There is little government or RBI can do on falling rupee. Lessons of May-August 2013 shouldn’t be forgotten
The rupee has come under renewed pressure, falling to an all-time-low of 69.09 to the dollar in intra-day trades on Thursday. Two of the reasons for it — rising crude prices, resulting in a widening of India’s current account deficit, and unwinding of easy money policies by major central banks causing global interest rates to go up and also triggering capital outflows from emerging market economies (EME) — were known even at the start of this year. But there have been two other developments, which weren’t fully factored in. The first is global growth, which hasn’t been as strong or synchronised as was being projected by agencies such as the International Monetary Fund. The US economy has continued to grow, but others have been losing steam. That has contributed to a stronger dollar and, together with the US Federal Reserve raising interest rates to counter the Trump administration’s fiscal stimulus measures, accelerated fund flight from countries such as India. The other development has been heightened trade wars and sanctions on Iran. While the US has been the initiator in both, the resultant uncertainties and upward pressure on oil prices has primarily impacted EMEs.
There is little that the government or the RBI can do in these circumstances. Since April, foreign portfolio investors have made almost $ 9.1 billion worth of net sales of equity and debt in Indian markets, while the RBI, in trying to prevent the rupee’s free fall, has seen its foreign exchange assets deplete by over $ 16.9 billion. A falling rupee will, no doubt, add to the woes of international crude prices that are already at their highest since November 2014. But it will also make India’s exports more competitive. Moreover, the rupee’s exchange rate should be seen not just against the dollar. In “real effective exchange rate” terms — that is, against a basket of 36 currencies and adjusted for inflation differentials vis-à-vis the respective countries — the rupee is even now about 7.1 per cent stronger than in May 2014, when the Narendra Modi government came into power. A gradual weakening may, in fact, do more good than bad.
The right policy response in today’s volatile environment for global capital flows is not to do anything silly. That would mean not succumbing to election-time pressures. Sharply hiking MSPs for crops or slashing excise duties on petrol and diesel would be counterproductive. The lessons of May-August 2013 shouldn’t be forgotten. The run on the rupee witnessed then was a result of global investor worries over India’s “twin deficits”. A sell-off on that scale, forcing the RBI to increase interest rates just when the economy is in recovery mode, would be truly disastrous — both economically and politically.