Preventing India from becoming the world’s dollar store !

Is there really an economic solution to the crisis?

Will the falling rupee turn our country into the “worlds dollar store” or a “global flea market”?

• Is it easy to buy everything for dead cheap in india for anyone who has the dollar?
• Can we prevent this and get a better value instead?
• Does the solution really lie in economics and tweaking the financials?
• Or does it require exemplary geopolitical will and skill?

Find out the real story behind the spectacular slide of the rupee and a new perspective on possible solutions !!
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Does the solution lie in economics or geopolitics ?

The Plummeting Rupee, A Cause Or An Effect?

Much is being discussed, and indeed much has been written about the spiralling downward trend of the rupee against the dollar. But let’s 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 the 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?

The answers are many and the perceptions are diverse. References to CAD, decreasing capital account inflows, depleting reserves, balance of payment 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 depreciated rupee and not towards its real cause. For that, another question needs an answer.

Who Says We Need The Dollar?

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 there is a sudden surge for the dollar, or not even about why we need to exchange the rupee for the dollar. 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 USD for anyone who wanted to redeem them.
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This promise was readily accepted by the representative countries (44 in number, including pre-independence India represented by C D Deshmukh), partly because together they constituted the Allied forces, among whom the United States anyway exercised considerable clout. But this was also because it was commonly believed that the United States had the largest official gold reserves in the world. This belief was indeed not far from the fact. Significant gold deposits discovered in California in the mid 19th century coupled with the gold deposits that the country received from others for wartime safekeeping, not to mention the spoils of war in the form of 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, i.e. the dollar, increased manifold. The world started queuing up for the greenback, and the United States gladly obliged.

A few other events resulted in significant increase of the supply of the currency 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. In addition, a significant amount of dollars were supplied domestically to fund the Great Society Programs initiated by President Johnson, which included expansive (and expensive) projects concerning healthcare, urban development, transportation, etc. Added to this was the war in Vietnam, 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 with this the promise of redeeming dollars for gold. If the dollars indeed came back for redemption, it would spell doomsday with a capital ‘D’ for the US. Anticipating this, in 1971, the then US President Richard Nixon emergently and unilaterally announced to the world that the United States will suspend the convertibility of dollars to gold – a move that later became famous as the ‘Nixon Shock’.

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

Around the same time of the Nixon Shock, the United States structured one of its most significant and spectacular trade arrangements 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 Saudis agreed that the sole currency for trading in their oil would be the USD. From that year on, if any country had to buy oil, it had to do so by paying the Saudis, and soon the other OPEC countries, in 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 dollar demand 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 1970s, two countries decided that the world keep needing the dollar.
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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 a “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 they can lay their hands on to pay for fuel. The rising dollar is conspiring to turn India into the world’s 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 spiralling rupee ensures that a level playing field is difficult even in our own country. Simply put, at the current exchange rate, Indians and Indian companies have to work work 68 times 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? At the very least, can 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. Irrespective of the jargon that economists spew out, 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, let’s just look at three areas (and there are many more) that drive the rupee’s relationship with the dollar because of the demand for the latter. All three are concerned with broadly two questions. What are the commodities that we trade? Secondly, whom do we trade with?

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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 it’s not like others don't do it. Russia and China have a dollar independent deal, as do many others. Why are both the Foreign Minister and the Petroleum Minister so apologetic, almost hushed when talking of the restructured deal with Iran? Surely, our domestic economy cannot be subservient to someone else’s 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 policymakers routinely pontificate. 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 per cent. But is the solution in banning people from buying gold? We all know it. People buy gold when 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 the lay public to pledge their gold result in them opening their vaults? Let’s face it, people pledge gold only when they have the confidence of getting it back. They may even pledge gold for a compelling emotional national cause. In the absence of both, it seems unlikely that people will look favourably at buying gold bonds for something that they do not understand. Besides, even the poorest farmer in India knows 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 localised 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.
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What About 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 favour of China, as we import three times as much as we export to the country. And we pay for these in US dollars. Why can't we trade in the rupee or the renminbi.

We hear that the Chinese don't trust the rupee and they don't issue renminbi freely to the world. Why can't both the countries agree and back it up with 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 spiralling rupee compared to waiting for protracted border disputes to get resolved. Or is it that the Indo-China mutual mistrust story is a well orchestrated military bogey by the world that prevents both from getting together economically? But, if we have ourselves made our domestic economic policies subservient to 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) and UAE. But an effort with China is worth a try even if it means shaking up the global equations.

Time to Look Inward

It’s high time our foreign policy, our economic policy and our energy policy are synchronised to serve us rather than be subservient to someone else’s foreign policies.

What’s The Future Of The Rupee-Dollar Exchange Rate?

Let’s face it, the rupee plays no role in the exchange dynamics. Rather, it just gets kicked around helplessly. So, do we behave as curious bystanders and live from day to day, running around like headless chickens, or do we take charge and intervene? Obviously, the latter. 

But then, the steps involved in taking charge do not lie in the domain of economic and fiscal measures alone. It lies more in geopolitics and our ability take charge of our own political destiny. In any case, most of our economic and fiscal policymakers in recent years owe their education and professional emergence to the West. Will they then be able to take on the system that made them and make it work for 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 let's 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 30s! 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. Let's leave that for another article..

The author CEO of Helicon Consulting and the Consulting Editor of DSIJ. He can be contacted on vikram.l@dsij.in