Samantha Ritchie

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Artika Ashdhir in Mumbai gives her analysis of the imminent financial crisis faced by India.

The rupee has sunk to its lowest ever level. India faces the potential of a financial crisis of its own. This is bad news for the world economy, as the stagnant economies of the US and Europe were looking to the dynamism of emerging economies to be the motor that pulled the world out of recession. Certainly growth rates held up for a number of years. However growth has begun to slow in countries like India, China, Brazil, Indonesia, Turkey and South Africa.

There are a number of reasons for this: one the quantitative easing programme of the US Federal Reserve created capital flows which lead to investment in these economies. Rates of return where higher here than in Western markets. The Fed has now signalled that QE will slow.

Electronic money from the US created a debt bubble in India, which unsurprisingly is now beginning to burst. That’s what bubbles do. Once again, none of the experts predicted this.

But there are deeper, underlying problems with the Indian economy, including a growing current account deficit and a weak export sector. There are hopes that the weak rupee will boost exports, but the effect on society is uncertain as the price of oil and other essential commodities purchased on the world market has risen, and inflation is high.

In the meantime, the Indian government has passed a Food Security Bill, which aims to provide subsidised food for two thirds of the population. While perhaps noble in intention, this bill is not without its problems: it will be very expensive. Also, it makes the Indian government the biggest purchaser of agricultural products, and is having a strong downward effect on the price paid to farmers, further disincentivising farming, and potentially driving marginal farmers to seek employment in the cities.

USI Discussion on Rupee depreciation and food security bill – notes by Artika Ashdhir

  • Rupee has reached all time low and on 28th August it stood at 68 INR for 1 US dollar
  • This has created a lot upheaval in the markets, and among the people in general
  • All news channels have been aggressively following the fall of rupee and trying to simplify its cause for the masses.
  • There are speculations that India is on the brink of its own financial crisis and people are relating the fact weak rupee means weak economy

So when we talk broadly about the causes of rupee depreciation:

  • ¾ India’s trade deficit stands at $185 billion, cost of imports is increasing because 60% of our imports is in crude oil and due to depreciation of rupee this cost has gone up, and the exports has decreased due to less exports to crisis hit Europe and US, who’s economy is recovering quite slowly
  • ¾ Lower capital flows in the country, in 2011-2012 = FDI was $30 bn, Financial institutional Investors was $18bn in stocks and bonds, in 2013 it is speculated to be much lower, because
  • Firstly – due to financial crisis in Europe and slow economic recovery in US, FDI from these regions have been very low. Also short term investments have increased which can roll back anytime
  • Secondly – big companies like Arcellor-Mittal and Posco has withdrawn from its investment in India due to land issues in states Orissa
  • ¾ The current account deficit is quite high: it is speculated that the deficit in 2012-13 would be more than $77bn, as a result the Forex reserves of India have dropped from $320bn in September 2011 to $290bn now. Since the Forex reserves does not comprise of earned money but borrowed money, it is also speculated that it will deplete at a fast pace.
  • ¾ Since our imports are at an increase, the demand for dollar is increasing to buy more goods, exports are not brining more $, this Supply – Demand leads to further devaluation of Rupee
  • ¾ Reserve bank of India has not been able to control the devaluation of rupee, therefore the market speculators enter the market in a big way to sell rupee, and this has devalued the rupee even more.
  • ¾ Low growth and higher inflation has also contributed to the fall of rupee: eco growth in 2011-2012 = 6.5% and it doesn’t look encouraging in 2012-13.
  • ¾ Due to increase in petrol, diesel prices, gas prices and weather fluctuations have led to high food inflation, the consumer price index inflation is 9.64%. Also the roll back on fertilizer subsidies has increased the input cost for farmers, which has also contributed to the food inflation.
  • Emerging market crises go through three stages: in stage one, policymakers do nothing in the hope that the problem goes away and since the general elections are coming up in 2014, the focus is on that. In stage two, they cobble together some panic measures, normally involving half-baked capital controls and selling of dollars in an attempt to underpin their currencies. In stage three, they either come up with a workable plan themselves or call in the IMF. India is on the cusp of stage three.
  • The silver lining in this grim situation is that the Indian export based companies like Tata Consultancy services, Wipro, Infosys, Tata Motors, Mahindra & Mahindra, Bajaj Auto, Reliance are benefitting because of the rupee depreciation

And the Indian PM Dr. Manmohan Singh said in the Parliament today that “To some extent, depreciation can be good for the economy as this will help to increase our export competitiveness and discourage imports,”

Consequences:

¾ Food prices are rising, having a direct effect on the people/inflation

¾ Price of Gold which is also imported has reached a new high

¾ Job market has been facing a slow down since 2007 in India and with the current situation there is no sign of recovery anytime soon

¾ Now since the rupee buys less things, spending reduces which in turn effects the manufacturing sector, as it is, the industrial growth is running in negative

 

Amongst all this commotion the parliament passed the Food Security Bill on 27th August, total expenditure of which is 230bn rupees!

Salient features of the bill:

 

  • It shall extend to 75% of the rural population and 50% of the urban population
  • Each member of a priority household would get 5kgs of food grains per month
  • Every Antyodaya household would get 35 kgs of food grains per month
  • The PDS issue prices would be: Rs 3 for rice, Rs.2 wheat Re.1 millets per KG (actually called “coarse grains” in the Bill). These may be revised after three years.
  • Reform the PDS: its infrastructure, the distribution: reform the fair price shops which are licensed to distribute the food grains and these shops will be managed by women
  • Stock of grains would be procured by the central govt and state govt at minimum support price
  • For children between the age group 6months – 6 years the Bill guarantees an age-appropriate meal, free of charge, through the local anganwadi. For children aged 6-14 years, one free mid-day meal shall be provided every day (except on school holidays) in all schools run by local bodies, government and government aided schools, up to Class VIII. For children below six months, “exclusive breastfeeding shall be promoted”.
  • Every pregnant and lactating mother is entitled to a free meal at the local anganwadi (during pregnancy and six months after child birth) as well as maternity benefits of Rs 6,000, in instalments. But only if they are employees of government central or state
  • Conditional cash transfers in case of non-supply of food grains
  • To encourage transparency the entire system will be computerised and in a domain which would be kept open for inspection

Criticism:

  • We already have the public distribution system, its reform, especially infrastructure and unadulterated food grains would have been suffice, along with a wider reach
  • It’s a half baked bill, essential things like identifying the households that would benefit from this bill has not been defined, they talk about Anganwadis which will provide food to children and pregnant women, but the conditions of Anganwadis and its availability is a problem that has not been addressed, its impact on farmers is completely ignored!
  • Impact on farmers: by national farmers associations
  • Subsidy on fertilizers have reduced, which has inflated the input cost
  • The minimum support price at which the govts would procure the food grains from the famers is very low, thus they would run into debts and thus not sustainable
  • The retail shops would pay them more for the same products
  • If the small and marginal farmers get food grains at low prices like Re.1,2,3 then farmers would buy food grains rather than producing it and look for other jobs, this would increase the already high labour supply. Also, incentive for famers to grow crops would be taken away and this would increase insecurity, shortages and fuel food inflation
  • With the nationalization of agriculture, where govt as the biggest buyer, hoarder, and seller of food grains would distort the market mechanism and reduce the bargaining power of the farmers

Conclusion:

India is in the middle of a financial crisis, the monetary resources we have are depleting fast and on top of the the food security bill slams a huge bill on the exchequer, it is predicted by a lot of people that soon we will be in debt and have to take loans from IMF and we all know how it goes from there, the economic reforms in Latin America in 1980’s and India in 1991 are the best examples of it, which are speculated to be the reason for this crisis.


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Samantha Ritchie