Creeping devaluation is upon us. Two days ago we saw the rupee closing at 115.4 against USD, a fall of 4.4 percent in a day. This follows the fall of 4.7 percent to Rs 110.5 in December 2017. According to experts, the cumulative 9.4 percent depreciation against USD is going to help boost exports and slowdown imports growth. But the impact on remittances remains unclear. In a nutshell, this would let the current account deficit to marginally thin and help the cause of addressing external woes. The CAD in Feb18 is down to $1.24 billion from $1.67 billion in January - the impact of depreciation on CAD is already visible.
The impact on inflation would be less than the quantum of depreciation. Since major commodities prices (part of CPI basket) are already at premium to international prices, inflationary consequences of depreciation would remain subdued. Headline inflation has remained low since Dec17; and the trend may continue. Since the price adversary is low, the dent on economic growth would not be much due to fall of rupee. However, it is pertinent to note here that the equation of growth and inflation can turn ugly in case of too much depreciation. And that is not good for exports as the marginal impact of currency fall dilutes with incremental depreciation. However, imports can keep on falling against higher depreciation but at a higher cost of breaking GDP growth momentum, which is not desirable.
The more important question is how much depreciation is warranted. For evaluating that there is a need to see the impact of currency fall relative to trading partners. The indictor best covering this aspect is Real Effective Exchange Rate (REER). The REER was at 124.1 in Nov17 and it has come down to 115.1 on Jan18. The depreciation against USD, before yesterday's depreciation, was a mere 4.7 percent while the REER is down by 7.8 percent. The reason for higher REER drop is that the USD is weakening against global currencies and depreciation of PKR against Euro, British Pound and Japanese Yen was 9.2 percent, 9.4 percent and 11.4 percent, respectively.
After the latest depreciation, assuming rupee dollar parity continues to hover around 115-116 level, the cumulative depreciation against USD becomes 9.4 percent, while against other three currencies, reaches 14.5 percent, 14.7 percent and 15.9 percent, respectively. This will make REER come down to 110 level in a month or two. And if the USD continues to weaken, a likely outcome, against other currencies, by May-June REER would adjust further down to 105. That is a decent number and another around of similar adjustment of the rupee against USD by June end would bring the REER to its equilibrium value - square 100 mark.
But the IMF is more concerned on the external woes; as per IMF latest country report, the net international reserves were minus $724 million in Feb18 versus $7.5 billion in Sep16 when the Fund programme was concluded. The fall of $8.2 billion in 18 months is a cause of concern and the fund would look at it closely and may push authorities to depreciate rupee further. The need is to keep the currency at current level (Rs 115-116 per USD) till June and if needed, take it down to Rs 120 per USD and then sit tight to reap the fruits of depreciation. Any further slide in currency from Rs 120/USD would be counterproductive.