Why all the fuss over rupee depreciation?
With the rupee shedding over 10 per cent in value since the last week of July, there is a lot of attention on the volatile nature of the Indian currency yo-yoing with the US dollar. But, the current free fall in the domestic currency to Rs 49-50 levels is in a way mirroring a historical trend.
In early controlled exchange rate regime, the rupee exchange rate hovered around Rs 4 in the 1950s, Rs 5 in the 60s, Rs 7 in the 70s, and Rs 8 in the 80s. The liberalized era of 90s was different, the rupee moved in the Rs 20s (the rupee was also partly decontrolled in early 90s) and Rs 40 in the decade of 2000.
Not to forget two major devaluations by the government in between. The rupee was devalued first in 1966 by a massive 60 per cent from Rs 4.76 to Rs 7.50 against the US dollar. Twenty five years later in the 90s, the rupee was again devalued by 20 per cent from Rs 20.5 to Rs 24.5 against the US greenback.
The reasons for the two devaluations were not too dissimilar; twin deficit (current account and fiscal), soaring inflation, insufficient foreign exchange reserves, and the developed world demanding decontrol and liberalization to allow them to do business in India.
Pranab says RBI to look into rupee slide if necessary
But, the reason for the current round of rupee depreciation is related more to current grim global economic environment. The currency of every other emerging economy - barring China that managed its currency peg against the US dollar - is falling like nine pins.
The currencies of Russia, Brazil, South Korea, and Indonesia have plunged by between six per cent to 16 per cent since January this year. So the 10 per cent fall in the value of rupee against the US dollar is hardly out of context.
Still, the ill-fated dollar is finally emerging from the debris thanks to euro crisis. The sovereign debt woes of European Union are shifting foreign investors from euro assets to dollar assets. There seems to be no other alternative to US dollar. The gold rush, too, is waning a bit as there is now a feeling of a bubble building up.
Where does this leave the rupee? There is no support from the domestic economy. Foreign institutional investors are already fleeing Indian equity markets. The FDI investments unlike China were never big into India, anyway.
Inflation is near all-time highs and interest rates are pinching companies as much as home borrowers. The fastest growing economy is also turning out to be the slowest in terms of reforming the economy or tackling pressing economic issues.
Rate hikes will not tame inflation, says India Inc
So, all eyes - read: importers - are on the Reserve Bank of India, or RBI, to pull a rabbit out of the hat. But that is easier said than done. If the Mint Street sells dollar to arrest the rupee fall, the apex bank has to pare down its foreign exchange reserves, not matter how huge it is.
Secondly, this will also result in sucking out equivalent amount of rupee resources from the system, potentially squeezing liquidity. But the catch is any aggressive (mild ones will continue) open defence by the RBI to arrest fall will be read as an inherent weakness of the rupee vis-Ã -vis the dollar. That will mean giving speculators a chance to create further havoc with the likely rupee fall.
In fact, the RBI was in a similar situation in the 2007/08 period when rupee actually appreciated on the back of dollar inflows from foreign institutional investors into Indian equity markets. The exporter community cried hoarse from the rooftops but the central bank allowed the rupee to find its own level though with minor intervention. The rupee finally appreciated to a record Rs 39.37 levels in January 2008.
Like all the earlier phases in rupee's journey, the current phase of depreciation will also pass and rupee will find its own level.
The reasons for the two devaluations were not too dissimilar; twin deficit (current account and fiscal), soaring inflation, insufficient foreign exchange reserves, and the developed world demanding decontrol and liberalization to allow them to do business in India.
Pranab says RBI to look into rupee slide if necessary
But, the reason for the current round of rupee depreciation is related more to current grim global economic environment. The currency of every other emerging economy - barring China that managed its currency peg against the US dollar - is falling like nine pins.
The currencies of Russia, Brazil, South Korea, and Indonesia have plunged by between six per cent to 16 per cent since January this year. So the 10 per cent fall in the value of rupee against the US dollar is hardly out of context.
Still, the ill-fated dollar is finally emerging from the debris thanks to euro crisis. The sovereign debt woes of European Union are shifting foreign investors from euro assets to dollar assets. There seems to be no other alternative to US dollar. The gold rush, too, is waning a bit as there is now a feeling of a bubble building up.
Where does this leave the rupee? There is no support from the domestic economy. Foreign institutional investors are already fleeing Indian equity markets. The FDI investments unlike China were never big into India, anyway.
Inflation is near all-time highs and interest rates are pinching companies as much as home borrowers. The fastest growing economy is also turning out to be the slowest in terms of reforming the economy or tackling pressing economic issues.
Rate hikes will not tame inflation, says India Inc
So, all eyes - read: importers - are on the Reserve Bank of India, or RBI, to pull a rabbit out of the hat. But that is easier said than done. If the Mint Street sells dollar to arrest the rupee fall, the apex bank has to pare down its foreign exchange reserves, not matter how huge it is.
Secondly, this will also result in sucking out equivalent amount of rupee resources from the system, potentially squeezing liquidity. But the catch is any aggressive (mild ones will continue) open defence by the RBI to arrest fall will be read as an inherent weakness of the rupee vis-Ã -vis the dollar. That will mean giving speculators a chance to create further havoc with the likely rupee fall.
In fact, the RBI was in a similar situation in the 2007/08 period when rupee actually appreciated on the back of dollar inflows from foreign institutional investors into Indian equity markets. The exporter community cried hoarse from the rooftops but the central bank allowed the rupee to find its own level though with minor intervention. The rupee finally appreciated to a record Rs 39.37 levels in January 2008.
Like all the earlier phases in rupee's journey, the current phase of depreciation will also pass and rupee will find its own level.
Courtesy: Anand Adhikari
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