What’s important is the relative value of the currency vis-à-vis peer currencies and not its absolute value.
The sharp and swift depreciation in the value of the rupee against the dollar has caught some in India Inc on the wrong foot. While exporters must be enjoying their unexpected gains, importers who have unhedged exposures — about 34% of the foreign borrowings — are miffed.
But if they were expecting the Reserve Bank of India (RBI) to not revisit its options in the current different and challenging circumstances, they have only themselves to blame for misjudging the regulator. The good news is that the majority of businesses with foreign currency loans have been watchful, tracking the currency movements in the US where the dollar has gained enormous value after the US elections in early November. They appear to have understood the implications of such sharp upmoves for emerging market currencies.
Indeed, it is unrealistic and unreasonable to expect the RBI to go against the trend and spend large sums of hard-earned forex reserves to keep the rupee from falling. To be sure, the central bank would intervene if there is a speculative assault on the currency but its stated position has always been that it does not envisage any fixed level for the rupee. That’s as it should be because what is important is the relative value of the currency vis-à-vis peer currencies and not its absolute value.
Governor Sanjay Malhotra appears to be convinced of the need to let the rupee depreciate. That should be the right approach as it wouldn’t help the economy and exporters, if the rupee stayed uncompetitive vis-à-vis the Chinese renminbi or the Indonesian rupiah for long periods. Since September 1, the rupee has lost 2.91% to the dollar while the renminbi is down 3.28%. Indeed, at the start of January, the Indian currency was overvalued by about 8% as reflected in the real effective exchange rate. Since then the rupee has lost 0.9% but still remains overvalued. That undermines exports, worsening challenges as the strong dollar and rising crude prices weigh on investor sentiment in the net oil-importing economy. Those with foreign exchange exposures, therefore, should be prepared for more depreciation of the Indian currency.
In opting to let the rupee drift down, the central bank would have factored in the extent of “imported inflation”; typically a 5% depreciation results in 35 basis points of inflation. Higher inflation would give the central bank less room to cut policy rates. However, less intervention in the currency markets means that the local money markets lose much less liquidity since rupee resources are not sucked out. This too helps to keep interest rates in the system reined in. The RBI ostensibly does not want to use more forex reserves than it needs to. The world’s reserve currency has surged with the dollar index hitting 110 earlier this week. With President-elect Donald Trump’s tariff policies expected to be inflationary and the US Fed talking of fewer rate cuts than anticipated earlier, the dollar is expected to stay strong. Against this backdrop, it would not hurt to bolster India’s reserves of $640 billion. There have been suggestions that banks should float foreign currency non-resident account deposit schemes, as has been done earlier. While this could be explored, for banks it could be a challenge to lend to borrowers at higher rates so as to be able to offer investors attractive returns. Such efforts should be made when things are well under control.
Source: www.financialexpress.com