These are challenging times for the Indian economy. The current mood of pessimism is far more pervasive than it was during the 1991 crisis.
Indians, for the most part, do not have a “penchant for self-flagellation”, as alleged by Union minister for rural development, Jairam Ramesh. But they certainly do recognise the country’s economic prospects are crisis-ridden. The fate of the hapless rupee, that is testing new lows every other day, matches the national mood.
The big difference between now and 1991 was that the rupee’s value then was officially determined. Now it is market-determined. In 1991, when the government took an IMF loan, devaluing the rupee was a conditionality. Accordingly, the government lowered its value effectively against major currencies by 18-19% in two steps in a hush operation code-named Hop Skip and Jump. Now, the rupee is depreciating due to factors beyond the government’s control.
The rupee’s precipitous decline against the dollar is due in part to the country’s imbalance in goods and services trade with the rest of the world that hit a high of 4.8% of GDP in 2012-13. Forex reserves are down to $278.8 billion or seven months of import cover. The stock market has tanked. Food inflation is high. Growth is down to 5%. As if all of this weren’t bad enough, there is a steady drumbeat of commentary — as in The Economist — ‘how India got its funk’.
Is a falling rupee a good thing or a bad thing? It is certainly good for the country’s exporters as a cheaper rupee gives them a competitive edge in selling their goods abroad. It is even better when the exchange rate of our rivals like Bangladesh strengthens against the dollar while the Indian rupee weakens. That gives us greater bilateral competiveness in garment exports. It is bad for imports. It is also bad for those who want to vacation abroad or take loans to study abroad.
A plunging rupee is a heaven sent for those who depend on remittances from relatives overseas, as in Kerala. If remitting a $1,000 back home provided Rs. 54,000 in 2012-13, the recent low of Rs. 68.8 to a dollar provides Rs. 68,800. No wonder that remittances from the 2-million Malayalee diaspora are expected to surge to a record level of $12.5 billion or Rs. 75,000 crore this fiscal, according to the migration unit of the Centre for Development Studies in Thiruvanthapuram.
From the larger economy point of view, a weaker rupee is not one of the Four Horsemen of the Apocalypse. A weaker or undervalued rupee is good for exports. South Korea and China, for instance, deliberately undervalued their currencies to spur their export drive. China continues to undervalue the yuan. An undervalued rupee can certainly help in bridging the imbalance in the goods and services trade rate that is triggering comparisons with the 1991 crisis.
How undervalued is the rupee? One simple yardstick is The Economist’s Big Mac index based on the theory of purchasing power parity: In the long run exchange rates should move towards the rate which equalises the price of an identically produced burger or Maharaja Mac in India. If a burger costs $4.56 in the US, in India at the low of Rs. 68.8 to dollar a Maharaja Mac costs $1.53 or 66% less than its ‘correct’ level. The Chinese yuan is undervalued by 43%.
For such reasons, a weaker rupee is far from the disaster that it is made out to be. The best course of action for the government or the new Reserve Bank of India governor would be to leave the rupee to fend for itself. Since the government does not intend to impose capital controls, it can then use monetary policy to control inflation and stimulate growth. It is impossible to stabilise the exchange rate, free capital movements and have an independent monetary policy at the same time.
At best only two of these objectives can be satisfied. So, if India wants to stabilise the rupee and keep its capital account open, the use of monetary policy to stimulate growth by increasing money supply and reducing interest rates will have to be sacrificed.
If it wants to have a stable rupee and use monetary policy to revive growth, these can be accomplished through capital controls. If it prefers an open capital account and a strong monetary policy, the rupee will remain volatile. Pessimism regarding its downward trajectory is unwarranted.
N Chandra Mohan is an economics and business commentator based in New Delhi
The views expressed by the author are personal