Dr D M Deshpande
Indian currency is in the news again, mostly for wrong reasons. It has been falling continuously for quite some time; in fact, it is the worst performing Asian currency against US dollar losing 12 per cent this year. To put that in perspective, currencies of all emerging markets have declined, but the slide in the value of rupee is the highest. Falling Rupee is linked to national pride, quite unnecessarily. And a lot of noise is made out of the currency movements in the markets.
Exchange value is determined by a host of factors, some of them quite complex. Essentially, in the long run, exchange value depends majorly on fundamentals of the economy. So, if the macro-economic indicators of the economy are strong and robust, currency will generally not depreciate. That is, if the fiscal and current account s deficit are with in limits, inflation at low levels, growth rate is high, then the economy is doing well. Converse is true when the economy slips and is under performing. Since we have a significantly higher level of inflation vis-a-vis our trading partners, it is natural that Rupee value declines over a time period reflecting this reality. Hence, in effect, it should not affect our national pride!
In the short run, however, exchange value is also influenced by what is termed by sentiments. It is a wide basket that can capture a number of things, sometimes even contradictory, at the same time. Like for example, inflationary expectations, interest rates going up in the US and other western advanced nations or a crisis in one or the other part of the world leading investors to withdraw and run for safer havens like dollar denominated assets.
It is a double whammy for the Indian vociferous Indian middle class. Sliding rupee on the one hand, and rising crude oil prices in the international markets on the other, have come together. Since retail prices of oil are decontrolled and determined by market forces, petrol and diesel prices too have sky rocketed. Taxes too are very high on petrol and diesel in India, almost 100 per cent on the former and 60 to 70 per cent on the later; this has also not helped the matters. There is therefore a clamour for arresting the fall in the value of Rupee. While falling Rupee benefits exporters and IT companies, there are some firms who are hit hard. To take advantage of low interest rates abroad, such firms have borrowed heavily. Now they find that their liabilities in rupee terms are going up by every passing day. They have also believed that the Government and the RBI will intervene should the Rupee depreciate quickly. Nor have they hedged their currency transactions, costs of which are quite high in India. If they had done that, they would have got protection in times such as now from depreciating currency.
The RBI has three options. The first and the most obvious one is to use the Reserves of around $400 billion to sell dollars in the market. With more dollars in the market, it is hoped that the slide in rupee is arrested. The second alternative is to raise the interest rates; this is justified because of rise in oil prices which has cascading effect on the general price level in the country. The current inflation data is also an indicator of the possible use of this measure by the Apex bank. Third, it could borrow dollars from Indian Diaspora; this has become a go-to destination in times of currency crisis. Of course, it has cost attached to it in terms of higher interest rate obligations.
The RBI has tried all these options in the past; unfortunately results were nothing to write home about. The Central bank did intervene in May 2013 when the US Federal Reserve started the tapering talk. It continued through September; while the RBI lost foreign exchange resources in the process, nothing was gained, rupee was the worst performer! All the other moves, tightening of liquidity, raising interest rates, talks of issuing bonds to NRI›s, just proved one point, that there was panic and it was showing in the series of reactions. Foreigners were keen to withdraw funds from the Indian markets in what became a self fulfilling prophecy!
Fortunately in comparison to May 2013, the economic situation is much better. Rupee fell by a massive 23 per cent then between Jan. to September. The fiscal deficit then was 4.8 per cent compared to 3.5 per cent now. Again Current Account Deficit was 3.4 per cent; now despite a sharp rise, it is still less than 2 per cent. Global crude oil prices then averaged $107; in 2018 they are at an average level of less than $75. At least a section of experts believe that the worst is over and oil prices should start declining soon. As against $285 billion forex reserves then, today the kitty is over $400 billion.
In nutshell, what is happening in currency market is bad, but our best option is to hold the nerve. RBI is mandated to control inflation; it is required to intervene to arrest extreme volatility only, not to defend rupee to any predetermined level. Panic will only send wrong signals and will make things worse for the economy to recover.