Business Standard

Currency trouble

Depreciation is a problem, but it also presents opportunities

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The cracked 56 against the dollar on Wednesday, following a steady fall over the past few weeks. One of the basic facts about international currency dynamics is that first exhibit delayed reactions and then tend to overshoot the true, rational value of the exchange rate. It appears now that the rupee is undervalued — judging, at least, by various trade-weighted estimates of the real exchange rate. However, there is little doubt that the rupee’s precipitous fall – both in late 2011 and recently – was poorly managed by the central bank and other players. The purpose of regulating the currency markets is to arrest speculative trades, which the Reserve Bank of India has been trying to do; but some statements created an ambiguity about government action that has fuelled the rupee’s excessive fall. Quick measures to control the situation are in order.

However, there is little doubt that a correction from the rupee’s levels of last year was warranted and useful. In a free market with a freely floating currency, a currency should respond to basic economic cues. In this case, India’s huge – at a record four per cent of gross domestic product – reflects, in part, the rupee’s incorrect valuation. A currency depreciation will help reduce imports, by making them more expensive, and help make demand for India’s exports grow, by making them cheaper for the rest of the world. This will work to correct India’s trade deficit and reduce the economy’s external vulnerabilities. Indeed, if the government moves to raise petroleum product prices, signs of which are now clearly evident with the announcement of an increase in the price of petrol, the step will rationalise demand. That, together with the rupee’s movement, could mean that India’s troubles with the current account deficit should be a thing of the past. Neither India’s government nor its central bank can set a value for the rupee; the economic theory underlying quasi-fixed exchange rates has been thoroughly exploded. As Prime Minister told reporters yesterday, “in a market economy, the currency goes up and down.” It is necessary, however, to ensure that financial methods to hedge against currency risk are easily available to those participating in the world economy, and that a clear-headed assessment of potential gains and losses is always made.

There is no question, thus, that the fall of the rupee presents opportunities. It has lost almost 27 per cent in value in the last ten months, rivalling the devaluations of the early 1990s that kick-started India’s exports. As this newspaper reported on Wednesday, many local automobile companies are speeding up their indigenisation process, which will help the struggling manufacturing sector. Such efforts will be replicated across industries. It is worth noting that the rupee’s fall comes after the has steadily appreciated for some years — again, by almost the same margin, though some argue it still has some distance to go. This means Indian products are 60 per cent more competitive against Chinese goods than they were a few years ago. Exporters and manufacturers should be looking to take advantage of this. While the management of the rupee’s inevitable fall has left a lot to be desired, there is no reason why market participants should not move on and use it to make profits.

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