The Indian rupee continued its freefall last week as the economic news went from bad to worse for a government that is facing general elections just eight months from now.
The Indian currency has lost 15% against the US dollar this year, sinking to an all-time low of 65 last Thursday despite some intervention earlier in the week by the Reserve Bank of India. Market anxiety has led to volatility in the stock market, with the BSE Sensex down 4.8% for the year to date. Meanwhile, inflation continues to frustrate policymakers who have seen the rate of economic growth slow considerably in recent years.
With general elections looming in April and opinion polls indicating strong anti-incumbency sentiment, political uncertainty is further dampening the sentiment of investors, both foreign and domestic.
The rupee’s fall is a direct consequence of the current account deficit rising to almost 5% of India’s gross domestic product of a little under US$2 trillion. This in turn largely reflects the widening of the trade deficit.
India imports around 80% of its requirements of crude oil, accounting for about one-third of total imports. The rise in oil imports has strained the finances of government companies that have been allowed to increase prices of diesel, petrol, cooking gas and other petroleum products. Diesel is the most widely used petroleum product, notably for transport, and its price has a direct and cascading impact on the prices of a wide range of consumption products.
Besides oil, Indians have been importing increasing quantities of gold because the yellow metal is perceived as a hedge against inflation. Finance Minister Palaniappan Chidambaram has been exhorting people to curtail gold purchases to contain the current account deficit, and the government has curbed its own imports. As well, it has increased customs duties on imported gold, silver and platinum, which has led to a spurt in smuggling of precious metals. The government has also increased taxes on imported “luxury” products including colour television sets brought in from countries such as Thailand.
Given the fact that India’s imports tend to be inelastic, another reason why the trade deficit has been high is that export growth has been slow or stagnant in some cases. Among India’s major exports are polished diamonds and other gems, jewellery, textiles, clothing, handicrafts and processed foods.
Markets for many of these labour-intensive products in developed countries, particularly in western Europe, have shrunk or disappeared altogether, throwing thousands of people out of their jobs. And despite the government’s “Look East” policy and various trade pacts, Indian exporters have not been able to explore new market opportunities for their products in South and Southeast Asia.
Adding to the country’s economic woes, the GDP growth rate has decelerated significantly. After averaging nearly 9% a year between 2004 and 2008, economic expansion began to slow down. GDP growth last year was barely 5% and current indications are that it has since slipped to around 4.5%.
While the Ministry of Finance is keen to keep the fiscal deficit under control by curtailing subsidies on food, fuel and fertilisers, it is under tremendous pressure to step up expenditure on welfare programmes in the run-up to the elections. One such programme provides all citizens the right by law to food by making available five kilogrammes of rice, wheat or coarse cereals to each person at highly subsidised rates.
Although some economists have been critical of populist policies, politicians across ideological lines all by and large support the scheme.
A major drawback of government policies over the last four years has been their inability to control inflation in general and food prices in particular. Prices of most high-protein foods such as vegetables, fruits, milk and dairy products, edible oils, eggs, fish and poultry have gone up by at least 10% or more each year over the past four years.
Over the first half of August, the prices of onions more than doubled due to an anticipated fall in output. Onions have become a symbol of popular discontentment. Supporters of opposition parties on both the right and the left have taken to the streets wearing garlands of onions to register their dissatisfaction.
Food inflation has widened inequalities in a society that is already sharply polarised between the rich and the underprivileged. Since poor households spend half or more of their incomes on food, high food prices have resulted in social unrest. Compounding the anger of ordinary people is the perception that the government has not done enough to curb corruption or improve governance.
The Supreme Court of India also has been extremely critical of those in authority in cases involving the allocation of telecom spectrum and coal concessions. A number of important ministers, members of Parliament, chief ministers, bureaucrats and corporate executives accused of corruption have been kept behind bars under court orders.
The current state of the economy is all the more embarrassing for someone with the world-class economic credentials of Prime Minister Manmohan Singh. He had a long career in government as a technocrat before he became finance minister in 1991 and set in motion sweeping liberalisation that did away with bureaucratic controls over the economy.
On the defensive of late, he has denied suggestions that the Indian economy is in a crisis of the sort the country faced 22 years ago when its foreign currency reserves plummeted to barely 15 days’ import requirements. Dr Singh has pointed out that hard currency reserves today, at around $280 billion, are equal to more than seven months of imports.
But he and his ministers have been unable to restore investor confidence. Stock-market indices are at a one-year low and industrial production has fallen. Car sales have come down each month for the last seven months. For the first time in India’s history, the country’s entrepreneurs have invested more outside the country than the inflows of foreign direct investments.
To compound the discomfiture of the incumbent regime, opinion polls indicate a sharp fall in the popularity of the Congress party which heads the ruling United Progressive Alliance coalition.
As the election campaign draws nearer, those in government are keeping their fingers crossed for a reversal of fortunes.