Let it fall

RBI should not spend dollars defending the rupee

The rupee fell further against the dollar on Tuesday after opening at Rs 71.28, lower than Monday’s close of Rs 71.21. Some analysts’ expectations that it may slip further against the dollar in the foreseeable future might well be borne out soon. The US dollar is not showing major weakness, given expectations of trade tensions as well as the United States Federal Reserve’s decision to slowly tighten monetary conditions. For India, this continues to be a sign that macro-economic indicators need to be carefully scrutinised by the government and the Reserve Bank of India. While external account weakness is nowhere close to what it was during the months of the taper tantrum in 2013 — when the rupee depreciated by almost 30 per cent against the dollar in less than half a year — there is certainly no call for complacency.

There is no reason to suppose that the rupee will not weaken further and even go beyond the market’s current expectations of stability at around Rs 73 to the dollar. Much depends upon the strength of foreign portfolio inflows — foreign investors are concerned about recent rules by the securities market regulator that might constrain the ability to invest in securities, depending on the manager of the investing funds. Global crude oil prices also seem to have firmed up in the medium term. It is clear that together with rupee depreciation, there will be a significant inflationary effect, which will concern the Monetary Policy Committee of the RBI. Some believe that the MPC will thus be forced to follow up recent interest rate hikes with another in order to keep the consumer price inflation rate close to its ideal of 4 per cent. Strong economic growth numbers, released last week, will strengthen the case of the inflation hawks in this respect.

While there may be pressure, from politicians and some sectors of the economy, for intervention by the central bank to keep the rupee from falling further, any such temptation must be strictly avoided. In particular, there is no reason for the RBI to spend US dollars in its reserves to manage the rupee. This is not part of its mandate. It is worth noting that one major difference between today and the events of summer 2013, which brought India close to a crisis on the external account, is that currently foreign exchange reserves appear much more comfortable than they did at that point. This will not be the case if the RBI appears to be entering into a one-sided bet with the currency markets by defending the rupee, using reserves. If some other method can be found, then this particular objection might not apply. Yet all concerned must also keep in mind the benefits of a cheaper rupee. Indian exports are showing signs of life after a long period of stagnation. In the end, the only real form of security on the external account for an open economy is the sustained competitiveness of its exports. This requires domestic structural reform. For genuine macroeconomic stability, the government must return to the path of sustained domestic reform.