The Central Bank did its best to defend the rupee but squeezed by all sides they have given up the fight and seemingly allowed the rupee to float. The markets have not really digested the news so it is difficult to say where the rupee will end up but current quotes are around 115.10-115.50. It may move up a rupee or two in the short term.
This should come as no surprise to careful observers, the Central Banks started defending the rupee in the second half of 2011 and they have been fighting a losing battle since then. The reason they have allowed it to slide is to obtain the remaining facility of US$800m from the IMF. It is rumoured that the Government was shopping around in the Middle East for funds but had been quoted rates of 6-7%, so even at 3% the IMF loan is far cheaper.
We are basically back to where we were in 2008, which is when the last currency crisis occurred. In that instance the rupee dropped to about 115 (it may have touched 120 briefly, I have forgotten the exact dip) and interest rates spiked. I still carry a legacy of that era in the form of five year fixed deposit that is at 24%. In 2009, with the end of the war there was a positive story that the government could sell so they were able to tap the bond markets and rebalance the foreign debt. This time, having screwed three international banks and having alienated many foreign governments, that task will be a lot more difficult.
The IMF demands that the Government sets its macroeconomic house in order - or least embarks on a plan to set in order before it lends. One point is that the budget deficit needs to be brought down. This is excellent advice that the Government can follow by either cutting costs or raising taxes. The pattern that we have seen in the last six years has been no restrictions in Government expenditure, which means ever more taxes on the population. When one discovers that a great deal of this expenditure is spent on white elephant projects (eg Mihin Air, Lankaputhra Bank), or servicing high interest commercial borrowings the people need to start asking why they should fund the lavish lifestyles of so many cronies. (Read some comments on the COPE report for more on this subject here).
Until some means is found to get expenditure cut one must be resign oneself to the payment of higher indirect taxes. These are mostly imposed on essential foodstuffs (Dhal, onions, potatoes and canned fish are particular favourites). We saw this last month and once or twice last year. This is of course in addition to increases in fuel, gas, alcohol and a host of other items that took place in the month before and the months after the budget. Very little new taxes are actually announced in the budget, everything takes place the month before or a few months after. This little subterfuge really works, even I find it a little difficult to recall what exactly went up and when.
Due to the huge losses at the CEB, we can expect a (long overdue) increase in electricity rates as well. The non-operational coal power plant, built with expensive Chinese debt, no doubt contributes to this loss. The interest needs to be paid, even if no power is generated, and the consumer or taxpayer ultimately foots the bill, while those who build the plant walk away with their profits intact.
The exchange rate is linked to the interest rates so we need to wait and see where things end up. In anticipation of the depreciation interest rates were edging up, we need to see where they end up. Businesses which were making good profits on the back of low interest rates will find that borrowing costs go up, banks will find margins squeezed (as deposit rates rise) and overall increases in indirect taxes will bring about wage pressure. Company earnings will therefore be adversely affected but the biggest blow will fall on consumers.
When the average consumer is left poorer, does a the GDP growth number have much meaning?