion, according to Commerce Secretary Rahul Khullar. That’s a record for India - one that we cannot be proud of.

A more important number is the relative growth of exports against imports. Exports grew at 25.8 percent, while imports grew 30.4 percent. Exports are growing slower on a lower base, while imports are doing the opposite. We are consuming more of what the world produces than what the world consumes from out basket of goods -and the trend is accelerating.

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Next, let’s look at our ability to finance this import binge. As on 6 January 2012, foreign exchange reserves had fallen to $293.5 billion. But exclude gold and special drawing rights (SDRs) - use of which is a sign of bankruptcy - and the real foreign exchange reserves are down to $259.8 billion.

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Since imports are critical to our growth, we can’t just curb them arbitrarily. Doing that will slow down growth - and give the rupee another excuse to decline. The only remedy is to increase capital flows.

As against this, the country’s external debt had risen to $326.6 billion by last September, and is continuing to rise steeply as the government tries to bring in dollars by hook or by crook (liberalising non-resident deposit schemes, opening up more of our debt markets to foreigners, etc). Contrast the external debt with the reserves, and it is clear that India owes the world much, much more than it can currently repay.

At December’s rate of imports - $37.8 billion - we now have enough reserves to finance just over six months of imports.

But we are still importing a lot of inessentials. During April-December 2011, the country saw gold and silver imports grow 53.8 percent to $45.5 billion. Even if a significant chunk of it was meant for re-export as jewellery, the sharp rise indicates a reducing confidence in paper currency back home and a desire to hold on to assets that do not easily lose value. This is partly the result of inflation in India and abroad.

Of course, these figures must be tempered with foreign exchange inflows - both in terms of direct foreign investment and portfolio flows - both of which could increase this year due to the depreciation of the rupee. In the April-November period, FDI had risen to $22.83 billion - a health sign - cross the previous year’s figure by a wide margin. The depreciation of the rupee is apparently aiding inflows of a long-term nature.

As against this, the Reserve Bank, in order to stabilise the rupee, is selling dollars like crazy. According to BusinessLine, the bank sold $2.9 billion in November, the highest in 32 months.

But Morgan Stanley gives different figures for RBI intervention. Says a recent report: “The RBI began to increase its intervention in November, expending USD11.2 billion of its reserves (3.9 percent) - the second-largest monthly intervention in the RBI’s history. But judging by the price action in December, we believe that the RBI expended even more reserves in order to bring USD/INR off its record high of 54.3. Thus, we now believe that the RBI is making a concerted effort to support the INR (rupee).”

But actions that stabilise the rupee in the short run may destabilise it later. The problem is that intervention is a double-edged sword. The more money you expend in fruitless intervention, the less you have with you for a rainy day.

With the European crisis far from over, the RBI will have to retain ammunition for the first half of the year or more till foreign investors regain their risk-appetite and start investing in India.

We also have to give our exporters enough time to rejig their operations to take advantage of the currency’s depreciation.

In view of all this, it would be foolhardy to believe that the worst is over for the rupee. The macro numbers don’t support that view.

Be prepared for a roller-coaster on the rupee.