The immediate reason for the steep fall of the rupee against the dollar is that imports are more than exports. We are getting fewer dollars from our exports while we need more for our imports. The supply of dollars is less than the demand. This is leading to an increase in the price of the dollar vis-a-vis the rupee. The government believes that reduction of imports will solve the problem. The focus is especially on reducing gold imports that are considered “unproductive.” 

It is incorrect, however, to blame the import of gold for the decline in the value of the rupee. The share of fuel oil in our imports is 38 percent, against only 11 percent for gold. It is imperative, therefore, to reduce the consumption of energy. Yet Prime Minister Manmohan Singh has said that we must increase energy consumption. He cannot have the cake and eat it too. He cannot encourage higher import of oil and also expect the rupee to be stable.

There are three compulsions for imports. Oil is imported for production purposes, such as supply of electricity to software centers or for railway traction. Machinery is also imported to facilitate production.

The second underpinning is for investment in gold. The third is for conspicuous consumption such as diesel for SUVs, the consumption of Swiss chocolates and use of French perfumes. There is no dispute about the first category; these imports are necessary.

That said, the present policy is to encourage the import of Swiss chocolates and discourage the import of gold. This is wholly unacceptable. Swiss chocolates and gold are both a form of consumption. The difference is that Swiss chocolates disappear into thin air while gold remains in the family vault. The purchase of gold is actually a form of investment. It is much better than Swiss chocolates because the gold remains intact.

Manmohan Singh should prioritize imports. The first category of productive imports such as oil for railway traction and machinery and fertilizers should be allowed unrestricted. The second category of gold should be kept on an even keel ― neither encouraged nor discouraged.

The third category of consumption such as Swiss chocolates, branded furniture and luxury cars should be strongly discouraged.

India’s share in global trade is 2 percent; its share in global income is 6 percent; but the share in gold imports is 25 percent. We have a 5,000-year history; we have seen governments falling and currencies collapsing; we do not trust paper money; we know that our hard-earned wealth may disappear in a day when the currency collapses.

The proof lies in the experience of the past two years. Those who invested in gold have gained substantially, while those who invested in fixed deposits have lost value. The real value of your investment in the bank declines if the rate of inflation is higher than the rate of interest. Say you deposit 100 rupees ($63) in a fixed deposit account today.

You could have bought a T-shirt costing 100 rupees with this amount. One year later you will get 108 rupees from the bank. But the price of the T-shirt will increase to 110 rupees because of 10 percent inflation and it will go outside your reach. You will be the loser.

Inflation is largely dependent on the consumptive expenditures of the government. The government borrows huge amounts from the market to meet its increasing expenditures such as enhanced salaries to its staff. This leads to an increase in interest rates. The Reserve Bank prints more money to keep the interest rates down. This printing leads to inflation. The same quantity of goods produced in the economy are chased by a larger cache of currency notes. Thus your loss is the government’s gain. You lose the value of your fixed deposit but the government can borrow and pay huge salaries, perquisites and pensions. The prime minister wants the people to deposit their money in banks so that he can make merry unmindful of the fact that the people will lose their hard-earned earnings.

The value of the dollar is rising at the moment. Analysts seem to be veering around to the view that the bad days are over, and that the world economy will now move forward. I am not so sure. It seems to me that nothing has changed between 2008 and now which would indicate an improvement in the fortunes of the United States. It is as uncompetitive today as it was five years ago.

What has changed is that the United States has borrowed huge amounts of money from the global investors and provided a strong stimulus to its economy. The present upswing appears to be more due to this artificial stimulus and is not likely to be sustained. Therefore, the people of this country ought not to be carried away and be prepared for bad times that may come after one or two years.

The restrictions applied on imports of gold will not be effective anyway. In the 80s it was common to hear of seizures of gold being smuggled in through our coasts. The government was unable to prevent the smuggling. Ultimately it realised that along with the outflow of scarce foreign exchange, the government was also losing revenues from import duties. It rightly liberalized gold imports and started collecting import duty. Now the duty has been raised from 4 percent to 10 percent, making smuggling attractive again. Recently a truck was seized in Nepal while smuggling in 35kg gold from China.

Lastly, a reduction in the import of gold will not lead to a reduction in the current account deficit. CAD is the difference between imports and exports. The difference is covered by inward foreign investment. The simple equation is like this: Exports + Foreign Investment = Imports. Now, if imports decline, but foreign investment continues to come in as previously, then exports necessarily have to decline. This means that the method to contain CAD is to cut foreign investment inflows.

The higher demand of dollars for imports will lead to increase in the price of the dollar; decline in the price of the rupee and our exports will soon bounce back ― exactly as it happened in 1991-1992 when Manmohan Singh as finance minister allowed the rupee to be devalued from 15 to 25 rupees overnight. The present decline in the rupee is welcome because this will lead to rise in exports; make up for the loss of foreign investment inflows and wipe out the CAD.

The prime minister has embarked on a policy designed to appease government servants and politicians at the cost of the common man’s savings. I would encourage my countrymen to buy gold, and not deposit their earnings in banks so that Manmohan Singh is forced to think of the welfare of the people instead of serving only government servants and politicians.

By Bharat Jhunjhunwala

The writer is former professor of economics, Indian Institute of Management in Bangalore. ― Ed.

(Asia News Network)