Venkat, an investment banker, and Nikhil Akali, a senior executive in a captive BPO, both college mates, meet for dinner at one of their favourite restaurants. Nikhil doesn’t seem to be in his usual cheerful mood. Venkat enquires, “You appear bit dull today, what’s the matter?”
Nikhil speaks in a hazy voice, “It’s about the dollar-rupee thing again, with one going down and the other going up. Everybody in my industry is worried and all kinds of horror stories such as salary cuts and slow growth are floating around…I am not sure what’s happening.”
“I think this is something we must learn to live with. Today countries are so closely united and one man’s meat is becoming another man’s poison,” Venkat says philosophically.
The reserve currency
“The world adopted dollar as the reserve currency because of its ability to withstand any kind of onslaught, but suddenly why is it in trouble? Why is it giving nightmares for everybody?” Nikhil asks.
Venkat says nonchalantly, “That’s because the US is running a historically high trade deficit (it imports more than what it exports) and economists see this as the single most important factor affecting the value of the dollar. It’s simple — bigger the trade deficit faster will be the dollar’s decline.”
“But why is the US’ trade deficit widening,” Nikhil grows restive.
“Its due to pathological consumption,” Venkat continues, “If a country borrows to invest, it will be on the road to prosperity, but if it borrows to spend it will lead to despair.”
“Hey I am not getting a hang of it, can you explain,” Nikhil asks.
Borrowing binge
“The average US consumer has become a buyer instead of a seller. The consumption is not financed from the profits of the business but from borrowing. It goes like this: The US central bank (Fed) borrows from other countries such as India and China. Then the banks in the US borrow from the Fed and lend the money to consumers at ‘ultra’ low interest rates.
“This lower interest rates resulted in high credit demand, which were utilised for consumption, housing and financial speculation. Corporate credit demand for investment purpose remains weak as they have been borrowing heavily for mergers, acquisitions and stock buybacks and not for productive investment.
“The rest of the money was used to buy goods ranging from computer chips to potato chips that are made in China and India. As a result, Asian countries have been experiencing an influx of dollars and the US, an outflow of dollars. Most of the Asian countries found this game exciting and started lending more money to the US to keep their own export machines running.
“This acted as a double-whammy. While, on the one hand, the US wealth was getting transferred to other countries in the form of imports (remember when the US imports, exporting countries earn foreign exchange), financial speculation was slowly giving way to bubbles in the stock markets and the realty sector.
Rising bubbles
“Just imagine this situation, if the speculative money grows into the stock markets, companies in the US must make productive investments, which are simply not happening. So the stocks will not live up to expectations and will eventually fall to retrace their underlying values. On the other hand, when people borrow to finance their new houses, there must be sufficient creation of new jobs and salaries should be rising.
“Again, this has not been happening as the US has been shifting more and more jobs offshore and their own unemployment levels have been rising. So just remember any financial crisis arising out of realty or stock markets will further plunge the value of the dollar.
“While it is the high trade deficit that was depreciating the dollar, the appreciation the rupee is just the other side of the coin. India has been earning a lot of dollars and its foreign exchange reserves have been swelling.”
“But if you say if India has been earning a lot of dollars, why are our exporters, especially in the IT industry, feeling threatened?” Nikhil asks rather curiously.
“Unfortunately India is suffering from symptoms of Dutch disease,” rues Venkat.
The Dutch connection
“Hey I know Chikungunya and bird flu, but when did this new disease start,” Nikhil exclaims.
“The Netherlands during the 1960s discovered natural gas in their country. It started exporting the oil and earned a lot of foreign exchange. It resulted in its currency appreciating vis-À-vis other countries, which made their exports less competitive. And this is what happening to India also.
“India with its talented IT manpower started exporting software services. The country’s IT exports, starting from a few million dollars in the early 1990s, have now touched $40 billion and account for 65-70 per cent of the global off-shoring pie. It is one of the fastest growing sectors in the world.
“Apart from software, India is also emerging as a hi-tech manufacturing hub. So India has been earning a lot of foreign exchange and the IT/ITeS industry became a victim of its own success,” Venkat concludes as they both prepare to leave the restaurant after a lot of food for thought.
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