Friday, June 22, 2012

The Rupee Debauchery

This article of mine is published in The Economic Times on June 23, 2012 (Link)

Way back in 1957 Ayn Rand in her magnum opus showed the world as to what happens when the looting runs dry. When the government starts to trample over the productive society and re-distribute wealth it can certainly make some quick electoral gains but soon the nation is driven out of its vitality and resources; very soon there is nothing left for the government to re-distribute.
The sharp depreciation in the currency, a falling growth and rising inflation are just some signal towards such a scenario and to blame it like every other piece of internal economic travesty on some distant western country is an attempt to run away from reality.
The Indian rupee has been among the three worst performing currencies vis a vis the dollar in the past one year.  That is indeed quite an achievement considering that all our South Asian neighbours have done better than us.
The recent moves by the RBI including asking exporters to convert 50% of their dollar holdings into the rupee would do little in arresting this slide till the fundamental reason behind this fall is not addressed. Infact this move by the RBI reminds us of an old adage “Desperate Times Call for Desperate Measures” and the fear is that more such capital intrusions can come into play in the future should this slide in the rupee continue. While there can be several factors that can influence the short to medium term movement of a currency, on a secular basis the price of a currency is pretty much dependent on the forces of supply and demand. So in essence the increase in the amount of credit net of the actual growth (of real goods & services) is what determines the relative value of the currencies in the end.

A brief glance at net credit growth (credit growth net off GDP growth) of India and US shows that the net credit growth in India has been almost consistently higher (by a wide margin) than that of US except for a five year interlude between 2003-07. This fact as one can see clearly superimposes itself on the direction of the Indian rupee that depreciates remarkably over this period except for that five year hiatus.
It is indeed conspicuous to see the consistent low GDP/Credit ratio of India vis a vis the US. While the lower productivity of Indian labour can be cited as one of the reasons for this phenomenon, however this argument can be easily put into question by the outperformance shown by the Indian economy during its 2003-07 heydays. So clearly if the lower labour productivity argument does not hold much water then what could be the reason for this abysmally low GDP/Credit ratio for Indian economy and consequently the state of our currency.

The answer can be seen in the next graph. As one can see the prime reason for this state of the Indian economy has been the extreme government activism and control. This is reflected in the ratio of the annual government credit to the private sector credit offtake. It was only when the government reigned in its penchant of spending the taxpayer’s money that the Indian economy saw its most meteoric rise. Certainly the easy global credit conditions did help but this was the case even in the 90s when the Indian economy lagged compared to its other Asian and South American peers.
Since the beginning of 2008 the government’s plunder of the taxpayer’s money is back with a vengeance, with the government credit offtake over the private sector credit offtake rising rapidly. This has ensured again that the country’s productivity goes lower thus lowering the supply of real goods and causing the inflation to shoot up. Infact these re-distributionist policies of the government is the single biggest factor for the debauchery of our currency.
The currency of a country is like a stock that people own but unlike stocks that is owned by a few, the currency is the asset held by every citizen. Infact the poorer a citizen chances are the more of is his wealth stored in the form of currency. A depreciating rupee robs him of his hard earned wealth and transfers it to people holding other assets or foreign currencies. This would counteract any of the government intentions to help him out of his pecuniary.
While we all want poverty in this country to reduce substantially, however as the past 40 years since independence have shown this cannot be achieved by government playing Robin Hood but by ensuring rule of law, reduced corruption, legal and financial reforms. All of these are certainly difficult to achieve and may not yield quick electoral dividend and so are unlikely to materialise in the near future. While these policies of re-distribution may have helped the incumbent in the past election, but if the current fall in the rupee is any indication, the government may soon run out of resources to repeat the redistributionist bonanza spree unlike the last time and then may end up facing the wrath of the electorate.

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