Demand and high prices of oil and gold are playing the spoil sport and triggering high CAD. The government has taken steps to curb gold import, but smuggling of the metal has jumped manifold. The only long-term solution is to control inflation and to have an alternative of financial instrument that people can choose over gold
India’s huge current account deficit seems to be the biggest reason behind the depreciating rupee. Oil and gold are continuously playing the spoil sport and triggering this huge rise in CAD.
There is a view that oil might correct going forward on the back of the discovery of shale gas and the global slowdown. However, because of the weak rupee, India ends up paying just as much, if not more.
In gold, the government has taken steps to curb its import. However, it can do very less in stopping smuggling of gold, which has gone up manifold. Amar Ambani, head of research, IIFL, told CNBC-TV18, the only long-term solution is to control inflation and to have an alternative of financial instrument that people can choose over gold.
Below is the verbatim transcript Amar Ambani's views on depreciating rupee and the CAD
Rupee deprecation is fine because India's inflation is much higher than a lot of countries abroad and the US. So each year if the rupee depreciates by 2-3 percent we are all fine and that is how it usually works. However, what has happened in the last two-three months is the rupee has depreciated and the US dollar has spiked and this spike in the dollar has caused all the problems.
This spike happened because Ben Bernanke made a statement that they might immediately stop their bond buying programme and abruptly it might come to an end. He scared everybody, he himself possibly got a little confused. Later he clarified and we now know that it is not an abrupt end but it is a gradual end but of course that gradual end also is not so gradual.
The market sees it coming next year itself and the problem with that is if US yields rise and if the dollar strengthens then money can flow out of emerging markets (EMs) like India. And in the last two months that is what has happened.
You will see in the last two months alone Foreign Institutional Investors (FIIs) have pulled out more than USD 5 billion from India. And this is very important because India really needs this foreign funds and this kind of move out of the country really means that obviously the rupee is depreciating and once the rupee depreciates then possibly there will be more selling so it is like a vicious cycle, it accelerates the selling.
Our problem is we have had a rising current account deficit (CAD) and we need all this money to fund this deficit. India's CAD is currently the third largest in absolute terms in the world today. A couple of months back or three months back it was the second largest. It is third after the US and Britain and in terms of percentage of GDP we are higher than US and Britain also. So that is the size of our deficit currently and you can imagine the quantum of the problem. Therefore, this money is required and as far as CAD is concerned, oil and gold are playing the spoil sport.
As far as oil is concerned the view is that it might correct going forward and I don't mean the next few months, but possibly over the next two years and that is because there has been a shale gas discovery by US, it is because the global economy has slowed and therefore the demand for oil might not be that much. However in rupee terms because of this depreciation we are actually paying the same amount or possibly more.
The other problem is gold. The government has taken steps in trying to curb import of gold and recently there was a data point that came out which said that gold import in a particular month has fallen by 80 percent. Now I don't think anybody would believe that figure. This 80 percent fall in gold might have come in but the cases of smuggling of gold have gone up manifold so people are still buying gold. So just by putting curbs on gold is not really going to solve the problem because the love for gold among Indians is very high. So what really is the long-term solution is to control inflation and to have an alternative of financial instrument that people can choose over gold. That is the more long-term solution.
But these are basically two problems which are triggering this huge rise in CAD, And even if for some reason we were to assume that the government achieves some amount of savings there and the CAD corrects by USD 20 billion or so, and the CAD is close to USD 90 billion or so. If you correct it by USD 20 billion and you have foreign money and you assume that USD 20 billion worth of foreign money is coming into this country even then you have a huge gap, huge deficit that needs to be filled. And our foreign exchange reserves over the last few years have either been declining or they have been moving sideways.
Next year, India will need to rollover debt that is worth two third of the dollar currency reserve that we have. This can tell you the magnanimity of this problem which is why the government is trying desperately to control gold imports, trying to save the rupee, trying all measures. My feeling is that if the dollar is on a secular trend and if there are suddenly more redemptions from India then you can see further cracks in the rupee. And if that happens then even if the rupee corrects for some time and goes to 58-57 it can again become senior citizen.