As August inched towards its end, Indian Rupee losing 26 paise on Friday dived to a record low of 71 against the US dollar. Of course, as the day advanced, rupee had recovered slightly as the public sector banks sold dollars. And the reasons for such a fall are not far off: the heavy month-end demand for dollars from importers, particularly from oil-importers and foreign capital outflows from the capital market plunged rupee to an all-time low. But what is more disturbing is: going forward the trend appears to be weak.
The earlier all time low was 70.16 per dollar. It all started with the political turmoil in Turkey which impacted its Lira vis-à-vis dollar and the contagion spreading to all other emerging market currencies. But it is the rupee that has become the worst performing currency in Asia, depreciating almost by 11% since January. It is our widening current account deficit—the excess value of goods and services imported over the value of goods and services that we exported— which is around 2.5% of GDP for Fiscal 19, that caused continuous shortage of dollar-liquidity which is primarily responsible for this fall. And, the sluggish growth in our exports is of no use in easing this liquidity crunch.
Of course, Reserve bank has been intervening in the currency market to slowdown the fall of rupee by selling dollars and in the process its reserves have indeed come down by $26 bn from an all-time high of $426.88 bn in April, 2018 to $400.8 bn for the week ended August 17. Yet, some dealers opine that RBI’s intervention is not matching to the kind of rising demand that the market is witnessing for dollars.
As the RBI pointed out, in the days to come, rupee is likely to be impacted by global risk factors such as: one, geopolitical developments in West Asia leading to sharp hike in crude oil prices; two, faster-than-anticipated pace of rate-hike by the US Fed; and three, trade-related tensions across the major trading partners such as the US, Eurozone, China, etc., and the resulting volatility in the financial markets.
That aside, even domestic factors such as the growing cost of the rising import of crude oil owing to rising global prices, lowering of goods and services (GST) rates on a range of consumer goods, the tax cut on small businesses and the relatively high minimum support prices declared by the government for agricultural produce are equally causing concern, for cumulatively they are certain to adversely impact the fiscal position. And, increased fiscal deficit is likely to fuel the inflation further, which in turn will have its own impact on exchange rates.
Here it is in order to recall what Raghuram Rajan, Profssor from Chicago University, has warned at this year’s Jackson Hole get-together of Central bankers. He said that risk is building up again in the system and the trade wars initiated by the US are potential-enough to trigger the vulnerability in the system into a crisis. And, the prevailing global and domestic risk factors that India is facing today are likely to expose us to such vulnerabilities.
As common sense would dictate, it is the importers who are very displeased with the falling rupee, for it straight away affects their profitability. But surprisingly, this time round even exporters are vociferously airing their concern against the depreciating rupee, of course, for a different reason. They lament that in the wake of continuously falling rupee, they are finding it extremely difficult to negotiate for a right price with their importers. However, at the same time citing REER, they also argue that any depreciation of rupee is a move in the right direction, for it makes rupee more competitive among the trading partners. And this, they argue, shall in turn give boost to our exports. But this appears to be a myth, for our exports have indeed grown when the real effective exchange rate has grown. That aside, what exporters need to bear in mind is the impact of domestic inflation likely to be caused by depreciating rupee on the costs of their exports.
Now, this raises a valid question: Should the policy makers let the rupee spiral down in this manner? There is no ‘the’ answer but the prevailing global factors warn us not to fall into the trap of exporters’ arguments. Even otherwise, the REER announced by BIS Board places it at 100.39, which means there is no overvaluation of rupee, while the REER of RBI calculated with 2004-05 as the base year against the currencies of China, Hong Kong, the US, Eurozone, Japan and UK currently stood at 123—meaning rupee is overvalued by 23% in relation to these economies. This difference demands for a fresh debate on the very calculation of REER by the RBI.
That being the reality, the only way to move forward is: improving our macroeconomic fundamentals and diversifying our exports in terms of products and destinations by improving the quality of our products. This obviously calls for requisite structural reforms on the lines that the RBI recently asked for, if we have to stop depreciation of rupee on long-term basis. And that is what the policy makers should address fast.