Rupee tantrums

With the falling rupee and rising fuel prices turning into a burning political issue, the Centre seems to have urged the Reserve Bank to defend the currency. However, a measured rather than knee-jerk response is in order, even as the pain cannot be dismissed lightly. By falling 12 per cent against the dollar since January 1 this year, the rupee stands out as the worst performing Asian currency even as currencies of emerging economies the world over have taken a hit. Over the last month alone, the rupee lost 5 per cent against the greenback, while other Asian currencies remained quite stable against the dollar. During this period, crude prices shot up from $64 a barrel to cross $70 at one point. If oil prices remain firm, the current account deficit, at 2.4 per cent of the GDP in the first quarter of this fiscal against 2.5 per cent last year, is slated to be in the region of 2.8 per cent towards the end of this fiscal. When seen against the drying up of capital flows in April-June this year — net foreign portfolio investment (FPI) fell by $8.1 billion against a corresponding rise of $12.5 billion last year, while foreign direct investment amounted to $9.7 billion in Q1 2018-19, against $7.1 billion last year — the financing of the CAD may lead to pressure on forex reserves. In fact, FPI flows in equity and debt had turned positive in August, only to turn negative in both the segments in September. Hence, the rupee is not exactly poised to bounce back to mid-60 levels in a hurry, even if it is not in for a free fall.

However, the taper tantrum experience of 2013 informs us that intervening heavily to prop up the rupee can prove to be counterproductive. The RBI has so far displayed the right composure, by keeping its interventions to a minimum. As a result, forex reserves remain at mid-August levels of $400 billion. The central bank should focus on inflation control in order to restore investor sentiment. Import-intensive sectors such as telecom and aviation may see costs increases, even as export-driven sectors such as IT and pharma stand to gain. A further fall can be checked by staggering importers’ payments and issuing NRI bonds. These measures can check speculative run on the currency, akin to that witnessed in 2013 when selling by traders in rupee non-deliverable forward market overseas dragged it to ₹68.8 against the dollar.

In the long run, it is important to keep a tab on external commercial borrowings (which account for 38 per cent of the total external debt of $530 billion) and ensure that they are hedged for currency risk. India’s CAD problem is best addressed by ensuring that exports move up the value chain. As for oil imports, energy efficiency in transportation and industrial applications require urgent attention. Gold imports can be controlled, while on the capital account India should remain focussed on attracting long-term FDI in greenfield areas. Such structural changes will equip us to ride out externally-induced financial tremors.

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