The free fall of rupee

Subir Roy

Senior Economic Analyst

THE steady downward slide of the Indian rupee against the US dollar is causing a good amount of anxiety in the public mind and subdued concern in the government and the arbiter of the country’s exchange rate, the Reserve Bank of India (RBI). This year, the rupee has lost 8 per cent of its value in terms of the dollar, going from Rs 72 to the dollar in January to Rs 79, with the possibility that it will breach the Rs 80-mark soon.

The exchange rate policy is to let the rupee slowly depreciate in an orderly manner. It is desirable because it is good for exports, which are thereby made cheaper.

To the lay public, a strong currency is a macho sign of economic robustness and a period of depreciation in the exchange rate points in the opposite direction. The government is concerned but does not feel there is a crisis at hand. This is because other emerging economies are in a similar position of seeing their currency lose value.

The real effective exchange rate worked out on the basis of the exchange rate of India’s 40 important trading partners currently stands at 104.9, which is above 100, the level that is considered fair value. So overall depreciation has hit them more than India.

The government’s concern is reflected by the actions that it has taken to stem the slide in the value of the rupee. The RBI has raised the overseas borrowing limits of Indian companies and relaxed the limits imposed on foreign ownership of Indian Government bonds. In response, more dollars will come in and this will stabilise the value of the rupee.

This is not all. The RBI has been selling dollars in the market, thereby raising the supply of the hard currency and easing pricing pressure on the rupee. These dollars are being taken out of the country’s foreign exchange reserves which have steadily declined in recent months, breaching the psychological barrier of $600 billion to currently stand at $588 billion.

But both active intervention by selling dollars and changing the rules have not been able to steady the market and turn sentiments in the positive direction. The rates being quoted in the forward currency market indicate that traders are betting on the rupee going down further. The option prices currently prevailing indicate that the expectation is that the rupee can go down to

Rs 82 to the dollar by the year-end.

Significantly, the rupee is depreciating not because of any emerging weakness in the Indian economy but due to the headwinds from the global economy. The key development that has turned the world upside down is the war in the Ukraine which has caused global energy prices to shoot up. This will disrupt economic activity all around the world and pull down the growth potential of the global economy.

Plus, the US monetary authority, the Federal Reserve, has indicated and, in fact, begun monetary tightening in order to drain out the excess liquidity that was released in order to fight the economic downturn created by the Covid pandemic. So the US economy will decelerate of its own accord and also in response to high global energy prices.

There is now a fear of a global economic recession, along with the rise in global commodity prices. This will affect Indian exports and through costly imports push up India’s inflation rate. This peaked in April at 7.8 per cent and then came down to 7 per cent in May. Even that is too high as the target range that the RBI has set is 2-6 per cent. Indian inflation has been ruling above this target for the fifth month in a row.

But actually, unlike there being an inflation rate which the economy needs to aspire to, the government does not have a target exchange rate and is not even in favour of a rupee that is and remains strong. The country’s exchange rate policy is to let the rupee slowly depreciate in an orderly manner. RBI intervention in the foreign exchange markets, then, should be limited to smoothening out short-term sharp fluctuations within a process of gradual depreciation.

A slowly and gradually depreciating rupee is desirable because it is good for exports which are thereby made cheaper. It also simultaneously makes imports costly which can act as a damper for import demand unless there is a level below which imports of essentials like fuel, metals and edible oils cannot go. All that the RBI and the government wants is to avoid shocks like the one administered by the Ukraine war.

It can be argued that the current depreciation of the rupee is quite desirable. Essentials like petrol, diesel and LPG have all become phenomenally costly and that should force the public to reduce, or at least put a cap on its consumption of these items.

There is an overriding reason why fossil fuel consumption needs to be curbed – to reduce the country’s carbon footprint, which it has internationally committed to do. As for edible oils, if high import prices force the government to get farmers to switch away from water-guzzlers like rice and wheat to grow sunflower and mustard, that will be all for the good.

The one area in which it may be counterproductive to curb imports is metals and manufactured components. As the country has embarked on a mission to become atmanirbhar and reduce manufactured imports, particularly from China, upping the manufacture of components and finished products will require higher imports of subassemblies. A depreciating exchange rate will make Indian manufactures costlier. This will undermine their exports and raise manufacturing costs for the domestic economy.

The cardinal aim before economic agents in the country should be to strive for greater value addition at home. The easy way is to import components from China, the tough and right way is to manufacture them at home in a cost-effective manner.

India’s highly successful software industry must also try to do as much of their work in their Indian development centres, that is, go for offshore development and not near-shore development, which strict visa rules are forcing them to do. All this will make for a stable economy and ease pressure on the rupee.