Despite frantic measures by the government and the Reserve Bank of India (RBI) to prop up the rupee, it continues to fall. In the last three years, RBI's hawkish stance has not managed to cool inflation, but squeezed growth.
The RBI has tightened liquidity to contain the speculative shorting of the rupee. It has also kept rates high to make India more attractive for foreign investors. These moves have become counterproductive. Tight money and high interest rates have scared away foreign equity and debt investors. The forward premium on the rupee in international markets has shot up, keeping hedged dollar returns static.
The liquidity squeeze has created havoc in the economy and industry. Many banks are not disbursing even sanctioned loans. Most companies, even if profitable, cannot run their business with a sudden disruption in liquidity. In a tough environment, short-term interest rates have gone up by a massive 200 basis points.
Macro GDP, IIP numbers have been bad and the outlook has worsened. Banks fear unprecedented non-performing assets and huge losses on bonds portfolio eroding capital further. Inadvertently, the RBI's liquidity squeeze has further scared foreign equity investors about an expected plunge in corporate earnings and debt investors on a rise on bad loans and defaults.
On the other hand, the hypothesis that easy liquidity was fuelling rupee speculation was true only to a limited extent. Today, the Indian economy is a lot more externalised than most policymakers perceive. The capacity of corporates and HNIs to earn and keep their money outside is significantly greater. The non-delivery forwards (NDF) and non-delivery swaps (NDS) markets are very large and beyond the control of Indian regulators. Besides, the government's capital controls measures, perceived as a reversal of reforms, have further fuelled panic. The hike in import duty on gold will encourage smuggling, ultimately impacting official NRI remittances.
In our efforts to control inflation, we have stifled private sector investment and growth. India, adding 15 million people annually to the workforce, needs new investment and growth more than any other nation. Agriculture needs to release surplus "disguised unemployed" people. It is an open secret that our industrial and services sectors have hardly generated new jobs in the last 2-3 years and have been laying off employees.
At a fundamental level, all egalitarian governments want to control inflation as it is a tax on t