The rupee has crashed from Rs 45 to Rs 54 to the dollar, before recovering slightly to Rs 52.80 on Friday. In RBI Mid year policy review they have given more significance to foreign exchange policy rather than to control interest rate.But here, its not about depreciation of rupee rather than we should call it as appreciation of dollar. Dollars are gaining demand after euro crisis and that's why it is appreciating in compare to all major currencies.
Till recently confidence in India was high, and dollars flooded in from overseas Indians and foreign investors. Much of the black money that had earlier left returned through the Mauritius window. But now dollars are flooding out because people have lost confidence in the ability of the political system to make decisions or implement reforms. As long as confidence in India ebbs, so will the rupee.
This creates problems. Corporations and banks that have taken dollar loans suddenly face hugely higher repayment and interest rates in rupee terms. Importers face much higher rupee bills. By making imports more expensive, the rupee's fall can stoke inflation at a time when it is already over 9%.
For all these reasons, people want the RBI to sell dollars and prop up the rupee. Caution, please. Remember that exactly the same arguments were put forward in Thailand by businesses and banks in 1997 to prop up that country's falling currency.
That propping up helped only temporarily, emptied Thailand's treasury and sparked the Asian financial crisis. We must not fall into that same trap. India's foreign exchange reserves of $308 billion may look big enough to warrant spending tens of billions on propping up the rupee. Danger: the benefit will be temporary but the damage to reserves may be permanent.
Foreign loans coming up for repayment in the next six months total almost $150 billion. In normal times, lenders would happily re-lend this sum. But with investor confidence in India ebbing and the Eurozone crisis deepening, lenders cannot be depended on to re-lend maturing loans.
The Eurozone banking system could go bust if European government bonds are downgraded sharply by rating agencies, something entirely on the cards. In the accompanying financial panic, investors will withdraw from all markets associated with ris, including emerging markets like India, and rush into safe havens like the US and just sit on cash.
If that happens, dollar flows into India could come to a sudden stop. In that case, repayments of old loans will halve our foreign exchange reserves in six months, and deepen the panic.
That is an extreme scenario. But even without a Eurozone banking collapse, confidence in India is ebbing. Several Indian businessmen are saying it is easier to get decisions and make investments abroad than in India. If even Indians are losing faith in India, will foreigners be any different?
On Thursday, it issued new rules limiting the net open positions of banks in foreign exchange, limiting some forms of currency speculations, and reducing the ability of importers and exporters to bet on the future of the rupee. These steps helped the rupee to recover from 54.25 to 52.80 to the dollar.
However, technical fixes of this kind can have only a limited impact. They cannot reverse something as fundamental as loss of confidence in India.
How do we restore that confidence? There is no quick-fix for this. Reputations are built slowly but lost quickly. Anger against corruption has reached boiling point, and that is a good thing. But the political reaction to public anger has not inspired confidence.
Several people are being arrested on evidence that looks very thin, and seems guided more by politicking than a genuine attempt to catch the guilty. The opposition desperately wants to involve P C Chidambaram somehow in a scam originating in the DMK. The Congress government has responded by filing a case against telecom decisions taken by Pramod Mahajan when the BJP was in power.
Many bureaucrats and businessmen have indeed been complicit in big corruption. But the current wave of arrests looks increasingly like vendetta than a genuine desire to root out corruption. So, no bureaucrat wants to take any decision for fear of being hauled up by a vendetta in later years. Businessmen are reluctant to invest in such a murky atmosphere.
Key Analysis-:
Looks like we are toast. And also looks like this new year party would be all about how we have lost money for good. Well as with all disaster movies that show crises after crises hitting the protagonist and finally victory and well earned at that; I am sure that just on the other side of 2011 there will be a strong recovery we would all be proud of. Asides, for the next couple of weeks, particularly week starting 19/12 I would imagine that we are hitting the slowness in the scheme of things. General lethargy to trade and look at the markets. People would look at an alibi to postpone purchases of stocks and consequent low volumes.
This is actually a good time to cherry pick in the large cap names. Nice time to have them all, at a price that you have been waiting for. Remember, just like all good things come to an end; bad things DO come to an end to. So stock up as always said, till stocks last.
