Oppn sharpens attack as rupee sinks to 70/$

Crisis in Turkey makes rupee the worst performer of the year, upsetting Modi govt’s fiscal math

NEW DELHI: The rupee plumbed new depths on Tuesday, dipping below 70 per dollar for the first time ever in a rout of emerging market currencies led by the Turkish lira, complicating the job of the Reserve Bank of India (RBI), potentially upsetting the government’s fiscal math and handing fresh ammunition to political opponents of Prime Minister Narendra Modi.

By the close of trading, the rupee clawed back some of its losses to end at 69.89 per dollar, up from its previous day’s close of 68.93. In intra-day trading the currency hit a lifetime low of 70.08, following a 1.6% drop in the previous day’s trading. The rupee’s loss of 8.7% so far this year makes it the worst performing Asian currency. Dealers said some state-owned banks sold dollars to bolster the rupee, perhaps at the behest of RBI. “The sharp drop in the domestic currency complicates the RBI’s job of keeping inflation in check as India imports oil and even if oil prices stay at the current level, it will cost more to buy it. Moreover, this is more worrisome for corporate entities that have for- eign currency borrowings,” said Soumyajit Niyogi, associate director, India Ratings and Research.

While the macroeconomic context is different (largely because of India’s comfortable foreign exchange reserves now), the situation is broadly reminiscent of 2013, when India was governed by a Congress-led United Progressive Alliance government.

In 2013, India joined the ranks of the so-called Fragile Five emerging market economies (the others were Turkey, Indonesia, Brazil and South Africa) amid a free fall in their currencies. A string of policy measures put in place by then RBI governor Raghuram Rajan helped the rupee stabilise then. At the time, Narendra Modi, who was then chief minister of Gujarat, attributed the rupee’s loss to mismanagement by the central government and not just economic factors.

On Tuesday, Congress president Rahul Gandhi took a jibe at Modi. “Modiji finally managed to do something that we couldn’t do in 70 years,” he said on Twitter.

NEW DELHI: In the abstract world of economics textbooks, a depreciating currency need not always be a bad thing. Currency depreciation can help countries improve their trade balance.

An example can help us understand this. Let us assume Indians imported only iPhones and exported only shirts. A fall in the rupee would make our imports more expensive, because Indians would be paying more in rupee terms for the unchanged dollar price of the iPhone. This would lead to a reduction in demand for iPhones and hence reduce our import bill. Similarly, an American retailer importing shirts from India would be able to get more shirts for the same expenditure in dollars. This would make him re-route more of his orders to India and lead to a rise in exports. An increase in net exports means an increase in economic growth.

The preceding discussion raises questions on the validity of alarmist commentary every time the rupee reaches a new low vis-à-vis the dollar.

Are such reactions driven more by warped notions of economic nationalism than actual economic interests? Not necessarily.The real world is often drastically different from the abstract assumptions of eco- nomic textbooks. The argument for currency depreciation leading to an improvement in trade balance assumes price elasticity of imports and exports. In simple terms, a commodity is described as price elastic if its demand is responsive to a change in price.

One of India’s biggest imports is crude oil. An economy cannot adjust its petroleum consumption with change in prices. Energy requirements are driven by level of activity and wealth in an economy. Herein lays perhaps the most important cost of a falling rupee for India. A fall in the rupee means a rise in price of India’s crude oil basket (COB). This implies a rise in fiscal deficit and inflation. A rapidly depreciating currency also deprives the economy from exploiting the gains of fall in international oil prices. Chart 1 shows the annual change in prices of India’s COB in dollar and rupee terms.

In 12 out of 18 years since 2001-02, the change in the rupee price of India’s COB has been unfavourable vis-à-vis the dollar price. This means that when oil prices have fallen, the rupee price has fallen less than the dollar price and when prices have risen, the rupee price has risen more than the dollar price. A bigger fall in the rupee at a time of rising oil prices is bound to increase this pain.

It could be argued that the logic of depreciation being beneficial applies to other sectors of the economy. Our non-petroleum trade balance could improve. Non Resident Indians (NRIs) could be sending more money in remittances because every dollar gets much more in rupee terms. Unfortunately, the argument does not lend itself to a simple empirical scrutiny.

Chart 2 plots movements in India’s non-petroleum trade balance and current account balance with the rupee-dollar exchange rate. It does not show an improvement in trade/current account performance with a depreciating currency.

To be sure, a multitude of factors apart from exchange rates affect trade and current account balance. This is even truer in today’s age when the multilateral trading system is in serious jeopardy and world’s two largest economies, the US and China, are heading towards a fullfledged trade war.

ATTEMPTS TO TRIVIALISE COST OF FALLING RUPEE ARE UNJUSTIFIABLE. WHAT IS ALSO TRUE IS THERE ARE NO EASY AND QUICK SOLUTIONS TO SUCH PROBLEMS