A rate-and-rupee strategy could restore India external balances

Source– The post is based on the article “A rate-and-rupee strategy could restore India external balances” published in the mint on 26th October 2022.

Syllabus: GS3- Indian Economy

News- The article explains the current macroeconomic scenario in the country. It talks about the policy response to improve the external balances.

What is the situation of external macroeconomics indicators?

Foreign exchange reserves are $533 billion.

The Rupee has weakened by 4.5% against the US Dollar since September.

Trade and current account deficit are widening. CAD is likely to be 5% of GDP in the quarter ending September.

External balances are facing pressures from higher commodity prices, high inflation, monetary policy tightening across the world.

What is the internal economic scenario?

Investment scenario is weak. Some investment indicators are rising. It does not signal rising capital expenditure. It is mostly replacement capital expenditure from the pandemic period.

Saving rates have fallen. It has contributed to widening CAD. Higher public sector borrowing, lower household saving and lower bank deposits are responsible for low saving rates.

What can be the policy repose?

Policy rate hikes– It may check the inflation, incentive saving and discourage the household borrowings. But it could slow down income growth.

Increase public savings– It can lead to expenditure cuts. It will be negative for GDP growth and income.

Currency depreciation– It will make exports more competitive, imports more expensive and lower trade deficit.

A combination of higher interest rates and weaker Rupee is the optimal response. In September RBI moved to a two-pronged strategy of higher rates and weaker Rupee.

But there are challenges to this path. Real deposit rates are negative and trade weighted REER has not weakened since May this year.