Why Weaker Rupee Isn’t All Bad News

Source: The post is based on an article “Why weaker Rupee is not all bad news?” published in The Times of India on 22nd July 2022. 

Syllabus: GS 3 Indian Economy; Issues and Challenges pertaining to growth and development of the Indian Economy 

Relevance: Macroeconomic conditions; Rupee Depreciation  

News: Recently, the foreign exchange rate breached the mark of Indian Rupee 80 per dollar. 

What are the real problems with rupee? 

Why there is no reason to panic over the rupee 

As per the dollar index, the dollar has appreciated across currencies. Therefore, there has been depreciation of the pound sterling, the euro, and the currencies of nearly all emerging markets (EM) including the Indian rupee. However, the Indian rupee’s depreciation has been surprisingly modest, despite the fact that the capital has been flowing out of the country at the same time. 

So, what can be done? 

(A) Some observers argued that India can utilise (or sell a portion) the foreign exchange reserves amounting to $580 billion at present.  

Limitation of the foreign exchange intervention 

(1) When the central bank sells foreign reserves, then commercial banks are required to give rupees in return. Therefore, the banks will run out of liquidity. This will tighten money supply and, thereby endangering economic recovery. 

(2) The RBI can do “sterilisation” to solve liquidity crunch due to foreign exchange intervention. The RBI will buy government bonds from the banks. However, If the RBI purchases large amounts of bonds in the market, this could push bond rates down to inappropriately low levels, thereby endangering the inflation target. 

(3) Since investors know that there is a limit to the foreign exchange sales, they will be tempted to try to purchase as much dollars as they can right now. This will further increase the pressure on the exchange rate.
 

(B) Therefore, we need to go back to fundamentals and ask: Do we really want to prevent rupee depreciation? 

(1) The two most important drivers of growth for an emerging economy (EM) like India are investment and exports. However, the Private sector investment in India has been sluggish for several years.  

(2) But India’s last year’s recovery was highly dependent on the growth of Indian exports. Therefore, the only engine of growth upon which India can rely to ensure economic recovery is the export. 

(3) Therefore, the government should not prevent Rupee depreciation because If rupee appreciates against other Asian currencies such as the South Korean won, the Thai baht and the Taiwanese dollar, India will lose its export competitiveness in the global trade. 

Limitation 

Of course, there are costs to a weak rupee. The depreciation will push up inflation.