Tensile currency

The recent turbulence in the rupee is cause for concern as it reflects the vulnerability of the Indian currency. The financial markets had become complacent about the rupee because of its resilience against the dollar this year. The central bank’s statement that it would prefer a stable currency was interpreted to mean that the rupee would remain in the range of 58 and 62 against the dollar, with some support from the Reserve Bank of India whenever it threatened to break out of this zone. But the speed with which the rupee declined — almost 3 per cent in just three sessions last week — demonstrates that the tools at the RBI’s disposal are insufficient to stem a sharp decline. The rupee and other emerging market currencies faced an onslaught of selling last week as plunging crude oil prices heightened fears of a slowdown in global demand, causing funds to flee back into the safe haven of the dollar.

Yes, the Indian currency is on firmer ground now than it was in August 2013. Foreign exchange reserves have been bolstered by record inflows from foreign investors and the current account deficit (CAD) has improved thanks to import curbs on gold. But there is no room for complacency. Foreign investors who have pumped close to $42 billion into the equity and debt market so far this year, can be fickle. They have already pulled out $1.2 billion from equities since the second week of December. These investors are continuing to invest in debt due to the high yields and expectations of a policy rate cut. Any indication that the RBI is having second thoughts about rate cut in early 2015 may cause these flows to reverse. The CAD is also under threat as gold imports are likely to surge since import curbs have been lifted recently. While it is true that the decline in crude prices will ease the import bill, it will impact the realisations of our crude product exports. The slowing growth in exports is likely to be exacerbated by the contraction in demand in oil-producing countries. The resurgent dollar — which is also likely to strengthen further as the US moves ahead with its plan to hike interest rates — is yet another threat.

That said, India has two things going for it. One, the sentiment among foreign investors has undergone a sea change following the ascension of a strong government at the Centre. Two, despite the hesitant economic recovery, India’s growth rate is still far superior to most other countries; also, domestic consumption continues to be robust. The Centre’s drive to attract long-term sustainable flows into the country through the ‘Make in India’ campaign is a step in the right direction to help the currency. The RBI too needs to keep up its endeavour to control inflation as that is one of the primary determinants of the extent of foreign flows into the country. These efforts will ensure that the currency is strong in the long run despite short spurts of volatility.

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