Brave, New World Of Fall­ing Ru­pee

India Business Journal - - CONTENTS -

The ru­pee has slipped by around 7.5 per cent against the dol­lar over the last six months. Mul­ti­ple fac­tors have con­trib­uted to the re­cent de­pre­ci­a­tion of the cur­rency. Tighter oil sup­plies, geopo­lit­i­cal ten­sion and US sanc­tions on Iran have sent global crude oil prices soar­ing and bloat­ing In­dia's dol­lar de­mand.

Huge dol­lar purchases by oil im­port­ing com­pa­nies, along with spec­u­la­tive ac­tiv­ity, have largely weighed on the ru­pee. In­dian im­porters have rushed to pur­chase oil which is in short sup­ply. This has caused the value of the ru­pee, which is used to pur­chase the dol­lars re­quired to buy oil in the in­ter­na­tional mar­ket, to fall.

Be­sides, trade war ten­sion has sent some cap­i­tal de­ployed in emerg­ing mar­kets back to the US. This re­flects in­vestors' tra­di­tional flight to safety in times of un­cer­tainty. More­over, tight­en­ing of mon­e­tary pol­icy by the US Fed­eral Re­serve has caused the price of Amer­i­can debt to fall and yields to rise. This, in turn, has also pushed in­vestors to pull money out of In­dia and other emerg­ing mar­ket economies to in­vest in the US, where they can get higher re­turns.

The ru­pee's fall has raised fears of a re­peat of the cur­rency cri­sis of 2013 when the cur­rency suf­fered a dras­tic loss of about 20 per cent in just a few months. Though the slide this time too has been largely trig­gered by global cues rem­i­nis­cent of the ta­per tantrum episode in May 2013, the de­pre­ci­a­tion in 2018 has been far more or­derly.

The fi­nan­cial mar­kets ap­pear to be tak­ing com­fort from the fact that In­dia's macroe­co­nomic fun­da­men­tals to­day are in far bet­ter shape to han­dle ex­ter­nal shocks than they were in 2013. De­spite the ris­ing im­port bill, the coun­try is ex­pected to run up a Cur­rent Ac­count Deficit (CAD) of 2.5 per cent of GDP in FY19, far lower than the 4.8 per cent in FY13.

Thanks to its stock­pil­ing of dol­lars over the last two years, the RBI's for­eign cur­rency re­serves at a lit­tle over $400 bil­lion pro­vide im­port cover for nearly 10 months com­pared to barely seven months in FY13. But pol­icy-mak­ers can­not af­ford to re­lax their vig­i­lance. The fun­da­men­tal macroe­co­nomic in­di­ca­tors can de­te­ri­o­rate very quickly in­deed in the event of a run on the cur­rency.

In fact, a slid­ing ru­pee can set off a vi­cious cy­cle on the CAD and in­fla­tion num­bers. For­eign port­fo­lio in­vestors (FPI) are known to re­act in a knee-jerk fash­ion to dwin­dling dol­lar re­turns. The RBI has tried to pre-empt such out­flows by rais­ing the FPI ceil­ing for bonds and re­lax­ing its resid­ual ma­tu­rity con­di­tions. But then, In­dia's FPI flows in the last cou­ple of years have fea­tured a lot of hot money chas­ing rate dif­fer­en­tials.

Many an­a­lysts note that for some time now, the ru­pee has been sig­nif­i­cantly over-val­ued on a REER (Real Ef­fec­tive Ex­change Rate) ba­sis rel­a­tive to its trade part­ners. In­dia's for­eign ex­change re­serves can­not be squan­dered on de­fend­ing a rate that is at vari­ance with mar­ket re­al­ity. So, the RBI can in­ter­vene only to smoothen out volatil­ity in the cur­rency and not to peg the ru­pee to a par­tic­u­lar rate.

Given the cir­cum­stances, it is best that the RBI al­lows an or­derly cor­rec­tion of the ex­change rate. It should step in with mar­ket in­ter­ven­tions only if there is the need to fend off spec­u­la­tive volatil­ity. This is ex­actly what the RBI is do­ing as the ru­pee keeps fall­ing grad­u­ally. Per­haps it is now time to say good­bye to the panic sur­round­ing the weak ru­pee. Wel­come to the brave, new world of Rs 68 to a dol­lar, and this seems to be the new nor­mal.

Many an­a­lysts note that for some time now, the ru­pee has been sig­nif­i­cantly over­val­ued on a Real Ef­fec­tive Ex­change Rate ba­sis rel­a­tive to its trade part­ners. In­dia's for­eign ex­change re­serves can­not be squan­dered on de­fend­ing a rate that is at vari­ance with mar­ket re­al­ity. So, the RBI can in­ter­vene only to smoothen out volatil­ity in the cur­rency and not to peg the ru­pee to a par­tic­u­lar rate.

De­spite eerie sim­i­lar­i­ties with the fall of 2013, the ru­pee's slide this time is not dis­con­cert­ing.

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