The rupee's slide

The rupee is coming under increasing pressure. After remaining around Rs 86.50 to a dollar for a considerable length of time, it touched almost Rs 88 to a dollar in both the open and interbank markets last week, losing about one and half percent of its value against the greenback in less than a month, and more than 2.6 percent between 1st July and 25th November, 2011. According to analysts, the erosion in the value of the rupee was due to higher forward buying of the US currency by importers to hedge their positions. At the back of their mind was the growing perception that the rupee may not remain stable in the medium to long-term when the deficit on the merchandise account is widening, foreign investment is drying up and the SBP does not have enough foreign exchange reserves to intervene in the market on a regular basis. In our view, there could also be more potent reasons for the depreciation of the rupee against the US dollar. In the first four months of the current fiscal year, not only has the current account deficit almost tripled, other indicators of the economy have also worsened to destabilise the economy. There are now signs that the growth rate of the economy during FY12 would be less than projected, the fiscal position is not likely to be consolidated, energy shortages are expected to persist and political uncertainty appears to be exacerbating. It is also apprehended that the monetary policy that used to absorb some of the negative impact of the mismanaged fiscal policy in the past to control prices would not be applied with the same vigour due to the change of guard at the State Bank. The weakening of the euro due to the debt crisis in some of the European countries, was also a factor in stabilising the dollar at a higher level and weakening the rupee. While the rupee slide is largely a reflection of the frailty of some of the basic indicators, it is bound to have a number of influences on the economy. Prices of most items, particularly of those with high import content, would increase and the general cost of living would go up, resulting in more hardship to a large number of people. In a situation like this, some central banks develop a tendency to inject the foreign exchange reserves at their disposal into the market to stabilise the local currency in order to lessen the pain. However, it needs to be highlighted that while such a policy could provide some temporary relief, it is not a substitute for bringing about fundamental improvements in the economy that are necessary to ensure exchange rate stability. In fact, under certain conditions it may be advisable to let the local currency depreciate in order to achieve a balance in the current account by encouraging exports and restraining imports. Anyhow, if exchange rate stability is the target variable, it must be achieved through measures like fiscal consolidation, growth in exportable surpluses, and tightening of monetary policy to contain price pressures rather than administered means like prescription of import quotas and multiple exchange rates. The central bank could of course inject foreign exchange in the currency market to check the onslaught of speculative forces but it should be only on a temporary basis. We are of the firm view that authorities need to concentrate on stabilising and enhancing the competitiveness of the economy or else be prepared for a downward trend in the exchange rate of the rupee and let the impact of fiscal imbalance and other policy weaknesses spill over to the foreign sector. Propping the rupee by artificial means would not only be counter-productive but will make matters worse in the long run. Copyright Business Recorder, 2011