Exchange rate blues

The rupee’s slide over the last fortnight once again exposed its vulnerability during periods of intense volatility caused by watershed events. The Indian currency is down almost 3 per cent against the dollar since the US presidential polls, joining other emerging market currencies in a decline precipitated by fears that President-elect Donald Trump’s future policies could hurt their economies. Expectation of another policy rate hike by the Federal Reserve in its upcoming meeting in December led to a surge in dollar and bond yields in US-denominated securities, thus exacerbating the decline in currencies. The rupee’s decline against the dollar since the US election appears steep when compared to the 4 per cent overall depreciation in 2015 and 2 per cent in 2014. But such sharp declines in a short span are not uncommon when global risk aversion climbs, as witnessed in 2008 or 2013. The best course would be to let market forces move the price towards the mean, over time. That said, care needs to be taken that the country’s external account is under check and there are sufficient reserves, for currencies that score weakly on these parameters are more susceptible to speculative attacks.

Exporters might, however, not agree with this course of action, preferring the central bank to let the rupee depreciate against other currencies in order to make their wares competitive. The link between currency movement and export growth is, however, tenuous. Indian exports have continued to decelerate in periods the rupee depreciated. Two, slowing global growth and a crash in commodity prices have resulted in global trade shrinking sharply. It is hard to envisage a sharp growth in exports in such an environment — the World Trade Organisation has forecast that trade in 2016 will grow at just 1.7 per cent, the slowest pace since the financial crisis. Three, there appears to be a structural shift in trade patterns of large importers, with such countries reducing dependence on imports. Instead of looking for sops in the form of currency depreciation, exporters will do well to review their product offering to make it more relevant and lucrative.

Managing the currency to serve the interest of one section, such as exporters, can also become counter-productive. A weak rupee hurts domestic producers and consumers. The cost to the economy due to the increase in cost of imports cannot be ignored either. With crude oil prices likely to strengthen further, a weaker rupee can have a negative impact on the current account deficit as well as inflation. Capital flows in the form of foreign portfolio and direct investments are drawn to countries with relatively stable currencies. Such investors will incur a loss on their investments as the currency weakens, inhibiting future fund inflows. Since there is no ‘Goldilocks exchange rate’ — neither too high nor too low — that can be targeted, let market forces find the right exchange rate, with intervention in the forex market limited to periods of excessive volatility.

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