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Views | The lack of confidence

Views | The lack of confidence
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First Published: Tue, Nov 22 2011. 11 05 PM IST

Jayachandran/Mint
Jayachandran/Mint
Updated: Tue, Nov 22 2011. 11 05 PM IST
The sharp fall in the rupee is the result of both weak global risk appetite and the deterioration in the fundamentals of the Indian economy. The dollar has been strengthening against most currencies as the result of risk aversion leading to investors selling off risky assets and heading to the perceived safe haven of US treasuries. That has affected emerging market currencies. But the rupee has depreciated more than others, for several reasons.
One of them has been the huge trade deficit in October, which took everybody by surprise. Till then, the year-on-year export growth numbers masked the drop in monthly exports. For instance, merchandise exports fell from $29.3 billion in July to $24-25 billion in the subsequent two months. In October, however, exports fell to $19.9 billion. This fall of around $5 billion was matched by a $5 billion rise in imports and the result was a $19.6 billion trade deficit, a 17-year high. Most emerging markets in Asia are very different from India, in that they run current account surpluses. The rise in the trade deficit has, therefore, led to pressure on the rupee. This has been compounded by the fact that capital inflows into the country’s markets have been very marginal. India’s structural external deficit needs financing through capital inflows and the lack of these flows has led to rupee depreciation. With the slowdown, however, it’s likely that import growth, too, will come off, leading to a lower trade deficit.
Jayachandran/Mint
While capital inflows have certainly been hit by the uncertainties prevailing in the world economy, in particular the sovereign debt situation in Europe, the deterioration in domestic economic prospects must also bear a share of the blame. Growth estimates are steadily being pared and some estimates now put gross domestic product growth below 7% in the next fiscal year. Inflation has remained high for years, far more so than that in the country’s trading partners. In fact, Reserve Bank of India (RBI) data shows that the real effective exchange rate, based on six-currency, trade-based weights, was high even in end-October, implying that there are strong fundamental reasons for the depreciation.
That said, it’s interesting to note that the depreciation has not really been the result of large-scale selling by foreign investors. On the contrary, what seems to be happening is that those who had taken dollar loans and had not hedged their positions are now scrambling to make amends. The dollar shorts are now covering and that has exacerbated the situation. RBI can, in the short run, certainly act to stem the panic. But for the direction of the currency to change, what is needed is the return of confidence, both in the global markets and in the prospects for the Indian economy.
Will the rupee continue to weaken against the dollar? Tell us at views@livemint.com
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First Published: Tue, Nov 22 2011. 11 05 PM IST
More Topics: OurViews | Foreign Exchange | Asia | RBI | Commodities |