Quirky policies, knee-jerk reactions characterise our forex management

Each time the Indian rupee is mauled, the Reserve Bank of India (RBI) unveils a slew of measures that at best can be termed as palliatives. The RBI had to bestir a few days ago in the face of merchant trade deficit for June 2022 hitting a record $25.6 billion and the Indian rupee continuing its downhill course (79.16 per dollar).

India’s current account deficit (CAD) widened to $23 billion in the third quarter ended December 2021 (Q3 FY22), forming 2.7 per cent of the country’s gross domestic product (GDP) and reflecting a rise in overseas trade. As a rule of thumb, 2 per cent is considered safe, anything above 4 is considered risky. Hence the pressing of the panic button.

The broad measures unleashed are making NRI foreign currency deposits in Indian banks attractive and doubling the limit for automatic route to accessing external commercial borrowings (ECB) from the existing $750 million.  The purpose of this article is not to repeat the minutiae but instead focus on omissions and commissions in our forex management over the years not in a spirit of fault-finding but to learn from our mistakes and myopic views.

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ECB at $219 billion comprises a third of India’s external debt as of September 2021. Its attraction lies in the lower rates of interest in the US and Europe vis-à-vis India but the elephant in the room is the exchange rate risk inevitable for those not fortunate to enjoy the natural hedge — being able to import with the aid of foreign exchange earned through exports.

Sluice gates of ECB

Quite often it has meant losing in swings (exchange rate risk) what has been earned in the roundabouts (savings in interest).  So, the RBI could rue its decision to open the sluice gates of ECB by liberally doubling the borrowing limit given the sober prognosis that the rupee’s slide against dollar is likely to continue.

Of course, companies with comfortable debt servicing ratio (say 5 times profits before interest) can afford to borrow and take advantage of the interest arbitrage provided such arbitrage works in their favour after factoring in the cost of exchange rate risk cover which is redundant if it has a natural hedge like Reliance has).  Infrastructure companies that enjoy only INR revenue streams are particularly vulnerable to exchange rate risk.

Under the Liberalised Remittance Scheme (LRS), as of October 21, 2021, all resident individuals, including minors, are allowed to freely remit up to $2,50,000 per financial year for any permissible current or capital account transaction or a combination of both.

In FY22, outflows under the LRS scheme were at an all-time high of $19.61 billion, up 54.6% from FY21. In FY21, outward remittance under the scheme was $12.68 billion; in FY20 it was $18.76 billion; and in FY19 it was $13.78 billion.

It is surprising that the RBI has not deemed it fit to put brakes on free outgo of precious foreign exchange through this route, particularly on gifts that now account for 47% of the outgo under this facility. Are such gifts the fig leaf for stashing wealth abroad?

While foreign education cannot be stopped, given the woefully inadequate opportunities back home as the recent plight of Indian medical students in Ukraine graphically brought out, we cannot afford to be gung-ho on other counts. Stemming the forex outflow on this count by asking Ivy League foreign universities to set shop in India seems to be a non-starter.

Hot money down the drain

In June 2022, Foreign Portfolio Investors (FPI) pulled out ₹46,000 crore from the Indian bourses, totting up an aggregate net outflow of ₹2.13 lakh-crore in the first six months of 2022. It is now common knowledge that FPI is the ficklest of our forex receipts given its revolving door mechanism.

Yet, we have done nothing by way of introspection but instead have made access to Indian gilts easier in a firefighting spirit, i.e., to somehow increase the inflows. We permitted foreign investors into our bourses in 1992 in the wake of liberalisation and globalisation but time has come to dispassionately review if its perceived benefits — boost to our forex inflows and reserves, improvement in corporate governance standards and better price discovery — have been achieved.

Sadly, none of them has been. Truth be told, in their wake, our bourses have become more frenzied. And they have made our forex management vulnerable with their free entry and exit in the absence of a deterrent tax against early withdrawal.

The appellation ‘hot money’ fits FPI to the T. To be sure, such hot money might have come to our rescue on occasions but the bottom line is their unpredictability as the availability when they are most needed makes them fair-weather friends.

FDI inflows

India has reported the highest foreign direct investment (FDI) inflow to the tune of $83.57 billion for the financial year 2021-22, up by $1.60 billion from the previous year.

It is FDI that India needs more than the FPI for reasons already well-known. Suffice it to say, unlike FPI, FDI is permanent and durable, brings in the latest technology, best goods and services, greater employment opportunities and catalyses greater tax flows into the governmental coffers.

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Yet what we are getting is piffling compared to what China got, catapulting it into a manufacturing powerhouse. That Tesla has passed India by is reflective of our continued inability to attract big-ticket FDI.

Sadly, raising funds through the GDR/ADR route — raising of equity by Indian companies abroad and listed in foreign bourses — too has dwindled. Was the Satyam scam of 2008 the final straw that disillusioned foreign investors?

India received remittances worth over $89 billion in 2021 which was a healthy 8 per cent higher than the $82.73 billion in 2020. Despite the world having been affected badly by COVIDin 2020, the remittances that year were a shade over the $82.69 billion in the non-COVIDyear of 2019.

That NRI remittances are more than FDI inflows is at once a telling commentary on the power of Indian diaspora as well as on our inability to attract big-ticket FDI. But NRI remittance is bound to suffer when a global recession takes hold.

Let us then not whine about brain drain.

Abid Hussein, former planning commission member and former Indian ambassador to the US, quipped long ago — “it is better to have brain drain rather than brain in the drain”. That is sure to hit patriotic sentiments hard but the larger message was there is nothing wrong in seeking fortunes abroad.

Import substitution through Atma Nirbhar Bharat sounds more platitudinous. Crude oil and palm oil afford us no respite. Both are essential commodities and their imports have to continue unabated.

Need to address the problem

We need to address the problem sector-wise. We are right now seeing 100 per cent imports vis-à-vis the country’s semiconductors needs. In 2020, India spent $15 billion in electronics imports, with 37 per cent of these being imported from China.

The demand is only set to increase with the introduction of 5G and growing consumption and production of electronics.  We are a software giant but a semiconductor pigmy. This has to stop.

The government has done well to increase import duty on gold from 7.5% to 12.5% from July 1, 2022. There is absolutely no reason to indulge this fad and the consequent needless outgo of precious foreign exchange.

Every crisis is an opportunity, and in fact, we in India sadly act only when a crisis blows on our face. It is time for the Indian government to look for long term solutions to our recurring forex crises. Fire-fighting cannot be the only solution. Our forex reserves at $588.314 billion as of July 1, 2022 representing as it does 12 months import cover gives no immediate cause for alarm but no cause for complacency either as there are grim forebodings of things worsening.

(The writer is a CA by qualification, and writes on business, consumer issues and fiscal laws.)