Tables seem to have turned, as the proverb goes. The hunter has turned the hunted. Rhetoric, charges, counter charges and some truly hilarious explanations are doing the rounds to explain away, the rupee going south or the price of oil going north, be it from the proletariat, the government, the intelligentsia or all and sundry. Falling rupee and rising crude price both will have a cascading effect on the prices of essentials, affecting the life of the common man. On the other hand, it will keep bond yields at a higher level and may force authorities to raise interest rates, which can arrest the fall by attracting foreign capital. This, However, will adversely impact long-term debt funds, as their net asset value and returns fall, when interest rates go up. Higher interest rates will also hurt borrowers. Home loan EMIs could go up. Foreign travel and foreign education expenses will rise, burning a hole for all those students and parents who harbour such ideas.
The rupee has fallen more than 10% against the US dollar since January. US Dollar which was around Rs. 58 in 2014, is almost Rs. 72 today. According to analysts, it is still overvalued in real terms and may touch the Rs 75 per dollar mark in the near future. Oil imports, amid rising crude oil prices, are leading to an increased demand for the dollar which, in turn, is making the rupee weaker.
Yet another reason being that, the US bond yields have significantly risen, which has made the dollar attractive. The 10-year US bond yield has jumped by more than 82 basis points in the past year attracting investors to the US treasuries and making the currencies of the emerging markets, such as India, weaker.
Annual consumer inflation in India declined to 3.69 percent in August of 2018 from 4.17 percent in July. The lowest rate since October of 2017, was mainly due to a sharp slowdown in food cost. Inflation Rate in India averaged 6.49 percent from 2012 until 2018, reaching an all-time high of 12.17 percent in November of 2013 and a record low of 1.54 percent in June of 2017. Though this may be cause for cheer, the eroding rupee is likely to create inflationary pressure in the economy by making imports costlier. A greater outflow on account of rising crude prices and consequent rise in fuel prices in the local markets will only compound the problem. Oil from Iran which will be reduced to a trickle, come November, India would truly be at the mercy of OPEC Nations. Whereas the food items will see a rise, due to higher transport cost, the industries that use imported components will witness a surge, in their raw material cost both passing on the increased cost to the consumers.
According to Bloomberg Intelligence, the equity inflows into the country have moderated, averaging $2.9 billion (Rs 19,823 crore) a month in January-February 2018, compared to a monthly average of $3.6 billion (Rs 24,608 crore) in October-December 2017. FIIs are concerned with volatility in currency, with appreciation or depreciation not really mattering, as they impact their returns in the equity and debt segment. Rupee weakness will increase the cost of holding debt, for foreign investors and could lead to outflows from debt.
A further decline of the rupee from the current levels seems eminent, due to its overvaluation in real terms. However, availability of large foreign-exchange reserves should help the RBI defend the rupee, against any steep depreciation through intervention in the currency market. At the end of March 2018, the RBI’s total foreign exchange reserves stood at $424.5 billion (around Rs 29 lakh crore). All interventions have a down side and this one also has one, that of altering seriously the fiscal discipline.
Almost 80% of the import Bill is attributed to crude oil. India has been a major beneficiary between years 2013-2015, of the fall in international crude oil prices. It is reported that almost the entire reduction of about 0.6% of the GDP, in India’s fiscal deficit between FY14 and FY16 was attributed to the sharp fall in crude prices. Lower crude prices also contributed to the narrower current account deficit. Since the pass-through of the fall in crude prices to retail consumers was limited, the government retained a large part of the benefits by hiking excise duty on retail fuel products which directly impacted inflation. The Government spending increased in terms of allocations to welfare schemes that possibly helped the last mile in the society.
Crude prices have been rising for some time now, and Brent crude touched a 47-month high of $78.57 per barrel today, exchanging at Rs 5,657 at Rs 72 to a dollar. A barrel is 159 litres or valued at Rs. 35.57 a litre, which is sold to the consumer at an average of Rs. 85 in the local markets. Rs. 50 for every litre sold is shared between the State and the Centre. Petrol or Diesel are not luxury items since they directly affect the last denominator. In a way a large share of what the government earns is passed on to the consumer albeit through indirect taxes. Apart from affecting the common man, one could also safely conclude that higher crude prices will adversely affect the twin deficits, fiscal and current account deficit of the economy, which will have spill-over impact on the monetary policy, and consumption and investment behaviour in the economy. Inflation that has been pegged low, will surge in time to come and with a weightage of only 2.4% in headline CPI, the adverse impact will entirely depend on the extent to which future higher crude oil prices are passed on to the consumers.
The thinking in the Government portals seems to be that the increase in oil prices is “unavoidable” as India is linked to the global economy and if petrol and diesel were to be sold cheap, it would have to be bought at higher prices and subsidised in which case, all the money from the social security schemes would vanish. Be that as it may, the important question here is, development and social security schemes cannot be dependent on revenue accrued due to just one entity. Fiscal prudence would then be highly skewed. Other revenue generations like taxes on income earned must be more evenly distributed. A country where 90% of the business is in the informal sector, how at all, this will be achieved is anybody’s guess. Admittedly, more have now come in the tax net. Just over 2 crore Indians, or 1.7 per cent of the total population, paid income tax in the assessment year 2015-16, according to data released by the I-T department. More than 10 million Indians filed a zero tax in the last financial year. Are 2% Indians subsidising the needs in some way or the other, of the remaining 98%? The financial model for the Country needs to be reinvented if we were not to fall into an abyss of economic mismanagement.
This can lead to a serious social risk of growing inequality gap, between the rich and the poor which of course calls for an effective fiscal policy that broadens the coverage of social spending. A progressive taxation system that taxes the rich more, may be needed. There is extreme secrecy in parting with income data. For the entire period 2000-2015, the only data that was released is at the aggregate level, total numbers of taxpayers, total tax revenue, etc. In order to study the evolution of income distribution, one would need to have the detailed data by income range, for may be the last 10 years. Whichever way, the income-expenditure paradigm is looked at, we need to increase the sources of income and not play ball with just one egg.