Dr Ashwani Mahajan
Once again rupee is in crisis and has depreciated by nearly 5 percent since August, 2018, from rupees 68.7 per US dollar to nearly rupees 73 per US dollar by October 5, 2018. Prime Minister Modi has taken over the command to manage this crisis. If we see overall depreciation it’s more than 13 percent during 2018. Present decline in rupee value has been primarily due to outflow of foreign institutional investors and rising crude prices.
Conflicting Signals
Whereas, generally people are worried due to depreciating rupee, those at the helm of the economic affairs are busy making their own, generally personal views about the value of rupee, which is sending conflicting signals. Recently Vice Chairman of NITI Aayog expressed the view that rupee is overvalued and therefore it is expected to fall further. The former Chief Economic Advisor before leaving India had expressed similar views. Economic Affairs Secretary Subhash Garg had said that rupee can go even to rupees 80 per US dollar. Interestingly Prime Minister Modi during his last election campaign had criticized these UPA regimes for having ruined the rupee. Under these circumstances constantly falling rupee and irresponsible statements by important Government functionaries are actually causing embarrassment to the Government.
RBI’s Role
As Central Bank of the economy Reserve Bank of India, is considered to be the custodian and controller of foreign currency. Though the exchange rate (value of rupee in terms of foreign currency) is determined by the market forces of demand and supply, role of RBI’s interventions is also of great importance. Supply of dollars comes from the export of goods and services and also by inflow of foreign investment, both FDI and portfolio investment. On the other hand, demand for dollar comes from import for goods and services and outflow of foreign investment. If demand for dollars exceeds supply for dollar rupee depreciates, and more rupees are shed for every dollar. Same is happening at present as outflow of FIIs and rising crude prices are causing demand for dollars exceed their supply. Therefore, the rupee is depreciating. If RBI intervenes and raises the supply of dollars picking from its foreign exchange reserves, it can stem the fall of rupee. Till a few days back RBI was not inclined to do the same.
Is RBI’s Approach Appropriate?
Approach of the RBI, not to intervene in foreign exchange market, does not seem to be appropriate for many reasons. When the present regime took over the reign of power in 2014, foreign exchange reserves of India were hardly 312.4 billion dollars, which have increased to more than 400 billion dollars at present. In raising these reserves, net foreign institutional investment has a great contribution. It is interesting when FIIs bring money into India, the same is absorbed by RBI and rupee is generally not allowed to appreciate, while when they take their money out increase in the demand for dollars cause rupee to depreciate. The underlined concern of RBI has generally been that appreciation of rupee may impact exports adversely. However, when FIIs money outflows, RBI leaves the market forces on their own whims, saying that it will not intervene. This approach is fundamentally inappropriate, because if RBI absorbs dollars when FIIs bring money, why doesn’t RBI supply dollars when they go out?
What Can We Do?
It is true that Government does not have any control on the factors causing the depreciation of rupee in the recent past. Rising oil prices are leading to increase in Current Account Deficit (CAD). On the other hand increase in interest rates by US Federal Reserves and reduction in income tax rates by US administration are encouraging reverse flow of investment by FIIs. However, in the long run Government has a role to play in reducing the outflow of money by FIIs by making efforts to disciplining them. It is notable that FIIs do not pay any taxes on their profits. Therefore, they don’t have any obligation on transfer of money overnight. The government can impose a minimum ‘lock-in-period’ on the investments made by these FIIs, to keep them invested in India. In some countries tax is imposed on conversion of currency by FIIs, which is known as ‘Tobin Tax’. This may also discourage the outflow of investment by FIIs.
In the past few days the major reason for the depreciation of rupee has been the net sale of securities by FIIs and taking the money out of India. In such a situation demand for dollars increase overnight and in view of generally low supply of dollars rupee depreciates. A small scarcity of dollars causes a big fall in value of rupee. However, if we see, India doesn’t have any deficiency of dollars per se. Today India is sitting at huge stock of foreign exchange reserves to the tune of more than 400 billion US dollars. Since the beginning of the year 2018 foreign exchange reserves have declined hardly by 11 billion US dollars, despite huge outflow of portfolio investment and rising crude prices. In the last one month FIIs have sent hardly 1.3 billion US dollars abroad. Extra burden on the economy due to increase in crude prices has been nearly 10 billion US dollars since the beginning of 2018. Since our foreign exchange reserve are more than sufficient to meet additional demand for dollar due to above mentioned factors, Reserve Bank of India (RBI) can easily intervene in the foreign exchange market to stem any depreciation of Indian rupee.
RBI intervention may be win-win for economy
We must understand that depreciation of rupee means a burden on economy. It increases the cost of debt servicing by both private sector and the Government. Cost of foreign travel and education also increases and so does the inflation. Foreign exchange reserves give promise to deal with the future payment problems, however, they do not earn any significant income. It is important to stabilize the value of rupee, to save the economy from problems related to depreciating rupee. Today Indian economy is in good shape, as GDP is rising fast with both industrial and agricultural production increasing and inflation is also under control. Therefore, Reserve Bank of India does not need to worry on that account. RBI’s shying away from intervening into the foreign exchange market does not serve any purpose. Let’s hope that the good sense will prevail and RBI will intervene to stabilize the rupee.
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