The recovery of India's rupee, dragged to record lows over the summer as foreign investment retreated from emerging markets, has stagnated.
Trading at about 15 per cent below levels seen through most of the first half of 2013, the currency, analysts say, reflects doubts over the government's ability to draw down its multiple deficits, and may also signal the end of a short-lived honeymoon for Raghuram Rajan, the new Governor of the Reserve Bank of India.
The setback, analysts say, reflects doubts over the government's ability to draw down multiple deficits, and may also signal the end of a short-lived honeymoon Raghuram Rajan, the new Governor of the Reserve Bank of India.
About two weeks after taking charge in early September, Mr. Rajan raised lending rates, an audacious move given that India has been coping with its worst economic crisis since 1991.
"The government needed to be more proactive and just showed that fighting inflation is its core priority," said Bundeep Singh Rangar, chairman of London-based advisory firm IndusView.
"So far, all the actions taken have been to contain a crisis and not to prevent it," he said.
The rate hike followed other steps Mr. Rajan took immediately after stepping into his post, including the provision of a special RBI window allowing banks to swap dollar deposits into rupees at fixed rates. On the margins of the G20 summit in St. Petersburg, Russia, Indian Prime Minister Manmohan Singh met Japan's Finance Minister Taro Aso, and the two nations raised to $50-billion (U.S.) from $15-billion a currency swap arrangement – in effect adding a yen cushion to defend the rupee. A few days later, the market regulator enabled foreign investors to buy more Indian bonds.
While that helped to halt a slide in the rupee's value, the biggest relief came when Fed chief Ben Bernanke surprised global markets on Sept. 18 by delaying tapering of the Fed's stimulus program. India's stock market surged 3.4 per cent the following day. But the euphoria hasn't lasted.
A full Indian recovery needs more than higher rates and a currency backstop. With growing dependence on oil and coal imports, and populist programs that fuel inflation and encourage gold imports, India faces a slew of problems that can only put downward pressure on the rupee.
Retail price inflation is hovering close to double-digits, despite 14 interest rate increases in the past three years. The rupee weakened in the first place because India's current account deficit (CAD), which measures the gap between its foreign exchange inflows and outflows, remains worryingly high. So does the internal deficit, creating what economists call the "twin deficit" problem. Together, the two deficits make up 9.4 per cent of India's gross domestic product.
"Let us remember that the postponement of tapering is only that, a postponement. We must use this time to create a bullet-proof national balance sheet and growth agenda, which creates confidence in citizens and investors alike," Mr. Rajan said last week, in reference to the U.S. Fed's $85-billion-a-month bond buying program.
It does not help that Mr. Singh's Congress party leader, Sonia Gandhi, has led the passage of a controversial food security law that would make state-subsidized wheat, rice and other cereals available to 67 per cent of India's population of 1.2 billion.
General elections are less than seven months away, leaving little elbow room for the Congress-led coalition to initiate bold reforms or belt-tightening measures.
India's GDP began slipping after Wall Street descended into turmoil in 2008, dropping to 5-per-cent growth in the year ended last March from between 8 per cent and 10 per cent between 2003 and 2007. It has slipped below 5 per cent in the first two quarters this year.
India's appetite for diesel fuel, gold and better food have made matters worse.
While global oil prices have risen to six-year highs, India's state-controlled oil companies sell refined fuel below cost. The fuel subsidy in 2013-14 is expected to rise by 75 per cent to roughly $10-billion.
Stoked by rising fuel prices, domestic inflation surged to double-digit levels in the past two years and food items exceeded annual inflation levels of 15 per cent. A state-funded rural jobs program has driven up wages, resulting in a yawning government deficit.
Mr. Singh's government, keen to maintain growth, has provided income tax concessions. That has prompted increasingly affluent Indians to buy gold, which exacerbates its current account deficit.
The problems are compounded by coalition politics. Socialist-minded regional parties supporting Mr. Singh's Congress oppose any rise in state-controlled fuel prices.
A move to allow foreign direct investment through retail, conceived to attract firms such as Wal-Mart Stores Inc., also flagged, owing to political opposition.
India has begun a process to attract remittances from expatriates, who sent $69-billion home in 2012. The central bank governor said India will not need to dip into its reserves to defend the rupee from falling further. It also has the option of issuing sovereign bonds.
For the moment, the government is urging state-owned companies to raise loans abroad to take some pressure off the rupee. Finance Ministry officials said recently that they have asked state-controlled petroleum companies to raise funds for expansion overseas.
With real assets backing them, these companies – including exploration firm Oil and Natural Gas Corp. Ltd. and refiner Indian Oil Corp. – typically can bring in foreign exchange on better terms than the government would get if it were to issue sovereign bonds. But the initiative has yet to gain traction, and there isn't much the central bank governor can do on his own to push the program along.
The real challenge is for the federal government to open up sectors still under state control, such as housing, to attract more foreign investment.