External vulnerabilities: Time for a rupee review

News: India’s exports in May were up 15.5% on last year’s figure. On this upbeat momentum, India could see another year of robust exports, beating the $418 billion record set in 2021-22.

High oil prices are also a major reason for a rise in exports this year, since petroleum products made up a big share of our overseas sales.

But, increased oil prices also inflated this sector’s import bill by 91%. Overall, our trade deficit widened to its widest ever gap of $23.3 billion. Pressure on this front isn’t likely to ease anytime soon.

Hence, RBI should weigh the option of bridge support for the rupee in aid of broad macro stability

What are the challenges involved?

With the Russia-Ukraine war now past 100 days with no end in sight and Europe set to choke off most of its Russian intake, the global price shock is here to stay.

Cheaper oil from Russia, meanwhile, faces logistical and insurance burdens that negate some of its savings.

Throw in the impact of climate action, which could result in a tighter Opec grip as non-Opec output slows, and the scenario signifies an increased import bill for months to come.

Energy costs on the whole are rising globally.

Coal imports spiked 167% in May to feed a power shortage; domestic supply of coal is poor, and the demand is growing. Thus, India’s trade gap is expected to widen and the rupee to weaken as dollar demand gets the better of it.

Capital markets have already seen a sell-off by foreign investors, whose exit via rupee conversion into dollars pushed its value down. Rising US interest rates and rupee erosion due to local inflation could see even more money pulled out of India. In a world unsettled by war, ‘safe haven’ assets are luring investors away.

Should the RBI respond?

Its usual practice is to buy and sell dollars to contain volatility, but otherwise let the exchange rate float. The Forex reserve has fluctuated around $600 billion, remains large enough to keep an external crisis at bay.

RBI’s priority at this juncture, however, is inflation control. It could strategically choose to boost rupee in aid of internal price stability. Selling dollars would reduce domestic liquidity and also ease swelling oil bills.

Source: This post is based on the article “External vulnerabilities: Time for a rupee review” published in Livemint on 5th June 22.