The Government has used our foreign currency reserves to address a severe rupee crunch in the kingdom. Last week they sold US$ 200 million from our reserves to pay off the Rs 8 billion outstanding debt on an overdraft account with the State Bank of India.
The Royal Monetary Authority borrows rupees from a special credit line with the Government of India and an overdraft facility maintained with the State Bank of India. The special arrangement with the Government of India permits our government to borrow rupees up to a maximum of Rs 3 billion, and the overdraft facility allows borrowings up to Rs 8 billion.
The RMA had exhausted both lines of credit before it recently cleared the Rs 8 billion loan.
The government has been remarkably quiet on the issue. So here are some questions, questions I will take up officially with them.
What caused the rupee crisis?
We import more goods and services from India than we export. So our trade balance with India is negative. And that causes a rupee deficit. But that has always been so. And that – the trade balance and the resulting rupee deficit – has always been easily resolved by the large amounts of rupees that the Indian government pumps into our economy in the form of generous aid to our government.
So why did we face such a big rupee crisis recently? Why did we have to borrow as much as Rs 11 billion to finance the rupee deficit? Rs 8 billion of that was borrowed in the past year alone, and that, in spite of increased Indian grant aid and huge inflows of rupees for the construction of mega projects.
The government has had to sell US$ 200 million to address the rupee deficit. Otherwise, RMA would not have been able to maintain the ngultrum’s exchange peg with the rupee. And we wouldn’t have been able to continue buying goods and services from India.
In other words, our economy was in serious trouble.
And the government had to bail it out by injecting US$ 200 million into it. US$ 200 million works out to Nu 10.3 billion at the current exchange rate. That works out to 14% of the GDP. And that is a huge bailout by any measure.
So why was our economy in such big trouble? What caused the rupee crisis?
What must be done to prevent another crisis?
Our foreign exchange reserves are not reserves in the strict sense – they are actually savings accrued carefully over several decades. The government has used US$ 200 million of it, in one go, to bail out our economy.
It’s obvious that if we don’t do anything different, if we don’t learn from our mistake, we will face another big rupee deficit by this time next year. Should that happen, the Constitution, which requires that foreign currency reserves must meet at least one year’s essential imports, will prevent the government from selling our foreign reserves for Indian currency. This simply means that the government will not be able to bail out the economy as easily as it has done this time.
So the question is, what must we do to prevent a similar crisis next year? How will the government prevent another rupee deficit from developing? What are the government’s plans?
How will the foreign exchange reserves be rebuilt?
The government has announced that the current reserves, equivalent to US$ 702 million, can finance 13 months of essential import. So even though the government has used up more than 20% of our reserves, what remains is still within the minimum limit set by Constitution according to which, “A minimum foreign currency reserve that is adequate to meet the cost of not less than one year’s essential import must be maintained.”
US$ 702 million at today’s exchange rate of Nu 51.5 for every US$ is about Nu 36.1 billion. And RMA has calculated that this amount – US$ 702 or Nu 36.1 billion – finances 13 months of essential imports. By dividing Nu 36.1 billion by 13 and multiplying it by 12 we now know that Nu 33.4 billion would be required to finance one year’s essential imports. The Constitution requires that the government set aside a minimum of this amount in the foreign exchange reserve.
But by this time next year, if the current trend continues, the volume of essential imports would have increased. That, plus inflation, would mean that the government would need set aside that that much more money in foreign currency to meet the minimum requirements set out in the Constitution.
But since the reserves must be maintained in foreign currency, there’s something else the government must think about: exchange rates.
Today the exchange rate has fallen to an all-time low. What when it strengthens? What if, by this time next year or the following year, the exchange rate rises to 2008 levels of Nu 40.4 per US$? That would mean that US$ 827 million would be required to finance one year’s essential imports at today’s quantity and today’s prices.
That would mean that the government would need to increase the foreign currency reserves by at least US$ 125 million. And that is without even factoring in increased consumption of essential imports and price increases for the essential imports.
The government has spent US$ 200 million. And the government has stated that the US$ 702 million remaining as foreign currency reserves is enough to meet the Constitutional requirements.
What we now need to know is how the government will replenish the foreign currency reserves to ensure that the reserves remain well within the minimum limits set by the Constitution. How will the government rebuild our foreign currency reserves?
Our economy was in serious trouble – that’s why the government used our foreign currency reserves. But that is only a stopgap measure, one that does not address the real issues and one that can be used only this once.
So the government must get serious. The government must identify its mistakes. The government must accept those mistakes. And the government must rectify those mistakes.
Otherwise, our economy, tiny as it is, will collapse.