Rupee's value matters

Dangers of an overvalued currency must not be ignored

Commerce Minister Nirmala Sitharaman has indicated that the government is moving away from seeing the value of the rupee as the crucial determinant of India’s export competitiveness. Instead, a higher rupee is seen as a natural consequence of India’s robust growth numbers. Speaking to the media on Sunday, Ms Sitharaman said, “It may appear as though we do not put so much emphasis on exchange rate anxieties. We may have to look at it in a larger macroeconomic perspective, but the attention of policy planners and state governments should go towards logistics and trade facilitation.” This comes on the back of two developments: The rupee was coming off a seven-week period of weekly appreciation, its longest such run since 2010, and in which period its increase in value against the dollar (4.3 per cent) was Asia’s best performance. The rupee also put in its best first-quarter performance since 1975. Meanwhile, exports, after quarter upon quarter of steady declines, showed their first improvements over the past two data releases. This is not just a consequence of an increase in petroleum prices globally — engineering exports, for example, grew by 47 per cent in February.

It is understandable, therefore, if the government looks at these two data points and assumes that the value of the rupee is irrelevant to India’s export performance. It is also true that the rupee does, after all, float relatively freely and thus the government can hardly force it down to its “true value” without massive intervention. However, there are nevertheless good reasons to be doubtful about this pessimism. Ms Sitharaman said that for countries that created an export-focused development path, the value of the rupee mattered — but indicated that India was somehow different.

This may not be the best way to think about the situation, however. While it is, of course, true that easing constraints on business and the building up of soft and hard infrastructure are also crucial aids to competitiveness, these will not help if the rupee continues to render Indian exports uncompetitive. Nor should the size of India’s domestic market cause the government to close its eyes to the fact that only a solid export performance, particularly in labour-intensive and cost-sensitive sectors, will help mop up excess unemployment in the years to come.

Simply put, while it may make for good headlines, an overvalued rupee is not in India’s best long-term interests. Unfortunately, the consequence of India being too small a trading power in comparison to the size of its economy is that the value of the rupee is oversensitive to capital inflows. These have been particularly robust of late. Inflows in March were the highest in over five years. The Reserve Bank of India (RBI) has been even more hands-off than usual: Over the same months of rupee appreciation, the only time the RBI’s reserves declined was in the week to April 7. The central bank is having to manage a complex liquidity problem at the moment, worrying about a return of inflation even as banks are flush with cash after demonetisation. The government might see this inflow as a vote of confidence, and a stronger rupee as a political asset. But responsible economic stewardship should cause it to keep an eye on sustainable exports growth as well — and it should not ignore the effect of an overvalued currency on competitiveness.