Why there is no reason to panic over the rupee

Source: This post is based on the following articles

“Why there is no reason to panic over the rupee” published in the Indian Express on 20th July 2022.

“The RBI should desist from launching a defence of the currency. Let rupee find its own level” published in the Indian Express on 20th July 2022.

Syllabus: GS 3 – Indian Economy and issues relating to planning, mobilization, of resources.

Relevance: To understand the performance of the Indian Rupee to the US Dollar.

News: Due to various international issues, the Indian rupee has now depreciated by 5.6% against the dollar. However, in terms of relative performance, Rupee has done well compared to most of its counterparts except the Indonesian Rupiah.

About the present situation of Rupee

In an ideal world, if domestic economic fundamentals are strong, the depreciation of the rupee should be accompanied by an appreciation of the Dollar Index (DXY).

Between March 2021 and July 2022, the rupee depreciation is 9.7% and the DXY appreciation is a sharp 17.4%.

Note: The Dollar index measures the currency’s value against six major currencies.

What are the reasons for the rupee’s depreciation?

1) As the US attempts to bring inflation under control, the recent gains in the dollar might come due to aggressive monetary policy by the US Fed compared to other major jurisdictions, particularly, the Eurozone and Japan, 2) Foreign portfolio outflows and the rush to safe assets as fears of a recession begin to gain traction, and 3) Widening current account deficits: Experts expect that current account deficit upwards of 3 per cent of GDP this year.

Thus, the recent decline in the rupee has been more because of the strengthening of the dollar.

How well the US dollar is performing?

In principle, Bretton Woods ensured that the dollar would be a “trust” currency. The US sits at the centre of an international financial system where its assets have been in high demand. For instance, with the US Fed embarking on one of the steepest rate hike cycles in recent times, investors have rushed to the dollar.

The dollar index has recently registered its highest level since 2002. Higher than expected inflation in the US.

What is the RBI’s response to the performance of the Rupee?

The RBI and government have taken a long-term view of bolstering dollar inflows. This would mean that the rupee could still face headwinds in the short term.

The RBI announced a series of steps to attract capital inflows to support the currency. Such as, 1) Relaxations on NRI deposits to ease investments in government and corporate bonds, 2) Measures for settlement of international trade in rupees to ease pressures on the currency, 3) The RBI also intervened in the currency markets to stem the rupee’s slide.

What should be done?

Unlike in the past, the RBI should discontinue launching a currency defence. It must let the rupee find its own level. This is because, a) A weaker rupee will act as an automatic stabiliser, b) Though in the near term it increases the risks of importing inflation, over time, it will boost the competitiveness of the country’s exports. Thus providing a much-needed fillip at a time when the global economy is facing strong headwinds.