The rupee fell and is still falling. We do not know; and it is difficult to predict how much more it will devalue. The numbers are startling and the impact devastating. In the last two months the rupee depreciated 25% to the dollar. The fallen rupee threatens India with hyper-inflation with the rise in fuel prices and other imports. The reverse flow of FDI (foreign direct investment) and the expected tightening monetary policy will only exacerbate the gloom and doom scenario in the domestic industry and some experts are even hinting that India is now heading for a recession.
THE REMEDY
Obviously, the government is trying to keep its chin up with such clichéd statements as “our fundamentals are sound” and is trying to shore up the rupee with some heavy sale of dollars to oil companies through a special window. However, these props may not be sufficient as they are usually offset by positions in forward markets.
Newly appointed RBI governor Raghuram Rajan tried his best to send all the right signals to the investment community in his maiden speech after taking charge. He reiterated the Indian Central Bank’s commitment to keep inflation under control and indicated a tilt towards internationalisation of the rupee. More importantly, the new governor announced the setting up of a committee headed by deputy governor Urjit Patel to “come up with suggestions in three months on what needs to be done to revise and strengthen our monetary policy framework”. All these events and statistics remind us of The Age of Uncertainty, a popular bestseller by Harvard economist and American diplomat John Kenneth Galbraith.
THE CAUSE
Let us first look at what triggered this great rupee fall. The immediate reason is the decision of the United States Central Bank (the Federal Reserve or the Fed) to begin the process of what they call QE tapering. What it essentially means is that the Fed, which has been pumping out $85 billion of cash a month (called quantitative easing) into the US economy has now decided to pull out this monetary easing. All this tapering business is quite beyond the comprehension of the ordinary citizen but a nominal understanding of this process is essential to understand why the world is facing one financial crisis after the other, confirming that there were no lessons learnt by our Oxford and Harvard educated policymakers.
PEEPING BELOW THE MATTRESS
The global financial slowdown since 2008 triggered by the sub-prime mortgage crisis in America forced the Fed to look at unconventional monetary policy to stimulate the economy. In a depressed economic climate, the credit market freezes and banks are unwilling to lend to potential customers like traders and manufacturers because of the perceived high risk involved. Banks are content to put their money in government treasuries or mortgage backed securities, offering a much lower interest rate. This mitigates them from risky lending but at the cost of lower profitability.
As the inter-bank lending rate was already close to zero, no amount of leverage at cutting interest rates was possible to alter the banks introverted lending behaviour. The only way left for the Fed to motivate banks to start lending to industry and business was to first pump in billions of dollars to buy out the banks toxic assets and securities. Second was to keep buying treasury bills so as to lower their yield. (Note that higher the demand of treasury bills, higher their price and lower is their yield or interest offered). This dollar splurge continued till the recent announcements by the Fed that it had decided to taper (withdraw) this monetary easing as the US economy was showing signs of recovery.
JUMPING FROM THE KETTLE INTO THE PAN
What is conveniently forgotten is that all this monetary easing has come at a huge cost. First, the US national debt increased from $ 6.3 trillion to nearly $ 12 trillion since 2008. The QE tapering has damaged the currencies of emerging economies irreparably, and is creating massive inflationary pressures and huge foreign disinvestment. The bare necessities of millions in these developing nations will now become more scarce and expensive. The backlash of QE tapering (causing the slowing down of emerging markets) on the American economy is already causing heated debate.
China, India and the IMF are warning America to think hard about the disastrous consequences of the taper. Meanwhile, the forex (foreign exchange) or currency market which determines the value of each currency is raking in billions of dollars every minute. This forex trading has an average daily turnover exceeding US $ 4.0 trillion. This number far outweighs the GDP of many economies put together. Obviously, such numbers can only be reached with highly speculative financial instruments like foreign exchange swaps, currency swaps, outright forwards, derivatives, options, etc.
APPLYING MORALITY
So what do we do about all this mess? Does it not look that we start managing our monies in a better way? But to be able to do that we first need to get our thinking right. We must apply the same moral principles and values that we practise in our everyday life to economics and finance as well. Call it sacred economics or divine economics. The time-tested fundamentals about truth and justice must be in place when deciding about how wealth is to be created, shared, loaned and distributed. A usurious society condoning all forms of gambling under fancy nomenclature of different financial instruments can never get its equation and numbers right. Currencies will fall and the economy will decay. Will we rise to the occasion and muster the courage to deny the Shylocks their pound of flesh?