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.