How to rescue the falling rupee

August 23, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

I can’t predict where the rupee will eventually land and I don’t think anyone else can either.

Of course, we are not the only country at the mercy of the dollar because almost every emerging market is suffering. But surely, that shouldn’t be any consolation.

The rupee has depreciated about 50 percent in the past three years and 15 percent this year. The situation is extremely worrying for us because of the debilitating impact it will have on India’s economic fundamentals that have been pushed to the brink by global factors.

The dollar seems to be flexing its muscle and violently at that. The U.S. Fed minutes did not soothe jangled nerves and markets continue to expect that QE3 tapering will commence in September. The U.S. trade deficit seems far healthier than a year ago and the country’s economy is in better shape. QE3 tapering is a foregone conclusion. But when it does hit us, I expect a lot more pain.

In India, there is a sense of despondency in the wake of policy announcements that haven’t really been executed. There is a sense of loss of credibility. It is unfortunate that these strains have surfaced in the midst of a change of guard at the Reserve Bank of India (RBI).

Sadly, we can’t say we did not see it coming. The RBI has been pointing to the twin deficits – fiscal and trade – for long while waging a losing battle on the monetary front. The International Monetary Fund (IMF) pointed out early this year that our fiscal deficit and inflation were among the highest in emerging markets. Our dependence on hot FII portfolio money was always there for all to see.

Our government, the markets and the rupee hid behind a huge wall of liquidity in the global markets. Looking back, it almost seems as though the RBI commenced its interest reduction cycle a bit too early and the outgoing governor did not wish to leave without correcting what he may believe was an error in policy judgment.

The fall in the rupee is a mere manifestation of the deeper malaise – high inflation, low interest rates combined with low growth.

The root of the problem lies in the consistently negative rate of interest imposed on savers. An open economy has its own ways of correcting artificial imbalances created by its policymakers. Negative real interest rates will almost always break out into currency depreciation. When this happens, no amount of intervention can help till the currency finds its right level.

Holding on to negative real interest rates for a long time has driven household savers into non-financial assets – in India, that means gold.

To begin with, there needs to be a true gold alternative. In the past few years, gold ETFs and loans added to its liquidity. Banks and PSUs pushed gold coins to cash in on the craze. Buying gold in India is as easy as buying a bar of chocolate.

Inflation-linked bonds can never be successful as an alternative to gold unless the government is courageous enough to give post-tax inflation-linked real returns. At the same time, gold loans and ETFs should be made inaccessible.

It’s time to also go back grovelling to the NRIs hoping that they will return for the premiums over international dollar interest rates.

Also, shouldn’t we open up incoming FDI for all sectors, except those considered sensitive to national interests? Especially for infrastructure, capital-intensive and environmentally safe projects. One would rather approve outgoing FDI on a case-by- case basis ensuring that, like in the case of China, they are in national strategic interest.

I do not see anything wrong in heavily taxing imports of luxury consumables and durables; and preventing low-value imports that can be produced locally. Given our vulnerabilities in coal and oil-based energy, pretending that we can do away entirely with capital controls is utopian.

The other day, a friend told me that “it was easier to import than transport” in India and there lies the real solution in the long run. Our manufacturing sector has to grow aggressively and has to be provided with enabling infrastructure. India needs to promote its own economic union with the goods and services tax. We spend an estimated $25 billion on defence imports; after 60 years we surely can do something to substitute this.

While NREGA and food security can be justified, inflation led by fiscal deficit has to be controlled by eliminating indirect subsidies and freeing up agricultural trade. To revive the rupee, we need to rein in the twin deficits. At the same time, painful as it may seem, we need to hold on to interest rates at a ‘real’ level to encourage household savings.

Most importantly, we need a majority government with a clear mandate for development. For now, India will have hold on till the next elections.

6 comments

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The Rupee devaluation is cost by excessive usage of exported items in our day to day life. So Government should work with people to solve the issue. Government should make the public transportation easy to use by all metro people. Work with state governments so that the train and buses are synched to reach any place in time. It will reduce the excessive oil usage in private cars and two wheelers. Use indian available coal for energy and use it in trains..This will reduce our dependency in export market. Also make Women group similar to self help group in sharing gold ornaments so that the gold ornaments can be part of the group which they can use when there is any function. Same time the gold of selp help group should be registered with banks.. That way Gold will be part of government.

Posted by MAlwar | Report as abusive

The food security bill is not going to benefit the poor but instead the politicians. Hence it is not in the interest of the country to pass such bills.Te damage is already done. One can only wait and see how it is implemented? I hope no more scams come out like the fodder scam and likes of that.We have failed miserably in implementing the schemes.

Posted by jgaiyer | Report as abusive

Rupee’s collapse is due to large current account deficit that is due to large petroleum , fertiliser and gold imports. If we had stabilised our population at 800 million these problems wouldn’t have been there at 1200 million population. Things would get worse soon may be rupee will touch 100 mark if we don’t work towards stabilising population. It is high time our politicians debate how they are going to freeze population in their constituencies.

Posted by KCSINGH | Report as abusive

A simple way to increase the value of Rupee against $, Just increase the purchase of oil from Iran with Indain rupee as transaction currency, rather than $…

Posted by Aravindan.V | Report as abusive

Food Security Bill, a pseudo commitment by the government. Definitely it does not provide any security, we all know the saying “Give a man a fish and you feed him for a day. Teach a man how to fish and you feed him for a lifetime”. The dollar-rupee vicious circle can lead to disastrous economy further. There has to be very open measures to save the country.

Posted by Nikhilesh.K | Report as abusive

The Indian Rupee is our national pride. Indian Rupee is a pillar of our nation, imparting hope and reassurance to Indians. We must have a strong Rupee. We must take initiatives to make the Indian Rupee robust. It is not impossible. We must have the will to do it. We must have dreams to make it a reality. There are many benefits of a strong currency. We should never be afraid of a strong Rupee. It will help keep prices down in a nation with a large appetite for imports. That is beneficial for the economy – and for struggling households nationwide. To go back to history for the purpose of an example – let’s take the case of the erstwhile German Mark. When it was legal tender, the German Mark was famous for its strength. Yet it did not hinder Germany’s export trade at the time it was in use. It rather made German exporters innovative and efficient. Because of that culture of innovation amongst German manufacturers, today, in the era of the Euro, despite the price advantage China enjoys, German goods are still sought after globally. Isn’t this an example we could keep in mind when advocating for a strong and robust Rupee?

A strong currency reduces the cost of imports, helps to keep prices in check. Say, if the price of the Rupee doubles from its current value, the price of imported oil, machinery, technology, and everything else is cut to half. A strong Rupee will attract foreign capital and encourage domestic savings. Businesses prefer to invest in a place where values tend to rise with the currency. A strong Rupee will encourage producers to be as efficient as possible. When domestic costs rise with the currency, producers run a tighter ship yet more efficiently. That is the path to progress.

Conversely, devaluing the Rupee simply makes everyone poorer. Most people keep their savings in the national currency. So, they are directly impoverished by devaluation. The only people helped (and only over the short term) are the relatively few companies that export. The idea of allowing of devaluation of the Rupee to make things better for the economy, according to me, is not a good solution to stimulate the economy.

Posted by VickramJaitha | Report as abusive