Fundamentals of the Indian economy drive the rupee

It is good domestic growth, and not fiscal & regulatory policy alone that will attract FDI

The mandarins at the Finance Ministry (including the Reserve Bank of India) are working overtime. But little seems to be happening. The downward slide of the rupee continues. Each day a new low is being recorded. This despite the fact that since the beginning of April this year, the rupee slide has been one of the biggest concerns of the government – or so it wants us to believe.

The government’s reaction has been predictable: A slew of measures have been announced and the senior team members including the Finance Minister P Chidambaram and the incumbent RBI governor have been issuing statements assuring the public and investors that the drop in the currency is a temporary phenomenon and that nothing much should be read into it – the fundamentals of the economy are, and will continue to be strong. They have been assuring the investors that the steps being taken by them would help in increasing the inflow of foreign capital, which in turn will have a stabilizing impact on the rupee. In fact, this week the government has taken a step in a new direction – curbing capital outflows- again with the aim of reassuring the investors that all is being done to safeguard the rupee.

None of the above has helped, the free fall continues. Therefore the question now we need to ask is whether the government measures are enough to stem the rupee’s fall. To my mind, to answer that, we have to look at the single most important factor, which influences the value of the rupee – fundamentals of the Indian economy.

For a layman, the value of the rupee is determined by the amount of foreign currency coming in and going out. Foreign currency comes in mainly on two accounts – firstly, India exports its produce and these export earnings are brought in; and secondly, (for the larger share) foreign investors want to participate in the India growth story and bring in foreign exchange for investing into India.

Going by the way the economies in the euro zone and the US have been behaving, it would be naïve to expect that the export earnings would be contributing significantly to foreign exchange inflows in the near future. In this area, the government can do very little but sit and wait for the global economies to come out of recession.

On the investment front – steady decline in GDP growth, constant and continuing contractions in industrial output, spiraling inflation, growing instance of financial corruption, policy confusions etc. do not help in portraying India as a favoured investment destination. It is here that the government has a very crucial role to play. In reality the only role the government has played till date is to try and correct certain policy nuances (FDI regulations etc.) but has done precious little to address the concerns of the domestic economy.

The government would do better if it were to concentrate majorly on the domestic economy. Foreign investment is a consequence of good domestic growth and not a consequence of domestic fiscal and regulatory policy alone. The fiscal and domestic policy regimes come secondary – primarily it is the fundamentals of the Indian economy, which will attract foreign investment and thereby help the rupee in regaining some value.