The Indian currency decline
Aug 29 2013
Furthermore, the rupee decline increases the implicit cost of India’s high foreign debt. As most problems have to be looked from their causes, the same holds for the Indian rupee. The big question is why is the rupee declining?
India runs a large current account and fiscal deficit. With such deficits, the country needs to attract sufficient dollars to close the gap; whereas, a weaker home currency makes that costlier. The current situation is worrisome because in India, the growth is slowing, inflation remains high, and political paralysis has stymied domestic overhauls.
First, India’s budget and current account deficits are responsible for the rupee’s slide, according to the nation’s finance minister, P Chidambaram. The minister reports that the government will be taking steps to contain the shortfall in the broadest measure of trade to within $70 billion in the year through March 2014, compared with an unprecedented $87.8 billion in the previous period.
Secondly, according to Bloomberg, the recently passed food bill has a role to play in the declining rupee crisis. For example, the planned spending of about Rs1.25 trillion ($18.3 billion) in subsidies each year will potentially worsen the fiscal gap.
In addition, according to Bloomberg, the increasing Indian oil imports also have a role to play in the rupee decline. For example, the nation’s petroleum imports averaged $14.2 billion in the first seven months, compared with $13.9 billion a year earlier as per government sources. These imports require the country to spend its valuable foreign exchange, which causes increased pressure on the current foreign exchange reserves.
Still, there seems to be another problem: the EU banks. Beyond India’s borders, EU banks are trying to reduce their percentage of debt and this reduction has caused investment money to be flooded out of Indian markets. If European debt troubles worsen, India could be hit with a balance of payments crisis.
According to the New York Times, a fundamental factor involves the country’s trade deficit, which is becoming a more serious problem, judging by the government’s mounting concern about gold imports. Gold and oil constitute around 45 per cent of imports, and with oil price remaining steady, evidently gold imports have financial process. With the decline in the rupee, such imports into India will become more expensive, because countries that export oil to India are paid in dollars.
Although the rupee has been declining, the depreciation does have some advantages as well. For example, the decline makes Indian goods cheaper overseas and therefore more attractive to consumers, which benefits exporters.
However, according to the New York Times, exporters may not actually see significant gains as the global economy is still stagnant and the price advantage on exported goods may not materialise any time soon given their relative inelasticity. In fact, some importers of Indian goods are asking exporters to lower their prices on account of this price advantage.
At present, the Indian government is attempting several things to stem the rupee’s decline, including trying to increase import taxes on gold and limiting how much money Indians can send abroad. For example, in July, after the rupee hit an earlier low, the Reserve Bank of India (RBI) made moves to raise interest rates to tighten liquidity in the domestic market. When that didn’t help, the bank changed track, announcing it would take action to flow more cash into the economy to bring interest rates down and usher in growth.
So, what’s the bottomline? With the rupee declining, investors would start looking for more RBI intervention in the market. The basic process will be that public-sector banks would start selling dollars in the market, which could allow for tempering of the rupee’s fall. The second defence could be through direct intervention by the RBI to sell dollars in the market.
The New York Times believes that this action will directly affect not just the fundamentals but also investor sentiments. However, there are limits on this intervention as there are limits on India’s foreign currency assets. One step RBI could take is to lower interest rates to ensure stability in the foreign exchange market before taking further monetary policy action.
(The writer is on the faculty of Indian Institute of Technology, Mandi, India)