India currency woes: self realization and the solution within!

India’s problems are purely on account of its inertia, contentedness, and lack of self realization of what it could potentially achieve and how much it could grow! Before we discuss a few potential solutions, let us analyze a few key facts:

• Indian economy is about 60-70% dollarized and is interconnected and coupled with the global economy. There is material impact of import of oil and petroleum products (US$169b), gold (US$54b), coal (US$15.5b), telecom, electronics and transportation (US$87b) and defense equipments (US$20b), ferrous and non ferrous raw materials (US$37b); the co-relation between international and local commodity prices are strong as local commodity and foreign exchanges proliferate, corporate and banks heavily rely on equity and loan funding or NRI remittances, and India's exports are service oriented. Imports of raw materials such as coal, non ferrous ore, iron and steel and scrap especially driven by lack of clear policies on mining and land acquisition.

• Imports of defense, electrical, electronic, transport and telecom equipment in increasing as India lacks a strong import substitution manufacturing policy. Further, infrastructure to kick start manufacturing is lacking nor has there been sufficient investment in manufacturing or technology to improve productivity. Plethora of licenses and clearances and lack of energy supplies has demoralized business houses and creates bad loans - many power, telecom and infrastructure companies are on the verge of becoming sick or are sick!

• Export of agriculture commodities is controlled by non-market friendly populist policies, inefficient supply chain and infrastructure. 

• Imports cannot be curbed as it would violate FTA and trade agreements.

• The parallel economy is estimated at about 50% of the actual economy is created out of high incidence of taxation, lack of legislation that legitimizes political donations, and inadequate banking infrastructure. Some of the money from parallel economy gets invested in gold and real estate and most of which always remain unaccounted or non-taxed.

• The primary objective is to create domestic economy, increase productivity, employment, control inflation and capitalize on demographic dividends. India has a large population with good demographics which means consumption story is here to stay so as investments and technology infusion. 

• Developed markets have spare capacity in high technology areas and skilled manpower which India can seek or attract before these countries are our recession. Developed markets are in recession so either developing markets help them succeed or they reel under recession.

The bickering over the volatile and depreciating currency must now stop and that policy makers must take decisive steps that are within their domain. Good policies that incentivize business will also create import substitution, jobs, growth, and lift population out of poverty!  Over the past 10 years, there have been a number of changes to the socialist era of protectionist and interventionist policies but more could still be done before we hit the list mile. Sounds easy, so let’s analyze a few actionable local initiatives that can be easily implemented:

Indigenization and recycling:

• Defense, electronic and telecom indigenization manufacturing policies will help reduce reliance on imports, spur growth and employment. Indian corporate has the necessary infrastructure and capability to produce defense equipments. The raw material in the form of coal, iron ore, aluminum, rare earth materials, and nuclear energy capability is available.
• The waste of the 1.2billion population can generate fertilizers and energy! Sanitation and waste management policy could reduce reliance on imports of fertilizers, improve sanitation, quality of potable and agriculture water, and help generate energy.
• Why acquire land when India could bore underground roads, railways, and channels that connect rivers! The cost of buying borer machines will probably be cheaper than acquiring land.

Local solution to an international problem:

• Issue of INR denominated bonds to Indian resident against delivery of gold to RBI will help build gold reserves and shore up reserves without impacting the currency or foreign exchange reserves. An action that requires strong political will help built reserve without creating external demand for gold and loss of foreign exchange. 

Disciplining growth:

• Recognize the importance of a “traffic policeman’ and ‘lane driving’ that help a disciplined traffic flow and accidents which in-turn help reduce consumption of petrol and diesel and reduce imports of oil.   It is said that there is more money in chaos and confusion; note someone is seriously loosing both money and state of mind! 
• Urban planning and clean drive will make India look neat and tidy attracting tourists, visitors and also reduce brain drain. Think, why would one not want to visit and why would someone leave a beautiful, vibrant, and culturally diverse country!
• Increase financial penalties and fines for offences by 10x of current rates. Increasing rates will improve governance and discipline population, channel energy and resource for productive purposes, and reduces corruption and parallel economy! Many countries including developed markets, Singapore, HK has proven that ‘fines create finer people’ before an era of ‘self discipline arrives’.

Deregulation towards a market based economy:

• The initiative on deregulation on petroleum pricing is directionally positive for reducing fiscal deficit and the Indian economy. Now, why not make minimum support price on commodities linked to its international prices so that export of surplus commodities is facilitated out of India that earns valuable foreign exchange for India or if international prices are subdued then local prices correct and control inflation bring much needed relief to consumers and help control interest rates. Considering complexity surrounding these issues, this may take some years but any step in this direction is worth the effort!
• On currency and futures exchange, market participants may be categorized to differentiate genuine hedgers, market makers and speculators. Speculators must be restricted; corporate without any track records on export, imports must have restricted access in the market. The currency futures provides a market efficient window to genuine SMEs hedgers that do not have bank limits to hedge on Over The Counter or those that create exposures that cannot be hedged without underlying contracts; further margin calls help manage volatility and systemic risks.

Financial reforms:

• Abolishing base lending rates will allow banks in India to lend at rates that are correlated to creditworthiness of the companies and companies that has strong earning potential. Many financially sound companies are paying a higher credit risk premium and/or seeking USD funding from international sources. Competitive lending rates commensurate with corporate risk will help channel funds into healthy economic and corporate growth/capital formation and may reduce reliance on USD debt which impacts rupee.
• Reduce income tax rates to 20% to improve capital inflows and disincentives outflows from India! The widening of tax net has reached a saturation point unless agricultural income is taxed.

Attracting long term debt and investments:

• Foreign corporate investing into India using FDI route must also be allowed to borrow via external commercial borrowings (ECB) from their parent or group companies with no end use restrictions up to a certain percentage of the equity invested. Many Emerging Markets have similar regulation in place and it helps shore up long term debt versus short term debt. This could be allowed for manufacturing industry where the local debt is hard to get as most of the companies are reaching the single borrower limit. RBI has relaxed regulation for expenditure on import of services, technical know-how and payment of license fees so why not allow ECB for expenditure and acquisition of intangible assets like product brands, etc.
• Thanks that FDI changes are already happening but still more can be done to satisfy the insatiable demand of the Indian consumers, grow manufacturing and employment. 

The list of simple and local solution to an international problem is endless and much will depend on political will and its implementation. The Indian population and economy is young, enthusiastic and highly informed of what the world of opportunities – nothing will stop them from growing or getting what they want! The change is inevitable and unstoppable.

30 August 2013