The twin problems of the falling rupee and rising fuel prices are that they are not created by our mistakes but due to external causes on which we have no control. Yet there are a few things we can do to alleviate the situation....
The falling rupee and rising fuel prices are two serious problems faced by the Indian economy today. We had the feel good factor of being the fastest growing major economy and a very satisfying GDP growth rate of 8.2 per cent for the preceding quarters of the current financial year, but suddenly we have been confronted by this twin problem. The situation is worsening on a daily basis and becoming panicky. The irony is that the problem is not created by our mistakes but due to external causes on which we have no control. We are not the only victim but the same is being faced by many other countries too, with the difference being in the degree of the problem. This column is a modest effort to have an overview of the causes of the problem and also the possible solutions.
Our currency is witnessing a free fall only in comparison with the US Dollar ($) while it is steady or has even improved in comparison with other major international currencies in the last four years. The value of US $ in the global currency market affects all international currencies, but the fall is more pronounced with currencies from emerging market countries. The steepest fall was in the case of the Turkish lira, and the same hit India immediately thereafter.
The question as to why the US $ is suddenly rising in value is answered by the new policies of the US government. President Trump has been basically a successful businessman and so the new policies of the United States are more mercantile in nature. Policies are being evolved on the theme of ‘America First’ so that the American money is invested more in the United States than in any other part of the world.
Economic parameters in the US have been improving and this has also led to the situation where more investment has been made in that country, and this causes the movement of dollars to the US from other parts of the world. The one-way movement of the dollar has created a demand-supply mismatch, and thus raised the value of the dollar in the world currency market. The increasing value of US dollars has a cascading effect, as importers try to corner them for future import before the value of this currency goes higher further. This increasing demand for the US $ works like a chain reaction and triggers still higher valuation.
The other reason for the US $ getting over-valued compared to other international currencies is the fear psychosis in international trade due to the trade war between the US and China, the two biggest economies of the world. The Indian rupee is the victim of this cross fire. The fear in the global trade has caused the cornering of the US $ which is the standard currency in international transactions.
The mercurial behavior of the US president has added to more tension. The President has threatened to withdraw the US from WTO, if things do not happen as per his liking. The US allies are also getting confused due to the unpredictable decisions of the US President. Trump has warned that there will be no free lunch, and all the allies have to contribute equally to all organizations like NATO and such mutual benefit associations. The US is changing its import policy, and subsidies granted to a few developing economies is being abolished. These US policies which are unilateral have a direct impact on the valuation of the US $ and other international currencies. The impact is severe on the currencies of emerging market economies like India as they suffer more due to loss of preferential treatment earlier given to them by the US.
The US Fed (Federal Funds) rate hiked twice during 2018 and has also strengthened the dollar to the detriment of other international currencies. The depression in the Indian rupee has a direct nexus with the Fed rate hike.
The Indian rupee is falling also due to the huge current account deficit. In June 2018, our current account deficit rose to 42 per cent which is approximately $160 billion. The deficit is caused by the huge increase in imports as against exports. The problem is becoming serious due to the rising price of crude oil in the international market as India is the third biggest importer of oil after US and China. We import 80% of our crude oil requirement and that makes us more vulnerable to the rising price of crude oil. As per an estimate of additional burden due to the rising price of crude oil, we will be hit by an additional Rs.45,000 crores this year.
The import of gold and electronic items has also a sizeable effect on our current account deficit which weakens our rupee. Some good policies of the government to curb black money have also had an unwanted effect on our rupee. Earlier, our stock market had a strong feeder route from round-tripping of black money which used to come in the garb of funds from some FIIs and FPIs. During 2018, there was a huge exodus of FPI due to a strict circular from opthe Securities and Exchange Board of India (SEBI) and the round-tripping route is also drying up due to amendments of our DTTA agreements with Mauritius and Singapore. Today our stock market is mainly supported by our Mutual Fund Investors and is less dependent on foreign funds, but the lack of foreign fund does affect our rupee as compared to dollars.
‘Our currency is witnessing a free fall only in comparison with the US Dollar ($) while it is steady or has even improved in comparison with other major international currencies. The value of US $ in the global currency market affects all international currencies, but the fall is more pronounced with currencies from emerging market countries. The steepest fall was in the case of the Turkish lira, and the same hit India immediately thereafter’
rupee has come along with a rising fuel price. The common citizens of our country are hard hit due to the rising price of petrol and diesel in the domestic market. In most of the states, petrol price is between Rs.80 and Rs.87 per liter, and it is rising every day. The price of diesel is not far behind. India is one the biggest consumers of petroleum products. In the year 2016-17, we imported 214 million tonnes of crude oil as per our requirements. The countries from which our imports are high are Saudi Arabia, Iraq, Iran and Venezuela. The reason for the price hike of petrol and diesel in India is mainly due to the increasing price of crude in the international market
It is common knowledge that price is determined on the basis of demand and supply. Last year, OPEC and Non-OPEC countries decided to reduce the supply of oil, as for the past few years the crude price had fallen due to excessive production of crude by the oil exporting countries. Saudi Arabia and Russia have been the major parties to this decision of production cut. The immediate result of this decision was the rise in the price of crude oil. The matter was further aggravated by the political and economic situation in Venezuela, compelled with the warning of American sanctions. There was a dramatic fall in the production of Venezuelan oil adding to the strain on the supply side of crude oil and thus leading to its anticipated price rise. The worsening relationship between Iran and Saudi Arabia and the prevailing situation in Libya also added to the problem. The trade war between US and China was another trigger for the deteriorating situation.
Last but not the least, it was the decision of the US to abandon the nuclear deal with Iran, which worked as the last nail in the coffin. The US has announced that countries will be subjected to sanction if they do not bring down the import of Iranian oil to zero by November 1, 2018. This decision by the US has disturbed the apple cart of crude trade in the international market, as Iran is a major producer of crude. India is affected more, as first, our Venezuelan supply route has dried up and secondly our Iranian supply route is under threat. We have some refineries which are custom built with Iranian crude in mind and these refineries will have to stop work if we do not get Iranian oil. All these external causes are cost multipliers of petroleum products for India.
Higher domestic tax is the other reason for higher price. The tax components which add on to the cost are value added tax (VAT) levied by each state, central excise duty, and together with this are dealer commissions. These components constitute 49% of the cost in the case of petrol, and 35% in the case of diesel. The central excise duty levied uniformly is Rs.19.48 on regular petrol and Rs.15.33 on regular diesel. The VAT component varies from state to state, ranging from 16% VAT on petrol in Goa (minimum) to 39% VAT in Maharashtra (maximum). The VAT component on diesel ranges from 11% in Chandigarh (minimum) to 28% in Andhra Pradesh (maximum). Dealer commissions come to Rs.2.5 per liter on petrol and Rs.1.38 per liter on diesel.
‘Our biggest problem is our big oil import to meet the demand of our expanding population. In the long run, we have to improve our public transport system so that less people use petrol and diesel for transport. We should also try to go for green fuel and electric cars. Less consumption of fossil fuel like petrol and diesel will also help the environment’
What are the options for the government and RBI to stop the rupee from falling? The options are limited, as the reasons for the falling rupee are mainly external. However, as a stopgap measure, RBI can sell a limited amount of dollars out of our reserve of 406 billion dollars. But, this exercise should be to a limited extent to keep our reserves intact. We can plan to issue bonds to NRIs which we did in 2013 to cool down the situation as a second short time measure. The incoming dollar will improve the value of the rupee as against the dollar. In the long term, we should try to improve our export of goods and services. We should also try to get foreign direct investment and also more clean investment in our capital market through FIIs and FPIs. We should try to put some curbs on unnecessary imports like excessive imports of gold and luxury items.
What can the government do to cool down the increasing price of petrol and diesel? Again, the answer is not simple and the government does not have many options. The government does not have any control on the decision of production-cut of crude by the oil exporting countries. India and China however, can form a cartel as they together import huge quantity of crude and bargain for a lesser price in accordance with buyers’ right. India has a good relationship with the US as recently we have finalized COMCASA. Communications Compatibility and Security Agreement being a key military communication pact in Delhi in pursuance of the first 2+2 dialogue, we should request the US to give us a waiver in our import of Iranian oil as some of our refineries are built only for refining oil from Iran and because we have a long and friendly relationship with that country. While punishing Iran for its nuclear policy, the US should not harm the interest of friendly India. The decision of the US is unilateral with respect to Iran, and we must convince US in our interest. We will have big comfort in pricing if we are allowed to continue import from Iran.
There is a demand that taxes should be reduced so as to bring down the price. The ideal situation is to bring petroleum products under GST so that there is one price throughout the country, but as of today, the state governments are not agreeing to it as VAT on petroleum products is their biggest source of revenue. The central government cannot force the states under the federal structure of the constitution.
There is a view that the central government should reduce or abolish central excise duty to reduce the price of petrol and diesel as the same falls in its domain. But, this is easier said than done. The fiscal deficit of the government of India will increase with the reduction of central excise duty leading to many more complications like increased inflation. Today, inflation in the country is four to five per cent but with high fiscal deficit it may go up. States can be persuaded to reduce a small percentage from VAT, but they have their own budgetary problems. Many states are helping farmers through loan waivers, and this is mainly sourced from increasing VAT on petrol and diesel.
In other words, India is caught between the devil and the deep sea. Our biggest problem is our big oil import to meet the demand of our expanding population. In the long run, we have to improve our public transport system so that less people use petrol and diesel for transport. We should also try to go for green fuel and electric cars. Less consumption of fossil fuel like petrol and diesel will also help the environment. It is left for each one of us to take a call.
by S K Jha
