Defending the rupee

Source: The post is based on an article “Defending the rupee” published in the Business Standard on 8^th July 2022.

Syllabus: GS 3 Indian Economy;

Relevance: Macroeconomic Conditions; Stabilization of the Indian Rupee

News: The Indian rupee and the currencies across the world, including in the developed economies, are under pressure. The Indian rupee has depreciated by about 4.4%. Therefore, the Reserve Bank of India (RBI) has announced measures.

The RBI’s foreign exchange reserves have come down by over $37 billion since the beginning of the year. Therefore, the RBI aims to boost foreign exchange inflows to support the Indian Rupee.

What are the reasons behind the RBI decision?

The rupee is under pressure because of a variety of reasons. They are as below:

(1) Higher commodity prices and increasing imports have pushed up demand for foreign currency.

(2) In June 2022, the trade deficit expanded to $25.6 billion. The current account deficit (CAD) is expected to cross 3 percent of gross domestic product this fiscal year.

(3) India is witnessing large outflows on the capital account. The FPIs (Foreign Portfolio Investors) have been selling Indian assets on account of rising risk aversion in the global financial system as well as increasing interest rates in the US. For example, the FPIs have taken out over $30 billion since the beginning of the year, from India.

What are the measures that RBI is taking, to control the fall in currency value?

Following are some of the measures announced by RBI:

Banks will be exempted from maintaining the CRR and SLR for incremental non-residential external and foreign currency non-resident bank deposits for a limited period.

Banks have been given more freedom in terms of offering interest rates on the above-mentioned deposits.

The rules for FPIs in the debt market have been relaxed. The Indian firms have been allowed to borrow abroad in more liberal terms.

Why would the above steps have a limited impact?

At present, there is a global environment for the overall global risk aversion.

The companies may not be willing to borrow abroad because of the pressure on the rupee.

The overall policy direction may end up increasing risks. It may not be a wise step to increase the foreign debt of short-term nature, in order to defend the currency.

The global environment is likely to remain uncertain for some time. Therefore, the RBI’s move to defend the currency may become increasingly costly and perhaps unsustainable.

The Way Forward

The RBI has ample reserves ($593 billion) to quell excess volatility. Therefore, it should allow the rupee to depreciate in an orderly way. It would benefit in the following ways:

(1) It would protect the tradable sectors

(2) It would also make Indian assets more attractive to foreign investors

(3) It will help stabilize the overall external account and the currency.

Further, the RBI should address the inflation problem through monetary policy.

In addition to the above, the RBI should encourage firms to hedge foreign currency risks.