Commotion over rupee

FCNR redemption can be an opportunity to let the currency slide

Unconfirmed reports last week that the Union finance and commerce ministries were "discussing devaluation" of the rupee caused the currency markets to swing widely on Friday. Eventually, the exchange rate stabilised following a denial by the government. However, the commotion was puzzling. The rupee is no longer pegged to a particular exchange rate. Only currencies that are pegged in this manner, to a value supported by the reserves of the central bank, can be devalued. Currencies that are freely traded can depreciate or appreciate, and central banks can at best manage volatility - as the Reserve Bank of India (RBI) has emphasised it will do, but only to maintain order in the markets and not to back a particular value for the rupee. Nor is it likely that ministries in New Delhi could order the RBI to change this policy, given the recent agreement it should focus on inflation-targeting.

In any case, the rupee will no doubt shortly respond to the unwinding of $26 billion in foreign currency non-resident (FCNR) deposits that banks raised three years ago as part of the measures following the "taper tantrum" in the summer of 2013, which destabilised India's external account. This unwinding will increase the amount of rupees in the market, causing a certain amount of depreciation. In other words, even if there are concerns that the rupee is overvalued, the RBI merely has to stand by and allow the currency to depreciate in an orderly manner as this process of redemption of FCNR deposits proceeds.

The flutter has once again pushed to the centre of the markets' consciousness concerns about the value of the rupee. If the commerce ministry is concerned that the rupee is overvalued, it is not surprising; Indian exports are largely uncompetitive, as can be seen from the fact that they have exhibited a secular decline for a considerable period. India's persistent trade deficit has been financed by strong inflows on the capital account - which, however, means that the rupee has not responded to the weak export performance by falling in value.

While a correctly valued currency is an important constituent of export competitiveness, it is not the only one. Ministries in New Delhi are hopefully not looking at short-cuts to export promotion through "fixing" a value for the rupee since they should be worrying about what they can control - the other components of competitiveness. This requires, above all, focusing on the impediments to doing business in India. The government deserves praise for making the ease of doing business an important policy objective. However, its actions in this sphere so far have not been transformational.

Better infrastructure - ports, roads, and power - will help, but the government's efforts in this direction must be speeded up. It is also true that regulations are still too onerous, and must be streamlined. Port administration must be made more efficient, so waiting time for exports is reduced. And exporters must be given guidance so they can access new customers and markets, especially as and when global demand revives from its current slump. If the discussion on export promotion circles around short-cuts like duty drawbacks or intervening in currency markets, then India's producers will not be able to take advantage of the next upturn in world trade.