A couple of weeks ago, when there was a press story that the commerce minister was meeting with the finance minister to discuss devaluation of the rupee, my instinctive reaction was “Nonsense!” I was referring to the fact that the rupee, being...
A couple of weeks ago, when there was a press story that the commerce minister was meeting with the finance minister to discuss devaluation of the rupee, my instinctive reaction was “Nonsense!” I was referring to the fact that the rupee, being market-determined, cannot be devalued, which is a one-shot step change that is only possible in a fully controlled market environment (as we experienced way back in 1991). It can, of course, depreciate if there is an excess demand for the dollar, which demand can also be generated for policy reasons by the central bank.
From the point of view of the economy, however, the commerce minister’s call for a weaker rupee is far from nonsense. It is well-known that our exports in dollar terms, like those from most countries, have been falling under the influence of both subdued global growth and lower commodity prices. And, of course, and again like everybody else, we suffer from the China problem. The yuan has been weakening sharply—the 5% drop in the rupee since January 2015 has been overshadowed by the more than 7% drop in the yuan over the same period. This is a double whammy, since we are not only getting less competitive in many of our export markets, like Southeast Asia and the Middle East, but many companies with domestic sales are getting hit ever harder by Chinese imports.
I spoke, last week, with one of my favourite competitiveness thermometers—a client who has industrial manufactures, is quite profitable and has both exports and significant domestic sales where it competes with China. I have been speaking with him on this subject a couple of times a year for over five years now, and he has never been parochial, most of the time saying the rupee was more or less just right for his business to be competitive. The few times he wished the rupee was weaker, the difference was modest. This time was a shocker—he said he needed the rupee to be between 68 and 70 to sustain profitability!
To follow up, I spoke with a few other clients. A commodity exporter said he needed 67.50 to 68; a company in speciality chemicals also suggested the same minimum range, which was something of a surprise since speciality chemicals is, for practical purposes, a business with a virtually unlimited market. Finally, I spoke with a garment exporter who was quite down in the mouth; I asked him what would happen to his exports and margins if the rupee was 69 to 70; he messaged back “both would increase dramatically.”
I’m sure there are hundreds—indeed, thousands—of such stories. And as so ably articulated by my friend TN Ninan in his Saturday editorial, services exports and portfolio flows, both of which are, in essence, good things, are overwhelming the deficit on trade in goods and keeping the rupee unconscionably strong.
While RBI appears aware of this—they have been intervening more or less daily buying dollars to prevent the rupee from strengthening beyond 66.50—I think it is time they dropped the fiction too-often articulated as policy that “we monitor rupee volatility but do not target any specific value of the currency”. Indeed, under Raghuram Rajan and apparently continuing under the new Governor, RBI’s ongoing fear of volatility appears to have increased—rupee volatility is at its lowest level since 2006.
The value of the rupee is as significant as the domestic interest rate in terms of its impact on economic growth, and if it is accepted as reasonable that RBI can cut interest rates to assist growth, it makes no sense to permit rupee strength to derail that selfsame growth.
Now, I understand that global markets are very uneasy and there could be events—a real turnaround in the US monetary policy, a Trump victory in the Presidential election and, of course, any number of unknown unknowns—that could trigger another market meltdown; RBI may be holding the line on the rupee to protect the economy from too much trauma in such an event. However, I think it has now reached a point where the side-effects from this treatment need treatment themselves.
RBI should buy dollars ever more aggressively to push the rupee closer to a level (say, north of 68) that supports growth. If/when that move gets exacerbated by global events, RBI can respond by selling dollars to calm things down, as it has many times before.
The increased volatility would drive companies to hedge more aggressively and, indeed, may also reduce the demand for foreign currency borrowings, which would be all to the good. The more competitive rupee would make Indian business stronger, which would increase the resilience of the economy to a global downturn. And, when global winds die down, the cheap rupee would make India’s star shine even brighter as an investment destination.
What’s not to like.
The author is CEO, Mecklai Financial. Views are personal