So, how does a currency is valued against some other currency, especially, Dollars? This question used to intrigue me a lot while I was in college (I am an B. Tech, so no course on this :( ). There are hordes of literature available on the issue and if anything else, they have helped me in getting confused even more! To cut it short, almost all trades between two different countries is done in a common currency, which is more often than not, the omnipresent dollar. Now, when a country starts importing more than exporting, the outflow of the dollar is more than the inflow and this simply means you have to start paying for your reserves or exchange your currency for dollars. Now, who will buy your currency, since the buyer will not be able to use it for trading! So, this pushes down the value of the currency and if the poor country keeps on importing more, it will have to keep bleeding more and the worth of its assets will keep sliding down ,significantly!
This is what is happening with our poor rupee. Our manufacturing is dying, we are producing less and less goods to satisfy our needs let alone exporting it to other countries. And this is simply pushing up our import bill. Actually, if you do read news, this is exactly what we call as current account deficit or CAD. Fiscal deficit is something different and I do plan to take it up sometime later on.
And until and unless we buckle up and start manufacturing goods of our own instead of relying on imported stuff(Heck, even the chair I am sitting on is made in China! We can certainly make them here, in our very own India!), we will continue to become even more reliant on dollars and our rupee will continue to slide even further, with 70 a mark not being far !
So, with this in mind, let’s see how the recent measures, be it open market operations or forcing the banks to borrow less rupee so that they can buy even less dollar(Which banks do to take advantage to currency price differences to make money, buying and selling in different markets and then making money! And if you happen to be a fan of Elementary , a series on Sherlock Holmes, this is what Irene was actually trying to do, hoping to make billions in the process1). So, the RBI has increased the Marginal Standing Facility (rate at which banks borrow from the RBI using their statutory liquidity ratio securities as collateral) rate. So far, banks (bearish on the rupee, that is they do not have much hope on Rupee. A view we share!) Borrowed from call money markets and bought dollars in the forward markets expecting the dollar to rise. Since, borrowing short term money will now be costlier, banks will most likely cut their forward positions and reduce speculative trading. This will reduce pressure on the rupee. I know this does involve a few terms. I will be clearing them up in some time and later articles.
In addition, RBI has capped the amount banks can borrow from overnight markets and will also conduct open market operation, where they will sale bonds. How does selling bonds help? Selling bonds at a good rate will entice buyers to buy them, in the process, liquidity will be sucked from the economy and people will have less money to buy dollars! The higher yields will attract Foreign Institutional Investors (FIIs)to invest more money in the Indian Bond market and this will provide more dollars.
All good till now, but is this really a great idea?
There are many reasons I believe the idea sucks. The major one being we are trying to do what shouldn’t be done. The liquidity crunch will lower the growth of our already ailing economy and will not help the manufacturing industry since the cost of borrowing money will increase and hence , the overall growth will be hurt. Badly. Even Infra sector will take a hit since loans will become costlier, coz banks will have them at higher costs! Simple enough!
The stock market plunge, especially the banking stocks plunging on the fears of rise in bank rates and CRR rates will only worsen the situation.
Even the benefits of FIIs is highly overrated since they do not contribute effectively to the economy. Most of them, if not all are interested in making money and will take their investments out if they fear any negative environment on economy and the coming elections will not help at all in this. What we need is more FDI, since it is here that real progress happens, infrastructure gets built up and people get employment. Making goods and , in effect, money in the process!
For real recovery, like in the case of broken bones, we need to think ahead of pain killers. Incentives to set up factories, SMEs Loans, better business environments, more emphasis in job creation rather than job taking in colleges and less politics while setting up a company will certainly help. So will creating avenues for entrepreneurs who wish to do more than just build apps for mobiles. Think of making mobile handsets! We need to have plans for these rather than announcing subsidies and taxing heavily the same product (Petrol and Diesel. That oil companies lose money on these is the largest misconception Indians are having!) and distributing food at giveaway price, which will come, eventually from the tax payers money and fill ministers and babus coffers. We need to invest more in states like Odisha and Jharkhand and reap the benefits of mineral wealth we are having there rather than providing windfall gains to foreign conglomerates. And we need to manufacture BMWs rather than importing them. We need to open up our economy more and actually help those willing to do something rather than creating roadblocks for them! We need to bring money from those Swiss banks and build factories with that. We need to stop harping upon gold!
The list goes on, I am sure you must have an idea by now.
Remember, rupee was at 5 a dollar before we started making our democracy a mockery of the very word and handing the wheels of the country to a fake family! We need to take those wheels back!
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