RBI should allow the pressures on the rupee to be expressed instead of wasting its reserves
When I was a kid in Texas, one of my favorite musicians was Jerry Jeff Walker, a lyrical country western star; and one of my favourites of his repertoire was
Pissin’ in the wind,
bettin’ on a losing friend
Makin’ the same mistakes we swore
we’d never make again
And we’re pissin’ in the wind,
and its blowin’ on all of our friends…
I found this song ringing in my ear during the first working week of 2016 as I watched RBI defend the rupee each day in the wake of a market crisis that appears to be unfolding with great speed and uncertainty. Granted its actions are completely in sync with the articulated policy of “managing volatility” although the second part—viz., “without a focus on a particular exchange rate”—does appear questionable given that the intervention only picked up steam when 67 came into sight.
Many analysts, including myself, question the basics of this approach since it appears to be predicated on the belief that the primary goal of exchange rate policy is to protect the market from global forces, which is the reverse of the now-discredited Washington consensus that markets know best.
Contrariwise, my belief is that the primary goal of the policy should be to ensure that the exchange rate is appropriately competitive for the economy and to contain volatility to the extent possible in achieving this goal. In other words, there should be a clear focus on a target exchange rate that RBI believes will enable a sound balance between export growth, domestic protection and inflation. Obviously, this target will need to be dynamic—in either direction—depending on how RBI reads the shifting global winds.
Now, it is possible that RBI may, irrespective of its pronouncements, be actually working in this direction as well. I note that the average value of the dollar in 2015 was 64.15, very close to the worst level in 2014, and that the rupee fell by about 5% during the year (somewhat less than the 8% rise in the dollar index). Thus, it is conceivable that RBI, while holding to its plan of controlling volatility, may also be guiding the rupee lower all the while, pushing the average in any year to the low of the previous year. If so, while it is currently intervening to protect 67 (which was the worst level reached during 2015), RBI may well be targeting 67 as the average value for 2016; this would suggest the rupee could move between 64 and 70 over the year. Further, if RBI were able to keep things as contained as last year the median value for the rupee through 2016 would be about 66.50.
The question this begs is whether, in the current environment, this median level would be adequate from a competitiveness standpoint. To be fair, on the export side, it is hard to make a case for a specific level of the rupee. In the currently feeble global growth environment (although both the US and Europe are showing some positive signs), simply running a much weaker currency is unlikely to help boost exports, unless, of course, like China, we already had a well-oiled export machine.
On the other side of the equation, however, dumping from more competitive economies, particularly if they have weaker currencies, can accelerate real terror in the domestic manufacturing economy. China, which has huge inventories and where growth appears to be sinking like a stone, is certain to be even more aggressive in pushing sales in India, and, as has been said before, anti-dumping measures are hardly a sustainable policy response. The Make-in-India initiative, which looks a tricky proposition at best, would be dead on arrival, unless the government and RBI recognise the need to, first of all, nurture existing players.
Since January 2014, both the rupee and the yuan have fallen about 8% against the dollar. With the live threat of an even—and, perhaps, much—weaker yuan, the rupee will also continue under pressure and, to my mind, RBI should allow this pressure to be expressed, instead of using up—wasting—its reserves in a battle that could well turn out to be “pissin’ in the wind.
While it is impossible to make any sort of sound forecast, my sense is that a median level for the rupee that is closer to 69, with a range of 65-72, during 2016 may provide the economy with a better chance to brave the foul winds that appear to be brewing globally.
The author is CEO, Mecklai Financial. Views are personal