A steadying hand

Rupee, Sensex volatility impedes business planning. India needs a stabilisation sovereign wealth fund.

Written by Janmejaya Sinha | Published: March 12, 2016 12:01 am
The department has also initiated e-filing of patent and trademark applications using debit cards, credit cards and internet banking. In addition to the macro factors highlighted above, over the calendar year 2015, India received .6 billion dollars of foreign direct investment (FDI).

The budget confirmed the fiscal deficit target of 3.9 per cent for the current financial year, and 3.5 per cent for 2016-17. The current account deficit (CAD) remained well-contained at 1.5 per cent of the GDP, and with oil prices at $30, few expect it to be under any imminent pressure. The GDP growth rate is over 7.5 per cent. Inflation is under control (consumer price inflation is below 6 per cent and wholesale price inflation has been negative for over a year). The interest rate differential with the US is a positive 6.5 per cent. If we were to believe that the exchange rate was a function of trade balance, the interest rate differential and inflation expectations between the two countries, then how does one explain the fall in the rupee from 63 to 68 to the dollar over the past year?

In addition to the macro factors highlighted above, over the calendar year 2015, India received $41.6 billion dollars of foreign direct investment (FDI). This is higher than before and better than most other countries. Although interest rates in India are high, they are lower than they were in August 2015. Company balance-sheets are certainly better than they were a year ago or, more pointedly, two months ago. So how does one explain the fall in the Sensex from a high of 28,000 to 24,000? Prior to the budget, the market was spooked by the RBI’s directions to write-off all bad assets by 2017. This had led to sharp losses and brought down the market by another 1,000 points. The appropriateness of the RBI approach is grist for another article, suffice it to say that bad loans are not new and have been accruing since 2008. The core reasons for non-performing assets (NPAs) have been sector-specific — infrastructure problems arose originally due to lack of government clearances for many PPP projects; steel due to a commodity glut accentuated by a reduction in Chinese demand; textiles because we have been shut out of Europe and the US due to an absence of trade agreements; power due to the discoms; and telecom due to the price of spectrum auctions.

Before the budget, there were some gyrations, but the Sensex stayed in the 23,000 range and the rupee below 68 to the dollar. Why? The important thing that happened over the last year was an outflow from India of $6.4 billion by foreign institutional investors (FIIs). The recent Chinese renminbi devaluation led to $2 billion of this outflow in January and February 2016, the sharpest exit since 2008. What this essentially shows is that despite good macro fundamentals and an increase in FDI, just $6.4 billion of FII outflows brings down the Sensex by 4,000 points (the last 1,000 were due to bank NPAs) and the rupee from 63 to 68 in less than a year. Then, in the 11 days of March, $960 million of FII money came in and lifted both the Sensex, to over 24,500, and the rupee to 67. The 10th-largest global economy is going through such massive gyrations on account of modest FII flows-in and -out of the country, causing sharp volatility that completely impedes business-planning.

In this context, it is worth noting that our economy today is over $2 trillion. We have foreign exchange reserves of about $350 billion and over 200 companies with revenues of over $1 billion in many vibrant sectors. Most people today see the Indian economy as a bright spark in a global perspective. Growth is over 7 per cent and, in the last 15 years, the economy has gone from about $480 billion to over $2 trillion. Even at the same pace of growth, India will be a $10 trillion economy before 2030. If the pace of growth were to accelerate, this number would be higher. Yet, small movements of foreign capital completely wreck sentiment and make business-planning difficult. Such spikes in the rupee-dollar rate and the Sensex help nobody but speculators.

To moderate such volatility, I would like to propose a stabilisation sovereign wealth fund. We need a fund of $15-20 billion to curb volatility. Could we get a UTI or government to find this corpus? Our CAD problematises the simple use of our foreign exchange reserves for this purpose, but the government still invests these reserves curr-ently, mostly in US government securities. However we do it, we need to find this corpus of $15 billion.

The governance of the fund would also be critical. Its ownership would need to be like the UTI, where the direct government stake would be less than 51 per cent but over 26 per cent. It would have to be manned by professionals located in a tax-advantaged location, and free to operate without currency restrictions. Needless to say, these would be top professionals, paid market salaries, governed by a board of eight eminent Indians chosen for their knowledge and integrity, and the finance secretary.

The charter of the wealth fund would be to invest counter-cyclic-ally in Indian equities and debt markets. Buy into India when there are sharp FII outflows, and sell when there are sharp FII inflows. Its purpose would not be to support the market but to curb volatility based on sharp FII flows, with set triggers below and above which it would not intervene. A clear framework could be provided with straightforward cautions that would not allow it to support or prop-up the stock of state-owned enterprises.

If we believe the long-term economic growth scenario for India is positive, a fund of this kind should make money.

I believe the government should create a committee of eminent people under the ministry of finance to flesh out the details of both how to raise the corpus and operate such a stabilisation sovereign wealth fund.

It would curb volatility and allow more predictable business-planning. All business leaders I meet say the need is urgent.

The writer is chairman Asia Pacific, Boston Consulting Group. Views are personal.

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  1. A
    ankita kishar
    Mar 12, 2016 at 8:23 am
    Modiji ki sarkar aaihe
    1. C
      Mar 12, 2016 at 8:03 am
      Why don't companies themselves hedge their currency exposures in markets? and as far as outflows are concerned, Last year was the only year after 2008 which saw net capital outflows from emerging markets as a w.and India is part of that group.Its better if we don't intervene in markets. so please stop pimping for businesses.
      1. K
        kulaputra kulaputra
        Mar 12, 2016 at 1:06 am
        This idea has been around for a ling time. There are several finance pracioners who have been voicing this for about 20 years now. It is time we acted.
        1. P
          Mar 13, 2016 at 8:19 pm
          BJP did not lose Delhi and Bihar elections because of lack of socialism? People in the street are not businessmen who will understand the benefits of bringing one party or the other in power? They behave strangely and unpredictably. They act with emotions. BJP had this historic opportunity to give new direction to this country but that opportunity has been squandered. What was needed was to go for painful hard decisions on economic, social and political reforms? Here are a few I can list if Modiji has willingness and guts to see India as a economic super power in next 20 years: 1. Reverse socialism with free enterprise (remove state from every enterprise. There will be lot of resistance by interest groups; ministers, babus, trade unions and contractors. But whatever the odds, close the eyes and do it. It doesn't require RS majority but iron will to do something good for the country). 2. Reduce tax rates drastically to attract foreign/domestic investment. Everybody knows in the world about business potential in emerging economies but they also see the other factors like taxation policy, babudom, rigid labor policies which prevent hire and fire quickly and easily. If in the bargain, social spending comes down, let it be so. No price is more when it comes to country's interest. 20% maximum tax should be the target. 25% maximum rate should be implemented by end of this government term. 20% by 2024 - Is Rahul also listening? 3. Business and enterprises leadership have a vision for next 20 years. Country's leadership should have vision for next 50 years. That means redesign your social sector schemes like MNERGA. No more FAWADA or BELCHA driven works but BULLDOZER and other sophisticated machinery driven works with modern and lasting facilities. There should be no difference in quality of roads, electricity, schools, hospitals and malls between villages, towns, cities and metros. No more TALAB KHUDAI and KACHHI SADAKS. TALABS only produce mosquito and KACHI SADAKS damage cars and motor cycles, besides take longer to commute. Sometimes even no roads are better than gravel roads. That will require expert contractors and sophisticated machinery, so be it. Those will use less manpower, so be it. 50 years vision requires airports every 200 kilometers. A stage will come when railways will be used only for freight, plan for that NOW. 4. All parties should agree for a consutional amendment to hold general elections for parliament and emblies together every 5 years. Direct elections of RS MP should be made possible (US Senate model may be copied. We tried to copy House of Lords). Combine ministries of steel, mines, coal, oil, natural gas, textiles, heavy industry, communication and nuclear energy into ONE ministry - Ministry of Industry. Combine ministries of civil aviation, road transport and waterways into ONE ministry - Ministry of Transportation. Disband HRD ministry, education is state subject. 5. Three huge industrial corridors declared as free trade zones should be notified with 100 km depth on either side of the railway lines: (a) Delhi Mumbai. (b) Delhi Calcutta (c) Delhi Chennai These corridors should be tax heavens and are expected to provide jobs to locals. Please don't get fooled with the false accusations that farmers will be uprooted and agricultural produce will be lost. No country has been able to become rich and advanced without industrialization. 6. Empty slogans will achieve nothing, concrete action will. You don't need RS majority for everything. Even if you keep pleasing poor and farmers and do nothing about 5 action points I've listed, what's the guarantee that BJP will return to power in 2019? What's guaranteed is however that India will still have poverty after 100 years, may be 1000 years if nothing is done and only political CHAPATTIS are cooked! Good luck Modiji.
          1. P
            Prateek Maheshwari
            Mar 12, 2016 at 5:09 am
            Sir, with all due respect, we already have the RBI stabilizing debt and FX markets in case of FII inflows-outflows, with an express goal to curb volatility in the FX markets atleast. Wouldn't adding more regulations simply stunt the foreign investor sentiment towards our capital markets and lower the amount coming in? Just a whiff of additional regulation is enough to spook the FIIs as you must have seen yourself, then adding another eny specifically designed for this purpose seems like a bad idea.
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