Who wants the rupee to trade at Rs 40 to one US dollar?
Not Prime Minister Narendra Modi. Not Ms Sushma Swaraj (who famously tweeted in August 2013, “The rupee has lost its value. The Prime Minister has lost his grace”). At least not any more, and it would not be polite to remind them of their promise during the election campaign last year. We should be happy that that was a promise the government has not kept.
Mr Arun Jaitley, the finance minister, was a model of discretion when he said a few days ago that, “Government would like the rupee to reflect its real value.” He is aware that the rupee has appreciated slightly more than 20% against the euro in the fiscal year 2014-15. Against six currencies, the trade weighted real effective exchange rate (REER) has risen from 109.58 in February 2014 to 124.34 in February 2015. Change in the REER measures the change in the relative value of the rupee vis-à-vis the chosen basket of currencies. Rarely does any currency trade at its real value on every day of the year. It is normal for a currency to witness bouts of appreciation or depreciation but, over a long period of time, a currency must reflect its real value.
Rupee value will change
Several factors affect the value of the rupee. The obvious factor is the rate of inflation relative to the rates of inflation in the countries of our key trading partners. The second factor is inflows and outflows that will strengthen or weaken the currency. The third factor is productivity change in India. Monetary policies of the major developed countries will also impact the currency of a developing country like India: recall the “taper tantrum” (to quote the IMF’s managing director) of the US Federal Reserve in May 2013.
2014 was an unusual year. Developed economies were crawling with low inflation and low growth, oil prices had collapsed, and commodity prices had declined sharply. India’s high interest rates attracted large quantities of foreign funds. The current account deficit remained under control and fiscal consolidation was on track. The value of the rupee was reasonably stable, especially against the dollar, but then came new problems.
The rupee appreciated against other currencies and exports were sharply affected. In February 2015, exports fell by 15% year-on-year. This was the third successive month of decline. There was negative growth, year-on-year, in the export of manufactured goods including leather and leather products, engineering goods and electronic goods.
High interest rates bring their own problems. Export competitiveness of manufacturers and exporters is eroded. Large inflows of foreign funds, especially into the capital markets, force the Reserve Bank of India to buy foreign currencies (especially dollars) to arrest the appreciation of the rupee. If managing the exchange rate takes precedence, managing inflation takes a knock.
The gathering clouds
There are clouds on the horizon. The first is, what will the US Federal Reserve do? Will it hike interest rates?
The second is declining exports. Exports earnings are a stable source of foreign exchange. Rising exports also boost manufacturing, increase demand for a variety of services, and create jobs. I am afraid we may have missed the export target for 2014-15 and only barely equalled the export value of goods in 2013-14 ($312 billion). Key export sectors such as textiles, gems and jewellery, and drugs and pharmaceuticals have seen a decline in their share of total exports.
The third worry is the sluggish performance of the core sector. At the end of February 2015, overall growth of the eight sectors is 1.4% as against 6.1% at the end of February 2014. Of the eight sectors, only coal, cement and electricity have registered growth at 11.6, 2.7 and 5.2%, respectively. The decline in steel is particularly worrying—from 11.5% at the end of February 2014 to (-)4.4% at the end of February 2015.
Some other pieces of news drifting in should also worry the government. Developments in West Asia and the pressure they may exert on oil prices. Unseasonal rain that has reportedly affected crops on 106 lakh hectares of land. Private flour millers have signed contracts to import 80,000 metric tonnes of Australian wheat.
Shut out distractions
Amidst all these, the value of the rupee should be the least of the concerns, especially when the declared policy is that the exchange rate will be determined by the market. Unfortunately, the election rhetoric and a false sense of pride have clouded the issue. If the exchange rate is a matter of pride, Japan should be only half as proud as India (120 yen to a dollar) and China 10 times more (6.2 yuan to a dollar)! My advice is, leave the rupee alone, unless there is unusual or extreme volatility.
The government and the RBI have their work cut out. The Prime Minister should resolutely shut out all distractions (religious conversion, ban on cow slaughter, joint session of Parliament, GUJCOCA, frequent foreign travel) and focus on the economy. Much will depend on reviving export growth, production of coal, generation of electricity, manufacture of steel, cement and fertilisers, accelerating the building of infrastructure, especially roads and railways, and enhancing productivity across all activities. There is no time to be lost.