Concerns over the rupee’s continuous slide against the dollar are understandable. Yet, broader perspectives must prevail in responding to the liquidity shock from reversing foreign capital. That will prevent panic attempts like asking banks to desist from rupee forecasts which make markets jittery, according to the central bank (Business Standard, 8 July). Assuming forecasts can actually be curbed, what about forward trades in overseas non-deliverable markets, where the rupee hit Rs.61 on 6 July, after the US-jobs data release? Besides, market expectations are now quickly settling in an Rs.62-65 range.
At a deeper level, the reality of filling an $80-90 billion current account gap from capital account financing needs confronting. Are there enough tools to manage a liquidity stall really? Over 2009 till May 2013 no reserves were accreted despite a net capital inflow of $77 billion equity and $32 billion debt. Eroding reserves’ cover—less than six months’ import and short-term debt by residual maturity at 65% of reserves—all but eliminates such support. Responses like above do not even qualify as macroprudential measures, and more reflect controlled economic systems besides underlining the contradiction with the advanced economy feature that India prematurely exhibits, i.e. asset flows financing the current account deficit.
Given its vulnerability to short-term capital flight (largely debt and of late, equity sell-off too), there isn’t much immediate support policymakers can provide to the currency. Moreover, all emerging market currencies are as brutally hit. Hence, acknowledging that depreciation is part of the solution to the vulnerable external sector is useful, notwithstanding the resulting damages to public and private balance sheets. It is no one’s case that forex reserves be squandered in defending the rupee against a strengthening dollar, but using some them to manage market beliefs can be more effective than curbing rupee forecasts or asking overseas funds to prove they aren’t speculating on the currency. Markets otherwise, will be quick to realize that forex reserves are of just historical pride for the country, like its hoarders’ love for gold.
Notwithstanding the currency’s steep fall, India can ride out this storm. But it can only grow its way out of the current troubles; there’s isn’t another path. This perspective must inform any macroeconomic strategy. Here, it’s important to distinguish between foreign debt and equity financing; rather than maintain nominal yield differentials in the light of an improving US economy, it is the shrinking growth differential that ought to be addressed. Apart from that equity flows respond to lower inflation, falling interest rates and growth, historically too they have proven less prone to sudden, herded flight as equity investors are diversified across stocks and take a more fundamental view.
Therefore, desperation in attracting some more foreign debt, which has just shown its fickle nature, is ill-guided. By the same logic, a monetary policy strategy meeting reportedly to be held this Friday should desist from raising interest rates; having missed the window to lower interest rates on 17 June, raising them now to prop up foreign debt inflow will only compound the negatives for an output recovery. A calmer approach should factor in the offsetting effects of falling global commodity prices upon future inflation; that the liquidity shock comes hand-in-hand with returning growth in the US and stronger sentiments in the eurozone, the UK and Japan; and finally, that unlike Indonesia and Brazil, India doesn’t really need to defend its currency by raising interest rates.
Renu Kohli is a New Delhi-based macroeconomist; she is currently Lead Economist, DEA-ICRIER G20 Research Programme and a former staff member of the International Monetary Fund and Reserve Bank of India.