Why there is no need to worry too much about the ‘record fall’ of the rupee

When P. Chidambaram was the finance minister, politicians known for their thin skin used to get excited when they read these newspaper headlines – ‘Rupee hits new depths’, or ‘Records fall’. He used to see the falling currency’s price as a result of his actions, but in these headlines he saw a point that if a generally weak currency like the rupee is falling, then every fall (even if it is by a few paise).

There will only be a ‘record fall’. But both the headlines and the minister’s reaction highlight the bias towards a weak currency. In fact, people pay more attention to the decline in the value of the currency than the rise in it.

Why is this history relevant? Because the headlines talk about the depreciation of the rupee against the US dollar. The newspapers do not report (which Finance Minister Nirmala Sitharaman highlighted on Thursday) that the value of currencies of all countries is falling against the dollar and that the rupee has depreciated less than many others—by 6 percent in the six months of 2022.

In comparison, the euro has fallen by 11.6 per cent, the yen by 19.2 per cent and the pound by 13.2 per cent. The Chinese yuan fell by only 3.6 per cent. But the currencies of Australia, South Korea, and of course, Pakistan fell more. So the correct headline would have been that the rupee has risen against almost all other currencies. But the news world is lagging behind.

Will it make a difference? The answer is yes because it takes the policy in the wrong direction. For example, Narendra Modi’s government came to power with a bias in favor of the policy of ‘strong currency’.

Such policy makers tend to forget that almost every country with a long-term record of successful growth (Japan and China being the best examples) has pursued a policy of ‘weak currency’ to win the export market.

The reason is simple- you can’t compete in terms of technology or product quality in the stage of development you are in, so if you are competing mainly in terms of price, a weak currency will help. With the passage of time, exports pick up pace and the economy is able to move abroad, then the currency starts to strengthen.

The cause-and-effect relationship between country and currency is misinterpreted by many. A strong economy gets a strong currency, which is helped by the inflow of capital. The causal relationship doesn’t work in the opposite direction—the currency of a weak or high-inflation economy doesn’t become stronger by artificially infusing or propping it up. Such a policy is not sustainable, it can drive out capital.

As far as trade is concerned, for more than four decades (including during Nehru’s self-reliance), India kept the rupee high. So while the countries of East Asia increased their trade, India’s share of the world market fell from 2.5 percent in 1947 to 80 percent to 0.5 percent.

Two opposing comparisons will make the point clear. The Indian rupee was stronger than the Pakistani rupee (now one rupee is equal to $ 205) because the management of Pakistan’s economy was very messed up. At the other end of the scale, the Thai Baht was once available at a 10 per cent premium to the rupee, but today it is worth ~2.20.

Despite a strong currency, Thailand has maintained its annual trade surplus. India’s trade and inflation record has improved in 1991 after its currency and other policies were market-friendly. Despite this, the trade deficit remained for most of the years, despite the depreciation of the rupee.

Clearly, the economic reforms so far have been inadequate. If the leaders of India want a strong rupee, then they will have to manage the economy better. Inflation has to be controlled, productivity has to be increased, etc-etc. The Reserve Bank should spend billions of dollars to support the rupee, this path is wrong.

The fact is that except in the recent past, inflation in India has been higher than inflation in the markets of its importance. Obviously, the weakness in the domestic purchasing power of the rupee will be reflected in the lower exchange rate. Change the scale of work, only then the rupee will come in its color without the intervention of the Reserve Bank.

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