India’s gross domestic product has topped $1 trillion, thanks to a strengthening rupee, making it the 12th country to achieve the milestone, Credit Suisse said on Thursday.
“Indian GDP at the current price level is 41 trillion rupees. With the rupee appreciating to below 41 against the US dollar, yesterday was the first day for the economy to be a trillion dollar economy,” the Swiss investment firm said in a note.
The rupee, which is trading around 40.76 to a dollar, has appreciated about 8.4 per cent this year and is up 15.4 per cent from a three-year low of 47.04 in July last year.
Stock markets in eight out of 10 countries had risen in the one year after their economies first crossed $1 trillion.
However, India’s $944 billion stock market should probably drop because of slower earnings growth for sectors such as autos, banks and cement, before picking up as inflows pick up into fast growing economy.
“Given our outlook… it is likely to go down again in the near future before it sustainably stands above this mark,” it said, referring to $1 trillion.
Bust the basic question is Should India stop accumulating reserves so rapidly and let the rupee appreciate against the dollar?
The answer for this must be YES, as a similar advice was given to all emerging Asian economies at the annual meeting of the World Bank and IMF. It is noted that reserves in the region had risen by an astonishing one trillion dollars, vastly in excess of any prudential norm. Countries were stockpiling dollars to prevent appreciation of their currencies. This aimed at a mercantilist maximization of exports, ignoring the considerable costs involved.
What are the benefits?
First, preventing rapid rupee appreciation reduces the shock to exporters.
Second, reserves are protection against trade shocks (like high oil prices), financial shocks (like the Asian financial crisis) and political shocks (like war with Pakistan). Yet India has actually weathered, at far lower reserve levels, a tripling of oil prices between 1998 and 2003, the Asian financial crisis of 1997-99, and the Kargil war of 1999. The Asian financial crisis also proved that the right way to combat such crises was through capital controls, not large reserves. Meanwhile, the costs of reserve accumulation are rising, especially when accompanied by sterilisation. Reserve accumulation means a poor country is lending money very cheaply to the US and Europe. If the same resources were harnessed for investment, economic growth would accelerate, inflation would diminish, and the welfare gains would run into billions. Reserve accumulation involves an interest loss. If India’s foreign debt carries an average interest rate of say 5% and Indian reserves consist of foreign securities yielding an average of say 2%, that entails an interest loss of 3%. At a reserve level of $100 billion, the cost will be a whopping $3 billion a year.
Sterilisation entails further serious losses. Government securities held by the RBI are really interest-free: the nominal interest is offset by the rise in RBI profits. But sterilisation means that the entire interest on these securities, which may average 5-6%, is a net drain. Preventing the rupee from appreciating creates a serious moral hazard. For starters, it encourages importers not to hedge their imports. This actually increases our vulnerability. Preventing rupee appreciation only strengthens expectations that the rupee will rise soon. This induces an ever larger inflow of dollars, worsening reserve accumulation in a vicious cycle. This can lead to unsustainable and potentially destabilizing inflows. So, there is a case for greatly reducing RBI intervention in the forex market(foreign exchange market). That may mean a sharp rise of the rupee followed by volatile ups and downs. This will reduce moral hazard and complacency, reduce unwanted and unsustainable inflows, and oblige traders to hedge currency risks. If sterilisation is also greatly reduced, it will mean a sharp increase in money supply that translates partly into higher demand and partly into higher prices. At a time when the economy is more open than ever, imports made cheap by appreciation will check prices. So will the bumper monsoon. The matter of timing remains. When should Reserve Bank of India let go of the rupee? One possible trigger could putting pressure on China. We like to think of reserve accumulation as an Indian problem, but it is a general Asian problem. And it is most acute in the case of China.Looking at the present situation we can infer rupee has appreciated more against the dollar more than most Asian currencies. Whatever India’s shortcomings on this score, they pale in comparison with those of some Asian neighbours, above all China. This is because a revaluation of the Chinese yuan by say 10% will allow India to let the rupee rise without eroding the ability of Indian exporters of manufactures to compete with the Chinese. The prudential argument for reserve accumulation is losing all credibility. But there remains a case for managing shocks to Indian manufacturer-exporters who have just become internationally competitive after years of painful restructuring. India competes head on with China in a wide range of manufactures, and will do so even more after textile quotas are abolished in 2005. An undervalued yuan will hurt us more than the US.Whether or not Malaysia, Hong Kong and Singapore appreciate matters little to us. Malaysia is a small economy competing in very limited areas with India. Hong Kong and Singapore are post-industrial economies with very high wages. Other countries like Indonesia and Thailand having been feeling the pressure of Chinese competition, and want yuan revaluation. We should not openly gang up with these countries and need to demand the authorities (like IFM) for Chinese revaluation. Rather, we should support the idea that reserve accumulation beyond a point is poor policy, for the countries concerned as well as the world economy. A tacit agreement to let the rupee rise freely the moment the yuan is revalued could be excellent economic diplomacy.
(Courtesy : CNN-IBN)