Notes for the Central Bankers

Dedicated to the Feds, RBI, Central bank of China and Bank of England, South Africa, Brazil and Australia

Are currencies overvalued or undervalued? Given the top three economies which have very wide disparities in their nominal and real rates of exchange, including effective exchange rates, it becomes pertinent to apply logic and facts for the widening CADs in these countries. Taking a closer look at the case of RBI in India, the Central Bank has taken a very dovish stance related to the CAD. Here are a few points that can be introduced for the widening CAD, affecting inflation in India.

  1. Too much dependency on oil and gold leading to a higher co-relation to global shocks, making CAD counter-cyclical to the rising Brent Crude linking to over-consumption needs attention. Rational import duties for gold and oil will allow a cushion for the government against the oil refiners, where volume refined arrests a cess based on profits booked, save capex.
  2. Unnecessary cess creating an import burden for oil refiners will also raise the retail price of oil and gold, leading to a inflation catastrophe. Limited cess on oil imports, and the movement of oil under GST, will reduce the petrol and diesel prices in the open market in India, leading to a uniformity of prices all across the states.
  3. Major expenditures for widening CAD is mainly due to oil, gold, imported machinery, and other intermediate goods, that can raise production back in India for lessening imports of such kinds. Gradual support under MoUs, under ‘Make in India’ initiative will create industry based infrastructure meant for low-end and mid-end manufacturing bases.
  4. Revaluation of the rupee will hurt the balance sheet of India Inc. for exports through non-controlled units, but a gradual rise in rupee involving the export basket will boost imports. Revaluation will also lead to the recognition of the rupee in the international corridor to address CAD.
  5. Reducing the loan rates will inject enough liquidity in the open market, reducing the inflation target of 2-4 % terms. More liquidity will lower interest rates to create credit growth, taming the rise of inflation.
  6. Interestingly, going by the 36 countries which are trade weighted, the real exchange rate of INR is currently overvalued by more than 17% relative to the base year of 2005. The real effective exchange rate of the rupee has actually gone up by 4.73%, since 2015-2016, while the nominal exchange rate of US Dollars fell by 9% during that same period. Decoupling with US Dollars for several countries, will allow a greater freedom, without being vulnerable to severe shocks in the USA.
  7. With a benchmark of Brent Crude touching more than USD 75 per barrel in the near future, inflation can close around 5%, which means tapping foreign reserves under RBI to arrest CPI, WPI and RPI. CPI, WPI and RPI means consumer price inflation, wholesale price inflation, and retail price inflation. RPI will be a chief cause of worry for the variation of retail prices under a geographical pocket, having heterogeneous prices.
  8. India and several other countries need to de-couple both the macro and micro financials and economics for arresting global shocks in oil and other basic commodities being imported, and arresting severe inflation to keep it under the target.
  9. Too much over dependency on the world’s reserve currency is actually hitting targets of inflation and CADs, which needs to promote currency transactions other than the USD, under targetted norms, to conceptualize regulated inflow and outflow of US Dollars. Pushing host currencies for international transactions will lead to severe arrest of the CAD.
  10. Setting up manufacturing bases for high-end to low-end segments under large scale manufacturing, especially related to electronic items, manufactured goods and items, including agriculture based products in India will reduce the burden in CAD.
  11. Macroeconomic based populism will lead to fiscal slippage, and bottlenecks for the RBI to reduce inflation targets and precautionary pressures, to make external sector vulnerable to any economic shocks, instead of trade protectionism and FTAs, asserting free trade agreements leading to severe non-protectionism, which needs to be closed as well.
  12. Overseas Corporate Bonds or OCBs, or even Domestic Corporate Bonds or DCBs will create a low interest buying program for the RBI against 7-8 % returns on these bonds after a fiscal target is achieved, including foreign reserves.
  13. Adding a surge to MSP or Minimum Support Price would actually create a certain surge in the per capita expenditure in any state leading to reversal of target measures, adding woes to inflation.
  14. Raising import barriers for basic items which are imported can actually be an impediment to the CAD, but eventually rational barriers to the imports will create a support for CAD and expenditures. Trade treaties supporting nominal duties can be more rational, being charged on savings, not volume of trades.
  15. Central bankers need to worry about the host currency transactions, which will lead to the real valuation of US Dollars, which can be under a severe pressure to maintain status as an international currency and valuation given the foreign reserves denoted and stored under the central bank coiffures of many countries. Diversified hedging of currencies will lead to rational trading in currencies reflecting real valuations, and more currency stabilities.

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