D M Deshpande
Rupee has breached the 70 a dollar mark and there are voices of concern all around. Some say it’s a blessing in disguise for, it helps boost exports and reduce expensive imports. Others argue that benefit for exporters is far outweighed by the cost it puts on the importers and the economy. They point out that a single import commodity such as crude oil will put pressure on inflation in the economy. They do have a point, in fact, everyone has a point. That is why the English economist Joan Robinson famously said for every statement about India, the converse is equally true! Almost the same could be said about the exchange rates, too.
Foreign exchange rate is influenced and determined by a complex set of factors. Yes, fundamentals in the economy have an upper hand. But aren’t their times when fundamentals are strong and the currency is falling? In the short run, sentiments play a major role in shifts that occur in currency markets. Studies show that one can make a reasonable projection of currency value over a period of 36 months and above. Any shorter term prediction is actually no more than a guess work like spinning of the coin and taking a call!
There is little doubt about the fact that the immediate trigger for the fall was the Turkish Lira which fell by a massive 30% since last Friday. However, there’s no explanation as to why India caught the ‘Turkish Flu’. While all major Asian currencies fell, the decline in rupee value was in stark contrast. Rupee fell by 2.1% while others by a mere 0.7%! Surprisingly, there’s nothing much in common between Turkey and India. Turkey’s deficit is more than twice when compared with India’s; it’s foreign currency borrowing too are twice of India’s when measured in terms of percentage of GDP.
Turkey has been battling falling currency and other grave economic problems at least since June. The political differences with the US have worsened the economic situation in that country. Take for instance, the immediate fall out of the diplomatic spat, the imposition of stiff duties on it’s exports to the U.S.A. What was already a dire problem, has only been accentuated now. But how did the contagion spread to India? Financial markets operate under certain misconceived classifications. Look at the tag of ‘emerging markets’; it has countries and countries, from Argentina to Latvia to Brazil and India. They all may have different fundamentals, yet they are clubbed under a single category. When one of these countries faces rough times, as Turkey this time, there’s a flight of capital from other nations too, to so-called safer havens. This would definitely put pressure on the domestic currency.
It is also important to remember that Indian rupee is the worst performing Asian currency in 2018, down by 8.8% against US dollar. It is not as if rupee has fallen only against dollar, it has precipitous decline against other hard currencies too such as Euro, Sterling and the Yen. Obviously, therefore, there are inherent weaknesses underlying the falling currency. It would a bit of an exaggeration to say that there is a run on the rupee. The decrease has been steep and certainly not a calibrated one over a period of time that could have given the soft landing to the economy.
The RBI has intervened in the markets by selling dollar reserves it has. As a combined result of it’s sale and investors moving money to safer and dollar denominated assets overseas, the foreign exchange reserves with the RBI have declined to $403 billion in the first week of August from $426 billion in April this year. The Apex bank needs to be careful because its open market operations could lead to steep decline in reserves in a short span of time. That in itself could lead to more problems as a result of self fulfilling prophesies.
As per current indications, the Federal Reserve will hike interest rates all through the year. This will dent dollar inflows in to several emerging markets and India won’t be an exception. Growing deficits will mean two things-high current account deficit will result in impending balance of payment problems. And second, splurging fiscal deficit, in an election year, will only add to the inflation woes in the economy.
One short term measure could be to attract NRI funds from abroad. Besides imposing additional cost on the economy in term of higher rupee returns, it is at best a short term measure. Long run rupee weakness can be curbed by doing right things again and again-boosting exports, reducing deficits and improving ease of doing business.