Having a war chest is useful in tough times, whether it’s for food or money.
Having a war chest is useful in difficult times, whether for food or money. The rupee depreciated by about 22% in just four months in 2013, falling from 53.67 to 68.81 US dollars between May 1 and August 28. Even though the Reserve Bank of India (RBI) raised its benchmark lending rate by 300 basis points from 7.25% to 10.25%, during this period the country’s foreign exchange reserves rose from 294 $.31 billion to $275.49 billion.
Focus on the previous year. The rupee has lost around 6% of its value since October 29, 2021 (from 74.94 to 79.69 per dollar), while the RBI repo rate has only increased by 140 basis points (from 4% to 5.4%). However, this was accompanied by a larger decline in foreign exchange reserves, from a high of $642.02 billion to $550.87 billion on September 9 this year.
The US Federal Reserve kept its key rate at 0-0.25% throughout 2013. Between May and November of the same year, the European Central Bank (ECB) even cut its benchmark refinancing rate from 0, 75% to 0.25%. Consumer price inflation averaged 1.47% in the United States and 1.35% in Europe in 2013.
The U.S. Fed’s proposal to taper (“tape”) its purchases of bonds and other assets totaling $85 billion a month was a major factor in the 2013 crisis. The strategy was made public for the first time by Ben Bernanke, then Federal Reserve Chairman, on May 22, 2013, although the actual reduction did not begin until the end of that year. However, this announcement, which spoke only of a gradual end to the monetary stimulus (read: printing of dollars) rather than a tightening, had a significant impact on India, mainly due to the large deficits current account (CAD) of the country in its external balance of payments.
In 2011-2012 and 2012-2013, these reached record levels of $78.16 billion and $88.16 billion, respectively (April-March). The “taper tantrum” raised questions about the country’s ability to finance its huge CAD since it caused capital flows to stop and because foreign exchange reserves had already begun to decline from their previous peak of $320.79 billion, reached September 2, 2011.
A run on the rupee was the result. The RBI was forced to sell dollars from its reserves and raise interest rates to protect the currency from speculative attacks. Major central banks have only just begun to scale back monetary stimulus or slow the pace at which they added liquidity to their economies in 2013. They are now tightening policy by reducing the money supply and raising interest rates. interest.
The US Fed has raised its key rate from 0-0.25% to 2.25-2.5% since mid-March, and on September 20-21 it is expected to raise it further to a target range of 3 -3.25%. In addition, the ECB increased its main refinancing rate from 0 to 1.25%. For the simple reason that annual retail price inflation is currently averaging 8.3% in the United States and 10.1% in the European Union, it is unlikely to stop.
People in these countries last saw these price increases in the early 1980s. Unlike 2013, their central banks’ adherence to a 2% inflation target would require real monetary tightening and interest rates. high long-term interest.
This has an impact on the flow of capital to India. On the contrary, rising interest rates in the United States and Europe are diverting money from emerging countries. Indian forecasts of C$120 billion in 2022-23, which would exceed even 2011-12 and 2012-13 levels, do not help. Consequently, external capital flows and the situation of the CAD are worse.
The rupiah did not experience an unfettered decline and the RBI did not have to resort to extraordinary monetary measures as it did during the taper tantrum era, despite a much more unfavorable external environment. Rates could rise further, but more to curb inflation than devaluation.
The main reason things have changed is that India entered this crisis with far more financial resources than it had in 2013. With $642.02 billion in foreign exchange reserves as of October 29 of last year there was more than enough firepower to dissuade any speculator from taking short positions in the rupee, including through “non-deliverable futures” in offshore markets like Singapore and Hong Kong .
These positions involve selling the rupee in the hope that it will depreciate against another currency and making a profit by buying it back later at a lower exchange rate. Many countries have resorted to the tactic of building up large foreign exchange reserves, particularly following lessons learned from the 2013 taper tantrum, the 1997-98 Asian financial crisis and the “short selling” of George Soros in 1992 on the pound.
India’s foreign exchange reserves have indeed shrunk by more than $91 billion since their highest less than 11 months ago. However, just like arms and ammunition in a conflict, reserves are meant to be used in a crisis. And that matters more when you start with nearly $650 billion in stock than when you have less than $300 billion.
We can compare this to the food industry, where on July 1, 2021, stocks of rice and wheat in government godowns reached an all-time high of 109.47 million tonnes (mt). Since then, they have declined to 60.11 metric tons on September 1, which is a five-year low from the same period last year.
The Food Corporation of India’s grain mountain has also been helpful in this case, especially in times of crisis. In the aftermath of the economic disruption caused by COVID, the Public Distribution System (PDS) not only delivered what was promised, but also proved to be the only reliable social safety net. A bad harvest could very well do to grain prices what the taper tantrum did to the rupee; the value of this grain surplus is also being realized now that stocks are at a bare minimum of comfort.
However, building up reserves of food and foreign cash comes at a price. In terms of food, this simply refers to the expense of maintaining and maintaining inventory relative to what is needed for PDS operations. For 2021-22, the “cost of ownership” of this pad has been calculated at Rs. 5.6 per kilogram. It would have amounted to around Rs 33,600 crore given that the average amount of equity held by the FCI during the year was almost 60 mT above the required amount.
In the case of foreign exchange reserves, where the RBI buys additional dollars and then issues domestic currency in exchange, the situation is more complicated. Therefore, he sells government bonds in an attempt to “sterilize” (or mop up) this rupee liquidity to stop inflation. There is a fiscal cost to building up reserves if the interest payable on them exceeds the profit the RBI obtains by investing its foreign assets in foreign securities and banks.
But maintaining food and currency reserves comes at a price comparable to maintaining a standing army and paying for defence. Only in times of economic downturn or when war breaks out can they come in handy. A budgetary and strategic analysis would determine whether and to what extent these expenditures would be borne by the government.
The three “Fs” – currency, food and fuel – have historically limited economic progress in India. In the 1960s, the first two were a major concern; the third in the 1970s; and the first two in the years leading up to the payments crisis of 1991. The first two problems were mitigated by storage, but there is still no cure for the vulnerabilities caused by oil, gas and coal.