General election is a trigger for rupee volatility: IHS Global Insight

Rajiv Biswas, Asia-Pacific Chief Economist at IHS Global Insight, believes that the rupee could become volatile and depreciate further if a weak coalition government takes over after the General Election in April and May. Edited excerpts from an interview with Business Today's Sarika Malhotra.

Q. Your estimate is that the rupee will become volatile. Do you see it depreciating further?

A. After sharply depreciating against the dollar in the first three quarters of 2013, the Indian rupee has stabilised between September 2013 and February 2014. This reflects a combination of factors, including confidence of financial markets in the new RBI Governor Raghuram Rajan's policies, improving forex reserves and narrowing of the Indian current account deficit to 0.9 per cent of GDP in the fourth quarter of 2013, the lowest in eight years. However, if the elections result in a weak and fragmented coalition government, this could again trigger rupee volatility and bouts of weakness. IHS Global Insight forecasts that the  rupee will depreciate from around 61 against the dollar in March to around 64 by the end of this year. However, there is also an upside risk for the rupee if the opposition BJP is elected and is able to form a coalition government with a reasonable working majority in Parliament. This could give some scope for moderate rupee appreciation and a rally in the Indian stock markets after the elections.

Q. What impact will a volatile and depreciating rupee have on the Indian economy?

A. A key risk for India from further rupee depreciation would be that import price inflation would increase, particularly for oil and gas which is a significant component of the wholesale price and consumer price indices. Furthermore, the rupee instability could also create uncertainty for global investors, possibly leading to some capital outflows from Indian equity markets, creating further depreciation pressures on the rupee.             

Q. Are global investors still looking at India and how do you compare it with 1991?

A. In fiscal 2012/13, India received $27 billion in total foreign direct investment (FDI) inflows, which was 18.5 per cent below the level for 2011/12. Although FDI inflows have slowed down sharply over the last twelve months, the overall level of FDI investment still far exceeds 1991, when India was only able to attract $129 million due to the highly restrictive regulations against foreign investment into India.

Portfolio capital inflows by foreign investors into Indian equities and bond markets amounted to $27.6 billion in fiscal 2012/13, far exceeding the small inflows in 1991, which amounted to just $4 million due to harsh restrictions against foreign investment. However, while India is still attracting large foreign investment inflows at present, there is no room for complacency due to the need for large capital inflows to finance India's chronic current account deficit.

Q. What key reforms should the new government pursue to bring back global investor interest in India?

The next government must pursue an aggressive strategic plan to make the Indian economy much more dynamic and boost GDP growth back to above 8 per cent per year. The first crucial strategy must be to accelerate foreign and domestic private sector investment in infrastructure, including crucial sectors such as power generation, ports and urban infrastructure. Such projects need to be fast-tracked to ensure they are built and become operational as rapidly as possible cutting through India's infamous bureaucratic red tape.

The second critical strategy must be to proactively attract foreign corporate investment into India, by removing the appalling uncertainty created in recent years over the taxation treatment of foreign investment, as well as fast-tracking investment approvals to ensure foreign investment generates manufacturing and service sector jobs on the ground in India as fast as possible.

Thirdly, a major programme of agricultural infrastructure investment is needed as a high priority. The need is to deliver large investment flows into areas such as agricultural irrigation and water storage, as well as agricultural storage and logistics management to reduce the high wastage of Indian agricultural produce.

Fourthly, it is vital that the Indian government sets out a credible roadmap for fiscal deficit reduction to reduce the overall public sector deficit to below 2 per cent of GDP over the medium-term, as well as gradually reducing various subsidies that are a major cause of the large fiscal deficits.