Inching towards inflation

A two rupee fall in its exchange value with USD — say, from Rs. 69 to Rs. 71 for a dollar — may cost the country an additional external payment burden of nearly Rs 1,50,000 crore, in Rupee terms on account of this year's total import alone on a c.i.f basis. Going by the current trend, India's import during 2018-19 is expected to top the $500-billion mark. Rupee may sink further to Rs 71 or more for a USD. Overall, the total Rupee-USD exchange burden may be even higher if one also takes into account the net difference between the inflows and outflows of foreign currencies. Rupees' exchange value over the next six months will depend on the trade deficit trend, net FDI inflow, and USD outflow from secondary market operations by foreign portfolio investors (FPI), foreign debt servicing cost, and profit repatriation by multinational companies (MNCs) among others. The domestic market has to bear the cost of Rupee downturn or USD upturn.

This is bound to result in an additional rise in both, the wholesale and retail, inflation rates by at least one to two per cent. India' s annual inflation rate had eased to 4.17 per cent in July 2018 from a downwardly revised 4.92 per cent in the previous month. It was also below market expectations of 4.51 per cent. However, inflation remained above the Central bank's medium-term target of four per cent for nine consecutive months. India's inflation rate averaged 6.52 per cent from 2012 until 2018, reaching an all-time high of 12.17 per cent in November of 2013 and a record low of 1.54 per cent in June of 2017. If the Rupee slide continues then the inflation rate could touch, or even exceed, six per cent during this financial year itself. It is a bad news for the economy, in general, and the election-bound ruling BJP-led National Democratic Alliance, in particular. Pressure on corporate profitability will also reduce the chances of additional employment in the industrial sector. Petroleum and products prices will be a prime mover of inflation.

High inflation hurts everyone — from small farmers to big businesses and, of course, the working class. It tends to contract both demands and supplies. Economy suffers. RBI alone can't control inflation. The government's export-import policy, focus on domestic manufacture and exports, and forced reduction of avoidable imports can contain exchange rate linked inflation. The country's existing gold and hard currency reserves may still look somewhat comfortable, though not quite dependable if the Current Account Deficit (CAD) expands beyond 2.5 per cent of GDP. With its growing monthly trade deficits, pressure for higher foreign borrowings, repayment of short-term foreign debts, and the slow-down of foreign direct investments, Indian Rupee (INR) continues to be under pressure.

Overseas investments into India saw a sluggish growth of only 0.27 per cent to $35.94 billion during April-December 2017. India's external debt crossed the half-a-trillion dollar mark to touch $529 billion in March 2018. More Indian businessmen borrowed from the overseas markets and NRIs parked higher amounts in bank deposits back home. India's foreign currency debt rose 2.4 per cent at end-March 2017, primarily on account of an increase in commercial borrowings, short-term debt, and non-resident Indian (NRI) deposits. Rupee depreciation will raise the foreign debt servicing cost and, in turn, force the domestic borrowers to raise the prices of their products and services to generate a surplus to buy USD at higher prices. It is a vicious circle. India's CAD for 2017-18 had widened on the back of a higher trade deficit. According to the RBI data, the CAD for last fiscal widened to 1.9 per cent of the GDP from 0.6 per cent in 2016-17.

The Rupee depreciation may not immediately contract the GDP growth rate. However, sluggish investments, rising interest rates, shortage of bank capital, weak rupee, rising imports, and stagnant exports are likely to see a tapering off of corporate profits in the coming quarters. Ironically, despite flood in certain parts of the country, the monsoon this year has been uneven and less than normal in several parts of the country. A smaller-than-expected food-grains output could push up food prices which, together with costlier imports, would drive up inflation. Already, interest rates are steadily rising. The deposits growth has slowed. Private sector investments are likely to stay subdued given sub-optimal capacity utilisation. Higher inflation will, ultimately, impact GDP growth.

The ongoing Rupee depreciation is also adding to India's borrowing woes — external and internal. Higher borrowings will impact bottom-lines. Corporate India's combined interest expenses had grown at the fastest pace in the past 11 quarters. In all, Indian corporate houses have raised nearly $42.3 billion in foreign currency debt during the year ended March 2018, according to World Bank data — highest among emerging markets outside of China. India's total external debt was up around 12.5 per cent in the past 12 months. The one-year forward premium in the dollar-rupee exchange rate is reportedly up 90 basis points from its lows in September 2017 to 320 basis points, now. Importers and companies with large unhedged foreign exchange position will be worst affected.

According to a study by India Ratings, only 42 per cent of the total foreign debt by corporate houses was hedged at March 2017-end. Interestingly, RBI itself has warned the government that "headline inflation, which averaged 4.8 per cent during Q1 FY19, is likely to face upside risks over the rest of the year from a number of sources, warranting continuous vigil and a readiness to head off those pressures from getting generalised." Notably, during this year, Rupee is already down by nearly 10 per cent against US dollar so far, against a six per cent appreciation in 2017. Diesel and petrol prices are already moving up steadily, threatening to raise the inflation rate further in coming months.

(Views are strictly personal)