What is there in the value of the rupee? Quite a lot if you go by the recent India experience. The rupee has lost over 10 per cent to the dollar in the last two months. In just over a year, since March 2011, it has plunged more than 20 per cent.

The Government was forced to sit up and take notice.

Echoing the sentiments of senior economists, the Union Finance Minister, Mr Pranab Mukherjee, said that the fall in the rupee was “a matter of grave concern.”

While several countries, especially emerging market economies were also dealing with currency fluctuations, Mr Mukherjee said that these were the outcome of the Euro Zone crisis.

This was, no doubt, a major contributory factor. But was that the sole factor?

Almost a week later the Finance Minister clarified: “Managing the rupee is market related. There is a lot of volatility… It depends on market forces and market forces are uncertain.” While the Euro Zone crisis is out of its purview, the Government could certainly try and bring some sanity to the market in these uncertain times and contain the currency crisis.

Two options

There are two avenues open to the Government. The first would be in containing inflation which is eroding the value of the rupee in the domestic market. The second would be reducing current account deficit that is eroding the value and perception of the rupee in international markets: hurting potential foreign direct and portfolio investments.

Inflation had spiked in India last year. Unlike earlier years, several economists noted that it was high cost vegetables, fruits, fish, meat eggs and milk that triggered inflationary spiral. Inflation in items like cereals and foodgrains as well as in edible oils was lower.

And the real problem seems to be coming from the supply side. As demand for these premium food items surged from a huge and emerging middle class, it created a supply crisis. Prices shot through the roof. Despite scorching prices, real demand backed by increased purchasing power of the middle classes continued to soar.

Almost all these items are produced in farms, pastures and orchards in rural India. These regions are not adequately linked with transport and cold chain facilities. Being highly perishable commodities, substantial quantum of these produce goes waste.

In the absence of transport and cold chain linkages, the propensity to produce more is snuffed out among the producers. New producing regions do not emerge as distance and transport are major constraints. The greater the distance between production and consuming centres, the higher would be the wastage.

In a recent report, the World Bank has advocated the imperative need to address these infrastructural problems.

Building transport and cold chain linkages between the producing rural heartland and consuming urban centres would address a major facet of inflation. Instead, the Government seems to be more pre-occupied with tinkering with interest rates. Interest rate jugglery is meant to address demand-driven inflation and not the supply side. A wasted endeavour of the Government as past experiences has shown.

As inflation soared, interest rates more than kept pace. The rupee lost ground in the high cost economy. There was increased demand for dollars to fund the surging import bill. The spurt in dollar demand depressed the value of the rupee further. Exporters had a field day as their dollar earnings fetched more rupees.

But there were also lower dollar earnings to contend with as exports to rich Western countries dwindled. For importers, it was the other way round. They needed to raise substantially more rupees to fund their dollar-import requirements. Rising fuel imports added to the pressure. The import bill shot through the roof, spawning a balance of trade crisis.

Adverse balance of trade added further pressure to the surging current account deficit. The pressure on the weakened rupee worsened and it continued its losing streak. It has now become a close-ended vicious cycle which needs some deft economic management to break the impasse and arrest the depreciation of the rupee.

Fuel imports shoot up

But one segment of the import bill and its implications on the balance of trade and current account deficit requires special mention. As a result of accelerated industrial and economic growth, fuel imports shot up. It was further compounded by spiralling crude oil prices. This was the single most important factor which impacted balance of trade and widened the current account deficit.

In recent times, there has been no pass-over of the spiralling fuel costs to the consumer. The extent of subsidy given to diesel, kerosene and cooking gas consumers have soared.

The ultra-rich continue to drive around in their high powered diesel guzzling SUVs as diesel sells at subsidised rates. The rich, middle class and lower middle class continue to use cooking gas which is also highly subsidised. Most of India's poor living in rural areas still has no access to cooking gas.

The principle of parity does not seem to be in existence here. Those who can afford a high-priced SUV can run it on subsidised diesel. Those who can afford a cooking gas connection are eligible for subsidy. Ironically, those who cannot afford either are out of the subsidy net.

However, raising fuel prices is not just an economic decision. It is a political decision as well. It has the potential to spur further inflation. The cascading impact of fuel price will inflame transport costs, thereby triggering across the board price rise in foodgrains, vegetables, fruits, fish, meat and other items of mass consumption.

But it will certainly help in containing the current account deficit, firming up the value of the rupee. Some efforts are now needed to contain the huge fuel subsidy bill. A short-term spike in inflation is sure to follow. But containing the current account deficit, strengthening of the rupee and reduction in inflation is likely to follow.

cj@thehindu.co.in

(This article was published on May 27, 2012)
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