The Hindu Business Line : The rupee: Lamb at home, tiger overseas

Advertisement

New Delhi, Feb. 23 Lamb at home, tiger abroad. That, in a nutshell, is what a combination of rising inflation and unrelenting forex inflows has been doing to the rupee.

Consider this. Since 1993-94, the official wholesale price index (WPI) has risen by 109.2 per cent, which means the price of an average good bought in the country has more than doubled in the last 13 years. At the retail level or after factoring in services, prices would have galloped much more; but that's a separate point.

On the other hand, the domestic cost of acquiring a dollar (indexing the 1993-94 exchange rate at 100) has gone up by only 41 per cent during this period. The price of a pound sterling in rupees has similarly risen by 83.5 per cent and that of the Japanese yen by a quarter — much below the cumulative average increase in domestic wholesale prices.

Thus, at any given world price, an average manufacturer exporting goods from the country would have seen a steady erosion in profits relative to what he could have made by selling the same at home.

In standard neo-classical economics, exchange rates seamlessly adjust to inflation levels: when domestic prices rise excessively, it becomes cheaper to import and as too much of imports drain out foreign exchange, the result is devaluation.

Different story

But the Indian story has turned out pretty different.

In the last few years alone, the rupee has lost heavily in purchasing power at home, as virtually everything around has become costlier.

However, a dollar that cost Rs 48.80 at the end of 2001-02 can now be bought for just Rs 44.28. Likewise, the rupee value of the yen has remained almost unchanged, if not marginally fallen.

Only the pound has gained some 24.5 per cent over these five years, but that's still peanuts compared to a bag of cement, a tonne of steel or a piece of real estate in any decent suburb.

What is more, foreign currency would have been still cheaper, had only the Reserve Bank of India (RBI) allowed textbook neoclassical theory to operate by not intervening in the market.

Huge inflows

Instead, even while rising inflation may have spilled over into ballooning trade and current account deficits, these have more than been offset by huge inflows on the capital account, leading to revaluation (and not devaluation) pressures on the rupee.

And since this harms the country's export competitiveness, the RBI has had to mop up the surplus forex and, in the process, add to domestic money supply.

The result: more inflation and the rupee getting weaker at home, while continuing to strengthen against the greenback.