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| Edited By: |Source: DNA |Updated: Nov 21, 2013, 01:44 PM IST
More evidence of the grim economic scenario was on display last Friday when the Sensex plunged by over 4 per cent and shed 769 points. Simultaneously, the rupee hit a historic low of Rs62.03 against the US dollar and gold prices surged to a two year high.
The Reserve Bank of India’s new capital controls to prevent the outflow of dollars are the immediate suspects for this mayhem.
Since May, investors have pulled out over $11 billion from Indian debt and equities. The RBI’s decision, earlier this week, to restrict outward investment by Indian companies had set alarm bells ringing.
The government was too slow in allaying apprehensions of more capital controls. And to add to it, the news of the US economy showing a sustained improvement prompted renewed fears of an early withdrawal of quantitative easing. An increasingly bearish market was thus left to fall.
Finance Minister P Chidambaram was only partly right when he said Friday’s fall did not reflect Indian market conditions and that the Indian market should not be so sensitive to US economic data. Negative investor sentiment has been building up for a while now. Growth has declined and some sectors have even contracted as is evident from recent industrial output data.
Though the RBI’s energetic defence of the rupee has prevented further weakening of the currency, the strains left by the defensive measures are beginning to tell. The steps taken to restrict dollar demand, like curbing speculation, selling dollars and constraining banks in various ways, cannot be sustained.
Though the rupee’s fall bloats the oil import bill, the only option is to pass it on to consumers. With inflationary pressures worsening, the RBI has no leeway to reduce interest rates to boost growth.
Making matters worse is the unsustainable current account deficit. Despite efforts to curb gold imports by hiking import duties, inflation coupled with the falling rupee and poor performance of stocks is making gold an attractive option again. The reliance on foreign capital inflows to finance the current account deficit stands exposed now. Foreign direct investment is down to a trickle.
Instead of displaying long-term commitment to the Indian growth story, many foreign institutional investors are pulling out. Over $169 billion, or 59 per cent of total forex reserves, have to be repaid within 12 months to service short-term debt. In consequence, the threat of a 1991-like default scenario is very real.
The macro-economic indicators are dismal in large part because the Indian economy’s supply-side constraints are coming to the fore. Despite being aware of onion production falling by 7 lakh tonnes, the government failed to react as retail onion prices shot up. Traders are being blamed for hoarding.
Similarly, domestic coal production has not kept pace with demand and triggered expensive imports. With assembly polls due in many states in November, the political implications of the falling Sensex and high inflation will not be lost on the ruling Congress.
