Let Rupee Find Its Value on Its Own

As the UPA government is celebrating its 9th year in power, Rupee has greeted them—the Prime Minister and his colleagues and the real power wielder in the present outfit, Sonia Gandhi—dancing down the hill merrily. 

As the oil companies continued to swarm the currency markets with their demand for dollars, rupee was pushed down to a new low of 55.39 per dollar on 22 May 2012.  Indeed at one point of trading, rupee touched an all-time low of 55.47 per dollar. The immediate fallout of the depreciating rupee is: Sensex lost by 1% to close at 16,026, while global markets rallied under the hope that Eurozone will soon shift to growth. 

As the fall of rupee continued, the RBI watched from the sidelines without intervening in the Forex trading, if market reports are to be believed.  And that appears to be the right course, for there is nothing much that it could really do either. 

Indeed, very recently, the RBI directed the Indian exporters to transfer half of their export earnings into rupee against the extant rule under which exporters are permitted to keep 100% of their export earnings in foreign currency. This measure is expected to bring in foreign currency of about $2.5 billion, which according to market analysts would suffice to fund the gap in the short term. Further, it has also imposed a cap on banks’ positions in the exchanges for trading currency futures and options at $100 million or 15% of the outstanding open interest, whichever is lower, and also directed them to bring down the positions within the limit by June 30.   

This may not really serve the purpose for long, for it is feared that the current deficit, which is currently at 4% of GDP, may rise further as the growth rate that has already fallen from 9% to below 7% by 2011-12, is all set to slide—as predicted by the market pundits—further. Yet, ours is considered to be the second fastest growing economy in the world. Ironically, it is this growth rate coupled with high inflation is what is fuelling the rise in imports. Which is why the current account deficit will continue to further widen, making the job of the RBI tougher. This increased need for foreign capital to fund its rising current account deficit will be further aggravated by the ongoing fall in foreign investment inflows as also the exiting of capital market by the FIIs under the fear of high risk usually ascribed to emerging markets. 

But the visibly upset Finance Minister says that the Eurozone debt crisis is to be blamed for the falling rupee, as it has impacted the Indian economy through deceleration in demand for exports from India and fall in the capital flows. But a dispassionate look at the whole episode tells a different story: domestic factors such as large and rising current account deficit, bloated fiscal deficit, which is incidentally worst among the BRICS countries, persistent high inflation rate, that too, mostly driven by supply-side constraints, which incidentally is dubbed as the highest amongst emerging economies, and reticence of the government in launching new reforms, have cumulatively made India a less favorite destination for foreign investors.

Market whisperings suggest that the RBI might launch a few more measures to checkmate the fall of rupee by augmenting dollar inflows into the country. One of such activities could be encouraging the NRIs to remit funds by inviting investments in specially floated bonds denominated in dollar currency, that too, at higher interest rate vis-à-vis the prevailing US rates. It may, to a certain extent, help in tiding over the fall of rupee further, but it will certainly become a terrific burden for the government at a later date, i.e., when servicing it, as it had indeed happened a couple of years back.

Looking back, some analysts opine that the RBI should have intervened in the currency market during end 2009 to 2011 when rupee had appreciated from 54 to 44 per dollar. Instead it kept quiet then, perhaps at the pressure of importers who obviously wanted rupee to be stronger in order to keep their import costs low. They further say that keeping away from market when the rupee is appreciating and intervening when it is sliding, that too, more because of weak fundamentals, is not a right exchange rate management policy for the RBI to adopt.

Some analysts even argue that in a way, the depreciating rupee might do good for the country, for it is certain to improve the export performance, while discouraging the imports whereby the current account deficit might shrink in the course of time.  Secondly, looking at the inflation differential of about 4% between the US and other important trading partner countries, it appears that letting the rupee find its real value—say around 65 over the next 6-7 months—is economically sensible.  

That said, the government cannot ignore the need for improving the investment climate in the country, besides improving the macro fundamentals by reining in fiscal deficit. It should therefore: come out of its stasis and align the oil prices with global prices at the earliest so as to not only reduce the mounting subsidies but also moderate the import of crude oil; professionally work towards de-bottlenecking the infrastructural constraints, particularly in sectors like power, telecom, oil and gas, fertilizers, airlines and textiles; and finally introduce a couple of reforms that would do well in uplifting the investment climate.   In the meanwhile, let the RBI focus on moderating the volatility in the market. 

As the government and the RBI are engaged in correcting the weaknesses in the system and improve the macroeconomic fundamentals, rupee shall find its own value. And that alone ensures sustainability.

-         GRK Murty