The rupee’s ‘new lows’: Why it’s not necessarily a cause for concern

News: The currency’s fall gets more attention than its rise. At present, the Indian rupee is falling against the US dollar.

What is the status of the Rupee fall vis a vis other currencies?

The Finance Minister has recently pointed out that almost all currencies are falling against the dollar, and the rupee has fallen less than most. For instance, Rupee fell 6% in the first half of 2022. Compared to that, the euro has fallen by 11.6%, the yen by 19.2%, and the pound by 13.2%.

China’s yuan has fallen less (3.6%), but the currencies of Australia, South Korea, and of course Pakistan have fallen more.

Actually, the rupee has moved up against almost all currencies.

What is the long-term cause-and-effect relationship between country and currency?

Many people tend to get wrong about the long-term cause-and-effect relationship between country and currency. The present government came into office in favour of a “strong currency” policy.

However, such policy ignores that almost every country with a successful long-term record of development (Japan and China being among the best examples) has pursued a “weak currency” policy in order to win export markets. In reality, A strengthening economy gets a strengthening currency, helped along by capital flows.

A weak economy, or one with high inflation, does not become strong if the country artificially boost its currency, or keeps it pegged too high. Such a policy would not be sustainable and would risk capital flowing out.

For example, At the stage of development, if a country can’t compete on technology or product quality then the country can compete primarily on price. In such situations, a weak currency helps. Over time, as exports gain momentum and the economy achieves external viability, the currency reverses its decline.

How does India maintain its long-term cause-and-effect relationship between country and currency?

As for trade, over more than four decades (including the years of Nehru’s atmanirbharta), India kept the rupee over-valued. So, while countries in East Asia boosted their trade, India’s share of the global trade total collapsed by 80%– from about 2.5% in 1947 to about 0.5%.

India’s trade and inflation record improved after its currency and other policies became more market-oriented in and after 1991. However, India yet has run a trade deficit in most years despite the rupee’s continuous fall. This shows the reform done so far is not enough.

What should be done?

Reserve Bank to spend billions of dollars to boost the rupee is the wrong way. If India wants a stronger rupee, then India needs to do a better job of managing the economy such as Inflation control, productivity improvement, etc.

Recently, inflation rates are rising. It is natural that this loss in the rupee’s domestic purchasing power should get reflected in a lower exchange rate. Change the performance metrics and the rupee will hold its own without the Reserve Bank having to intervene.

Source: The post is based on the article “The rupee’s ‘new lows’: Why it’s not necessarily a cause for concern” published in “Business Standard” on 2^nd July 2022.