Why India doesn’t need to worry

[akhil ch]

ABOUT THE FALLING RUPEE

 

 

 

 

 

 

The Indian rupee has breached the level of 65 to a dollar. Here are three reasons why a fall in its value is less of a worry now than it could have been over the past few quarters.

First, inflation is trending down. The latest data on consumer prices for July exaggerates the extent of disinflation, thanks to a strong base effect; food prices were high in the same month last year. But it now seems quite certain that the Reserve Bank of India (RBI) is on course to meet its January 2016 inflation target.

A falling currency can be inflationary since it raises the costs of imports. That is less of a worry now—thanks to declining domestic inflation as well as the sharp correction in global crude oil prices.

Second, the forex hoard has grown. The central bank has been assiduously buying dollars in the spot and forward markets to build a buffer in case there is another global shock once the US increases interest rates.

 

 

 

There is no easy way to figure out whether a country has adequate foreign exchange reserves, even though there are simple measures like months of import cover or more formal measures such as the Guidotti-Greenspan Rule. But RBI governor Raghuram Rajan said, in his meeting with economists after he announced the monetary policy on 4 August, the level of reserves has “certainly reached a fairly comfortable level”.

In other words, there is more reason to let the market determine the value of the rupee.

Third, corporate hedging has improved. One fear in recent quarters was that a sudden decline in the rupee would wreak havoc in corporate balance sheets since most companies had not hedged their foreign exchange liabilities. The rupee value of their foreign exchange loans could shoot up. Even the International Monetary Fund (IMF) has spoken with concern about this risk to economic stability.

But the latest data released by the central bank shows matters have improved considerably: the ratio of hedged positions has gone up sharply, from 15% of all foreign exchange liabilities a few quarters ago to around 41% in the first quarter of the current fiscal year. This still means more than half of the foreign exchange loans taken by Indian companies are not hedged. But the direction of change is positive.

Currency depreciation is generally akin to a stimulus because it boosts net exports, one of the three main drivers of economic growth, along with consumption and investment. Such a policy comes with attendant risks: to inflation through higher fuel prices, to foreign exchange reserves in case depreciation gets out of control to become a freefall, and to corporate balance sheets. The latest economic data tells us that each of these risks has receded.

Ergo, Indian policymakers today have more room than before to let the currency drift down to maintain competitiveness.