[Editorial Analysis] As the rupee spins downwards

Mains Paper: 3 | Economy

Prelims level: Rupee falling

Mains level: Measures need to strengthen the rupee

Context

• The crude prices-current account deficit-rupee macroeconomic equation had started becoming unfavourable, the government’s early arguments focussed on external factors outside its control the oil prices.

• U.S. Federal Reserve’s interest rate policy, turmoil in the international currencies, etc. The Reserve Bank of India (RBI), fighting a solitary battle, defended the rupee in the forex market by dipping into its $425 billion stockpile of reserves.

• Roughly $25 billion was spent between April and September. Yet, the rupee went from about 65 to a dollar to more than 71 to a dollar.

• The RBI intervened thereafter very selectively, probably recognising the futility of resisting the slide.

Jaitley’s reassurance

• Mr. Jaitley reassured markets that the fiscal correction target would be met without a cutback in capital expenditure.

• Yet, it did not change market expectations.

• The response measures could not turn the tide. The depreciation continues unabated. 75-to-a-dollar is within a hair’s breadth.

• The measures failed is not surprising. When holding $400 billion in reserves has not arrested the depreciation, how can tinkering around for $8-10 billion in inflows stop it?

• A durable solution would be to attract stable, long-term capital, not hot money chasing arbitrage differentials.

• The move to raise the import tariffs on select ‘non-essentials’ confers protection on local industries with competitive disadvantage vis-a-via imports.

• But were the items really chosen through serious analysis of the current account deficit? Import duties were ratcheted up on washing machines, but only on those ‘less than 10 kg’.

• Can the government explain why it considers imports of washing machines ‘10 kg and more’ essential?

• This is socialist-era redux. The rupee’s tumble has brought out the controlling tendencies that were retired in the 1990s.

Why have markets not bought the government’s reading of the macroeconomic situation?

• The government has defended its macroeconomic management as exemplary, saying that the rupee’s troubles are due to international developments beyond its control rising U.S. interest rates and global crude prices.

• But these short-term difficulties have touched what are traditional vulnerabilities.

• The twin (fiscal and current account) deficits get stressed whenever crude prices surge or there is a dollar-investments sell-off.

• The markets are readjusting their expectations of the twin deficits.

• The depreciation under way is confirmation that things have not changed, as is evident from the frequent use of stop-gap plugs rather than long-term fixes.

• In the four years since 2014, the NDA government has reduced the fiscal deficit by just one percentage point, despite the huge bonanza from the fuel taxes.

• The policy, as conceived, was to tax when crude prices are low, use the proceeds so raised to balance the fiscal books, and whenever prices rise, reduce the tax rates.

• The government dithered on expenditure reforms, and so its dependence on the fuel taxes has grown.

• Mr. Jaitley’s maiden budget had proposed urea prices decontrol, although he did not mention it in the speech. The plan was aborted in 2015.

Central bank’s limits

• The markets looked back to the RBI (in vain) for bringing a pause in the rupee’s slide. The burden of expectations tested the RBI’s commitment to the new monetary policy framework.

• Its exchange rate management duties are limited to subduing rupee volatility.

• In not hiking the policy interest rate last week, the RBI has remained duty-bound and within mandate.

• The RBI can open special windows for the forex needs of crude oil importers.

• Taking this considerable source of demand-side pressures off the forex market could provide the rupee some relief.

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