Dr Ashwani Mahajan
Rupee fell to nearly rupees 64 per dollar in the last few weeks, before appreciating to nearly rupees 62 a dollar recently. It is well known phenomenon that selling spree of the foreign portfolio investors causes depreciation of domestic currency, as and when they transfer huge amount of foreign exchange abroad. It is notable that after Narendra Modi took over the reign of power, stock markets reached new heights and Sensitive Index of Mumbai Stock Exchange (SENSEX) reached a new height of 28,822 on November 28, 2014 from nearly 23,000 in May 2014; which means that after the new government, share market jumped nearly 25 percent in nearly 6 months.
Economic analysts were saying that markets were booming, thanks to the proposed economic policies of the new government. Although, in reality except cooling down of inflation, there was hardly any sign of improvement in the economic indicators, markets were riding more on hopes. Economic crisis of the day, no doubt is the result of gross economic mismanagement and rampant corruption under UPA-II. Growth of manufacturing had reached zero or even negative; inflation was at its peak, rupee had nosedived to nearly 69 per dollar due to worst ever Current Account Deficit (CAD) in Balance of Payment. Hopelessness in stock markets was the natural outcome of the situation. There are many new steps undertaken by of the new government such including Jan Dhan Yojna, to encourage manufacturing and has thereby infused new hope in the economy. Global factors have also favoured Modi, as crude prices have declined, giving a big relief in CAD. In the process rupee also strengthened. With appreciation of rupee, prices of imported goods were bound to decline, which in turn helped inflation to cool down. Under these circumstances Sensex made a new record and people started talking about the Sensex’s new target of 50,000.
Why Sensex Nosedived Later?
In the last few weeks when Sensex started declining and reached a low of 26,724 on December 17, 2014, it was seen with surprise. When fundamentals of the economy are stronger than before; international agencies have continuously been revising the growth possibilities upwardly, though in few sectors, manufacturing is also looking upward; rupee had also stabilised near 61-62 rupees per dollar; there does not seem to be any reason for Sensex to decline.
For the last few years our current account deficit in the Balance of Payment has been going through a very difficult situation due to high crude prices. Rupee which was near 24 rupees per dollar, had declined to rupee 68.84 per dollar by August 2013. At that point there were three major reasons for BOP crisis, namely, oil, gold and coal. Today we see that crude prices have come down to nearly 50 dollar per barrel, solution to the coal problem has also more or less been solved and government’s efforts to keep gold imports under checks have been mostly successful. Thus we can say that, all major reasons for BOP crisis are no longer there.
Under these circumstances we are forced think that weather stock market is influenced by economic reasons or they are determined by speculation. In the last one and half decades, since the policy makers have paved the way for foreign portfolio investors, stock markets, debt markets and commodity future markets have been witnessing major ups and down. In any one day increase in Sensex by 800 point and the very next day decline by the similar quantum, proves the point that stock markets do not go up and down due to economic fundamentals; rather it is a game of speculators only. Within these speculators the most important role is that of foreign portfolio investors. On a day when these portfolio investors enter the market with huge funds brought from overseas, they cause unusual hike in the share prices. On this height they offload their shares, purchased at lower prices earlier and transfer funds abroad. In the process demand for dollar increases and rupee depreciates. It is notable that about a couple of weeks back on a single day rupees 5,000 crores were brought into share markets and stock prices jumped. Very next day these investors started withdrawing money and Sensex nosedived.
Vulnerability of Rupee Amidst global Upheavals
No doubt these foreign investors do indulge in speculation; their decisions are affected by international circumstances also. It is notable that due to a major fall in crude prices, these speculators are in deep trouble, as they are incurring heavy losses in commodity markets. To meet out the losses there, foreign exchange is being sent from India. At the same time Indian companies who had raised loans from abroad, are also increasing their stock of dollar, to meet out their payment obligations.
There may be many short term reasons for upheavals in the value of rupee; however, there are no two views that foreign institutional investors play a major role in the same. Every government, irrespective of party in power, gives importance to foreign investment. In the last more than two decades, new economic policy of liberalisation and globalisation has caused rising imports and insufficient growth in exports, which has led to widening of trade deficit. To meet this deficit, foreign investment has become a compulsion for all the nations. In such a scenario foreign investment has become a compulsion and no government can gather courage to stop foreign investment, even if it is weakening the domestic currency. In India too, we find same kind of problem. Due to the speculative activities of the portfolio investors, not only share markets show huge upheavals, value of rupee also goes up and down in the short period. To address this problem, a lock-in period of at least three years should be imposed, so that the portfolio investors are not allowed to fly by night. Along with this tax should be imposed on the profits of portfolio investors, as has been done by Brazil. With this, not only there will be stability in portfolio investments, there will be minimum losses to the nation.
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