Views | Rupee on a slippery slope

These are the days of the rupee’s slide. On Tuesday, the Indian currency plumbed another low of 55.47 against the dollar. It is unlikely that it will regain ground unless the government takes drastic measures to restore confidence in the Indian economy. The Reserve Bank of India (RBI) cannot do more than what it already has done.

There are two forces that are propelling the rupee down. At the moment, the demand for dollars is being fuelled by future/risk expectations of importers. Oil companies and domestic firms that are dependent on imports are covering their currency positions. They anticipate further erosion in the rupee’s value and, hence, an increase in their costs. Given that pricing power of these companies is limited at best, they stare at losses. Hence their rush for the greenback.

There are, however, deeper currents that are tossing the rupee around. In any current account deficit economy, the ability to finance the deficit by capital inflows is an important variable in determining the exchange rate. Currently, a mix of domestic and global factors has cast a shadow on India’s wherewithal to do so. The government clearly has taken a series of missteps and pays only lip service to the concerns of the markets. Globally, there is movement to other, more paying, markets such as those in South-East Asia and a flight of safety to the dollar. This is what happened on Tuesday after the rating agency Fitch downgraded Japan’s sovereign rating from AA to A+.

There are limits to what RBI can do. On the one hand, if it does not use foreign exchange reserves to stem the rupee’s decline, there is a risk that the exchange rate will spiral out of control in the face of adverse expectations. On the other hand, large-scale intervention will lead to doubt or even deterioration in the confidence that India can meet its short-term external obligations. This is RBI’s stated position and it has stuck to it. In any case, the corridor between these two positions is quite narrow. That explains the central bank’s “feeble” intervention in the currency market. Its other steps—such as asking exporters to convert 50% of their dollar holdings in the export earner’s foreign currency account and imposing limits on banks in currency futures and options—should be seen in this light.

The onus now is on the government to take corrective steps. It has to, without ado, raise fuel and fertilizer prices substantially, if not fully free these prices and let markets determine them. This, however, is only an interim solution. It needs to undertake structural reforms if India is not to head towards another crisis.

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