Analysis: With rupee at new lows, is there a case for downgrade?

The economy has become vulnerable once again as the import bill, inflation and deficits will rise

This had to happen sooner or later. The rupee nearing the 60 mark against the dollar was an event waiting to happen. There is nothing positive in the economy, apart from lip service from the government, that merited the rupee to hold at the 52-55 range. What triggered the slide this time around was the strengthening dollar on the back of rising interest rates in the US.

Interest rates in the US started rising after Ben Bernanke, chairman of the Federal Reserve, hinted that there can be a slowdown in bond buying after a strong set of economic numbers were reported. As US bonds crossed the 2 per cent mark, Indian bonds were touching new lows. Bond yield on the 10-year 7.16 per cent benchmark paper traded below 7.14 per cent. With hedging costs over 6.5 per cent (and rising on account of renewed volatility), there was little reason for arbitrage in bond markets, which led to a reversal of dollar flow from Indian bond markets. Analysts are now expecting over $1.5-2 billion of bond sales. The government’s plan of reducing the withholding tax on bonds proved of little help under these conditions.

The rupee at new low brings with it a new set of problem for the fragile economy. It imports inflation, and it makes debt repayment both for the corporate and government costlier. It raises the current account deficit and along with it the fuel and fertiliser deficits, thus further impacting the fiscal deficit. India’s twin deficits will just get worse.

Added to these woes are the other set of poor numbers like reduced auto sales, lower indirect tax collection, falling deposit rates and weak corporate results. Further, a falling rupee also reduces RBI’s flexibility on reducing interest rates. With reports saying that there are no signs of an investment pick-up after a blip in the previous month, there is little reason to be optimistic.

With elections less than a year away, the government has little time to bring the economy back on track and revive investments before the Election Commission clause of not making new announcements are triggered. In order words there is little time before ‘policy paralysis’ is actually triggered.

The eight per cent plus drop in the value of rupee has only made the economy weaker and vulnerable. Doesn’t it then makes it a good case for a downgrade?