The world over, people tend to view a strong national currency as a sign of virility, like an erect penis. That may be good sexology but it is poor economics. The exchange rate should be competitive. That often requires a weak rupee.
India’s exchange rate was Rs 71 to the dollar in early 2020. Then Covid struck and the rupee weakened to the range Rs 74-76 per dollar. Then came the Ukraine war and the exchange rate weakened further. It has now touched Rs 78.50 to the dollar and threatens to hit Rs 80. The Reserve Bank of India has been selling dollars to prevent this.
If the exchange rate falls to Rs 80 to the dollar, Opposition parties will scream that India’s prestige has depreciated and its honour has been devalued. BJP politicians will worry that this claim might cost votes in the Gujarat state election in December.
Too many people mistake a strong dollar for a weak rupee. The mix of Covid, the Ukraine war and rising interest rates has induced a rush of global money into the US. Hence the dollar has appreciated sharply against all currencies, not just the rupee. In the last year, the rupee has fallen 5% against the dollar, but the euro has fallen faster by 7% and the yen by 14%. India has appreciated against not just these currencies but even the Chinese yuan. India’s real effective exchange rate, measured by the 40-currency basket favoured by the RBI, is overvalued by 4%.
This is the paradox. Even as the public thinks the rupee is getting too weak, it is actually getting too strong, thanks to RBI intervention. That is the last thing India needs when falling export demand (because of a global recession) and rising oil prices are leading to a sharp worsening of the current account deficit.
Most developing countries are conserving their reserves to meet the coming crisis. But the RBI has run down its foreign exchange reserves from a peak of $640 billion in 2021 to $596 billion today. By selling dollars, the RBI has checked the rupee from sliding faster. But is this the right policy?
In theory the RBI is an independent institution. In practice it is a government arm. One hopes the RBI is not under political pressure to avoid crossing what the public may view as a major threshold of Rs 80 to the dollar.
Neighbouring countries including Pakistan and Sri Lanka are in dire straits because, among other failings, they kept their currencies too strong for too long, rendering their exports uncompetitive. They ran out of foreign exchange when the price of oil shot up. The lesson is that India should not attempt to check the rupee’s slide. Luckily, it starts from a much stronger position than its neighbours.
Optimists hope that a recession will reduce the other experts predict that chronic underinvestment for years in oil development will keep oil scarce for a long time.
World oil production is around 100 million barrels per day. Production in old fields declines by around 3 million barrels per day every year. New production of 3 million barrels/day is needed just to offset depletion of older fields.
Green activists have succeeded in making pariahs of major oil companies and putting hurdles in the path of fresh exploration. This may aid de-carbonisation in the long run, but in the short run will create persistent scarcities. Pessimists predict the price will cross $175/barrel.
Set aside such extreme scenarios. Right now, India’s current account deficit has suddenly widened and may touch 3% of GDP this year. In normal times this would be offset by a surplus in services trade and large net dollar inflows from abroad. Foreign direct investment has been strong, and this is stable money that will not flow out in a crisis. But foreign portfolio investment is falling sharply. Foreign investors have sold almost $40 billion of stocks and bonds in the last nine months, including $5.1 billion in May alone.
This can become a tidal wave if the current account keeps widening with a rising oil price. A mass exit of global money from emerging markets will mean a mass exit from India too, even if India’s position is better than that of others. The RBI should conserve its forex reserves to meet a crisis of that nature.
Above all, the RBI must stand up to political pressures to keep the rupee strong for reasons of pure image-manship. When India’s competitors are depreciating fast against the dollar, India should depreciate just as fast to stay competitive. If this means an eighty-rupee dollar, so be it.