Dr Ashwani Mahajan
At the advent of the new economic policy and globalization in 1990, rupee was equal to 17.5 rupee per US dollar (USD). Since then, it could not gain strength till date. In the last 3 months rupee has depreciated from 64 rupees per USD to rupees 67.7 per USD. Prior to the policy of globalisation value of rupee in terms of different currencies (exchange rates) was administered by Reserve Bank of India (RBI). As the barriers to trade started demolishing in the age of globalization; and the restrictions on foreign investment were also removed gradually, the determination of exchange rates also went off the control of the RBI. Now the exchange rates started getting determined by the market forces of demand and supply.
Today all the tariff as well as non-tariff barriers (which are also called quantitative restrictions) to imports have already been removed. There are least restrictions on inflow and outflow of foreign investment and there is no effective control on the outflow of foreign exchange in the name of royalty, dividends, interest etc. The foreign exchange received from the exports is much less than the outflow of foreign exchange due to imports and income transfers, because our imports overwhelm the exports. Therefore, this imbalance in the demand and supply of foreign exchange (say dollars) leads to depreciation of our currency. Although the deficit in our trade balance is partially compensated by huge foreign remittances received from our Diaspora and receipts from the exports of software and services including BPO services and foreign direct investment (FDI) and foreign portfolio investment (FPI) help us in maintaining balance between demand and supply of foreign exchange. However, when foreign investors, especially foreign portfolio investors take their investment back, or imports get dearer, naturally rupee gets weaker. In the recent months the main reason for rupee to get weaker has been an increase in the price of crude oil internationally, which is causing an increase in the demand for dollars.
In the recent months there has been a tendency for portfolio investors to take their money back to their respective home countries, what we call outflow of portfolio investments. This is causing an increase in the demand for dollars to make rupee weaker. Major reason for out flux of portfolio investors has been increase in interest rates in US. Recently, Trump administration has also started adopting various measures including cut in tax rates to attract investments. We need to understand that there is nothing like deterioration in the fundamentals of Indian Economy. Rather, there has been significant improvement in these fundamentals, say GDP growth is showing an uptrend, and foreign agencies are expecting GDP growth to be between 7.4 percent and 7.8 percent in the financial year 2018-19; manufacturing sector is showing better results and inflation is more or less under control. Therefore we can say that this weakness of rupee is primarily due to global factors. This is revealed from the fact that many major currencies of the world have been weakening vis-a-vis USD and weakness of rupee is no exception. In the last three months though currencies of all BRICS countries have gone weak, the currencies of Brazil and Russia have gone weaker more than rupee, as Brazilian Real has depreciated 7.0 percent and Russian Ruble has depreciated by 5.3 percent, as compared to Rupee which has depreciated by 4.4 percent. South African Rand has depreciated by 2.3 percent, while Chinese Yuan has depreciated by 0.5 percent.
Meaning of Depreciation of Rupee
Depreciation of rupee is no good omen for India. Though, whenever rupee gets weaker exporters are very happy, because they get more rupees for their exports. They always argue for weaker rupee, because they claim that weaker rupees can help us reducing our trade deficit. There is no dearth of economists who support this argument. However, we need to understand that weaker rupee multiplies our problems, causing imports to get dearer. Those businessmen who have borrowed from abroad, their burden of repayment of interest and principle increases in rupees terms. It is notable that many of our companies have been borrowing from abroad heavily due to lower cost of borrowing. However, when rupee gets weaker, their advantage of lower rate of interest, turn into disadvantage and they go into losses. People of India, who have already been reeling under high petroleum prices, may face dual attack due to weakening of rupee.
How to Support Indian Rupee
Though, it is correct that given the forces of demand and supply determining the value of rupee, stemming free fall of rupee is not an easy task. Neither we have any control over oil prices, nor can we stop portfolio investors to go out, due to the policies of US government. However, in the determination of exchange rate we can definitely bring in efficiency. We understand that, as and when foreign institutional investors (FIIs) bring foreign exchange into India, rupee starts getting stronger due to increased supply of foreign exchange (say dollar). At that point of time RBI under the influence of the thinking that stronger rupee may work against the exports, starts intervening in the market by purchasing dollars to stop appreciation of Indian rupee. However, when investors take their money back, RBI doesn’t do the similar intervention and let the rupee get weaker and weaker. These upheavals in exchange rates benefit speculators only. Since, it is well established fact that FIIs keep bringing foreign exchange and taking it off, from time to time; we need to minimise the impact of these actions of FIIs on the value of rupee. We know that to overcome the problem of instability in prices of agricultural commodities, the mechanism of ‘buffer stock’ has been used, the same can be tried for foreign exchange too. Whenever, there is increase in supply of dollars, due to inflow of foreign portfolio investment (FPI), Government may purchase the same and keep it in the buffer stock, only to release when there is an outflow of FPIs. In this way we can easily stop unwarranted upheavals in the value of rupee.
Apart from this, there is also an urgent need to impose effective controls to discipline foreign investors. Government can discourage FPIs to take their profits out by imposing tax, what we call ‘Tobin Tax’ in economics jargon. Apart from this we can also discourage foreign investors to take their money out frequently by way of imposing lock-in period, before which they cannot withdraw their investment.
(The author is Associate Professor, PGDAV College, University of Delhi)
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