Dollarization & The plummeting rupee, a cause or an effect?

India’s Global Trade

Much is being discussed and indeed much has also been written about the spiraling downward trend of the rupee against the dollar. But lets spare a moment to ponder whether the recent phenomenon concerning the rupee is going to be the cause for some unforeseen future impact on our economy or whether it is itself an effect of some events and actions that have occurred in past? Or perhaps both?

Or whether the root of the phenomenon can be traced to some amorphous, unexplained and uncontrollable aspects, conveniently clubbed with a helpless shrug by our government and termed as “global uncertainties” or whether they are indeed embedded in putatively isolated economic and financial policies of the government? Or perhaps both?

Or whether the down spiraling rupee is going to spell doomsday for our economy or whether it is in fact a signal of grave portent for its significant other, the US Dollar? Or perhaps both?

Answers are many and perceptions are diverse. References to CAD, decreasing capital account inflows, depleting reserves, BOP crises precipitated by a surging oil bill, increased gold imports are all real yet obvious and oft repeated and therefore tend to appear cliched. Moreover they point at the impacts of the devalued rupee and not towards its real cause. For that another question needs an answer

Who says we need  dollarization ?

It is obvious that the run on the rupee and a sudden surge in demand for the dollar has resulted in this spectacular depreciation of the rupee. But the real question is not why the sudden surge for the dollar, or not even, why do we need to exchange the rupee for the dollar, but the real question is, who says we need the dollar? Confronting this question is an economic and geopolitical imperative for India

The geopolitical strength of a country is reflected in the strength of that country’s currency.  Beginning with the industrial revolution in the mid 18th century, Britain established its unquestioned hegemony over the world and its currency, the pound sterling emerged as the preferred trading currency of the world. Similarly in the post war world order the United States emerged as the single most powerful nation and by incidence, its currency, the dollar, became the currency of choice for world trade

The formal coronation though of the dollar as the primary trading currency of the modern world was done in 1944 through the now famous Bretton Woods system where the United States promised to back its currency with solid gold. Specifically, an ounce of real gold in exchange for every 35 US dollars for anyone who wanted to redeem them

This promise was readily accepted by the representative countries (44 in number, including pre independence India represented by CD Deshmukh) partly because together they constituted the allied forces amongst whom the United States anyways exercised considerable clout but also because it was commonly believed that the United States had the largest official gold reserves in the world.  This belief was indeed close to fact because significant gold deposits discovered in California in the mid 19th Century coupled with the gold deposits that it received from others for wartime safekeeping not to mention the spoils of war in the form gold indeed made the United States gold reserves significantly large 

As trade progressed and more countries started participating in global commerce the demand for the anointed trading currency, the dollar, increased manifold. The world started demanding the dollar and the United States started obliging by supplying it with dollars

A few other events resulted in significant increase of the supply of dollars during this time. The United States took upon itself to fund the reconstruction of a bombed and battered Europe by supplying dollars to European nations under the Marshall plan. Significant amount of dollars were additionally supplied domestically to fund the Great Society Programs initiated by President Johnson which included expansive (and expensive) projects concerning healthcare, urban development, transportation etc. And the Vietnam war which consumed another huge supply of dollars for equipment and ammunition

While there was no physical constraint for the United States in supplying the world with any amount of paper dollars, there surely was that little problem of backing every 35 dollars with an ounce of real gold. There simply wasn’t enough gold to continue the promise of redeeming dollars for gold. If the dollars indeed came back for redemption it would spell doomsday for the US with a capital “D”. Anticipating this, in 1971 the then US President Nixon emergently and unilaterally announced to the world that the United States will suspend the convertibility of dollars to gold, famously called the Nixon shock

Normally reneging on such a promise should have impacted the confidence of world community and reduce its demand for the dollar and begin the search for an alternative trading currency. But events occurred which once against established that geopolitical supremacy of a country ensures the trading supremacy of that country’s currency

Around the same time of the Nixon shock, the United States structured one of its most significant and spectacular trade arrangement with Saudi Arabia, a country that had the most proven reserves of oil, a commodity for which the world was working up a voracious appetite. Under this arrangement (which had obvious dimensions of ideology, politics, religion) the Saudi’s agreed that the sole currency for trading in their oil would be the US dollar. From that year if any country had to buy oil it had to do so by paying the Saudis, and soon the other OPEC countries in US dollars

So the world readily swallowed and quickly forgot the reneged promise of the yellow gold and switched to accept the promise of the supply of the desperately needed black gold for the same US dollar. And the demand for dollar continued

The world and India realigned its trading strategy and put its agriculture, industry and services to work with a singular objective to earn the dollar from the United Sates to pay for its fuel to major oil producers

So in 1944 forty four countries agreed that the world needs the dollar and in 1970’s two countries decided that the world keep needing the dollar

But can India ignore the dollar?

The answer at least partially lies in a rhetorical question, does India have the spine to ignore the dollar? Ignoring the dollar or even attempting to chart a course out of the dollar quicksand requires a strong political will, exemplary geopolitical courage, short term economic sacrifices by the rich and a complete realignment of our sectoral priorities. Comfortably ensconced in its “soft state” image and the personal interest of the high and mighty linked to dollar denominated assets it looks unlikely that we can ignore the dollar at least in the near future

At this point all sectors of the Indian economy are working hard to produce cheap goods and services to earn every dollar that it can lay its hands on to pay for its fuel. The rising dollar is conspiring to turn India into the worlds dollar store. In fact with every basis point fall in the rupee against the dollar, India works that much harder to provide cheaper goods and services to the world. With an open economy, the spiraling rupee ensures that a level playing field is difficult even in own country. Simply put, at current exchange rate, Indians and Indian companies have to work work 68 time harder than their counterparts who earn in dollars to get similar returns ! How can we possibly correct this anomaly?

Does the answer lie in economics or geopolitics?

Is there light at the end of the dark dollar tunnel? Can at least attempts be made to shake ourselves free from the clutches of the dollar?

Tweaking interest rates, suggesting ludicrous bans and rationing, reducing money supply are all short term economic and fiscal solutions which are merely tactical. These are reactive and cannot prevent a long term tailspin of the economy. Let the economist spew out any jargon but the real panacea is in a geopolitical solution that is more strategic and proactive and has both short term and long term dimensions

To prove this point lets just look at three areas (and there are many more) that drive rupees relationship with the dollar because of the demand of the latter.  All three are concerned with broadly two questions, what are the commodities that we trade?  and secondly, who do we trade with?

Oil and Gas

A whopping 37% of our trade in value terms is dedicated towards buying this commodity. Rather than suggesting ludicrous bans on petrol pump timings what stops us from structuring slightly more robust solutions like non dollar denominated trade deals. Why does it take a currency emergency for our government to look at non dollar denominated sources like Iran. Why couldn’t we have done it anyways. And its not as if others dont do it. Russia and China have a dollar independent deal. So do many others. And why are both the foreign minister and the petroleum minster so apologetic and almost hushed when talking of restructured deal with Iran. Surely our domestic economy can not be subservient to someone else’ foreign policy? Restructuring a currency deal is also a relatively short term solution compared to unrealistic austerity measures and becoming energy secure on which our policy makers routinely pontificate  And then there are long term measures like investing in public transport infrastructure and developing alternative energy resources and laying transcontinental gas pipelines. What has the government been doing for a decade or for that matter for the last 60 years?

Gold and Precious Metals

Another 17%. But is the solution in banning people from buying gold? We all know it.  People buy gold when the confidence in every other asset class is shaken. So will banning gold imports magically improve the confidence of people in other asset classes. On the contrary, It may just give a fillip to the parallel economy

Or will merely requesting temples and lay public to pledge their gold result in them opening their vault doors? Lets face it, people pledge gold only when they have the confidence of getting it back. People may even pledge gold for a compelling emotional national cause. In absence of both it seems unlikely that people will look favorably at buying gold bonds for something that they do not understand. Besides, even the poorest farmer in India knows not not to pledge his dwelling to feed his bullocks. Pledging your safest long term asset for a recurring revenue expenditure makes no sense

Unless the government comes up with creative solutions. Like issuing gold bonds for localized and specific infrastructure projects or facilitating easy mobility of gold in capital markets. But the former requires accountability and the latter credibility both traits woefully short supply with our policymakers

Creative short term solutions and visionary long term strategies concerning just two of the top categories may just start the process of India moving away from the dollar trap

Our trading partners?

Why can’t non dollar denominated bilateral trade deals be structured with some of our leading trade partners? China alone accounts for a significant share of bilateral trade (USD 66 Billion). Currently this bilateral trade is tipped in favor of China. We import three times as much as we export to China. And we pay for these in US dollars. Why cant we trade in rupee or renminbi. We hear that the Chinese dont trust the rupee and they dont issue renminbi freely to the world. Why cant both the countries agree and back it up by bilateral guarantees? The Indian people would have been more excited to hear developments in this regard from the recent visit of our foreign minister instead of his appreciation for Beijing and his longing to live there !

Once again Geopolitics comes to the fore. Surely structuring a rupee renminbi deal is a possible short term solution for the spiraling rupee compared to waiting for protracted border disputes to get resolved. Or is it that the India China mutual mistrust story is a well orchestrated military bogey by the world that prevents both form getting together economically? But if we have ourselves made our domestic economic policies subservient to the external foreign policies who are the Chinese to bail us out

Sure we can do precious little about our other large trading partners like the US, Saudi, Iraq ( not anymore) & UAE. But an effort with China is worth a try even if it means shaking up the global equations

Lets please start looking inward

Its high time our foreign policy, our economic policy and our energy policy synchronized to serve us rather than be subservient to someone else’s foreign policies

And whats in store for the future of rupee dollar exchange rate?

Lets face it, the rupee plays no role in the exchange dynamics. It gets kicked around helplessly. So do we behave as curious bystanders and live from day to day and run around like headless chickens or do we take charge and intervene? Obviously the latter. But then steps involved in taking charge do not lie in the domain of economic and fiscal measures alone. Its more in geopolitics and our ability take charge of our own political destiny. In any case most of our economic and fiscal policymakers of recent years owe their education and professional emergence to the west. Will they then be able to take on system that made them and make it work in favor of India? Only time will tell

Honestly, being a democracy the only indication, that India has finally gathered the courage to take significant geopolitical steps in favor of our rupee, our economy, will come from within politics. Till then lets get ready for the rupee to be tossed around between 60 – 70 like a twig in a turbulent stream with economists, bankers and intelligentsia shouting suggestions from the river bank but never jumping in to rescue it

And what happens to the dollar?

Well, there is a school of thought that not too far in the future the world, leave alone India will go short on the dollar. Does not the Big Mac index say most currencies are significantly devalued against the dollar. The rupee in fact is said to be pegged in the 30’s!  But I do not want to take on academics and economist on this serious topic. At least not now. I mention it merely to end the article in a lighter vein. But clearly the race is on, between the world going short on dollar and the dollar searching for new ways to keep the world hooked. Lets leave that for another article…..