[op-ed snap] The challenge of managing currency

Note4students

Mains Paper 3: Indian Economy and issues relating to planning, mobilization of resources, growth and development, employment.

 

From UPSC perspective, the following things are important:

Prelims level: Current Account Deficit, Real Effective Exchange Rate, Market intervention by the RBI, Capital Flows

Mains level: Managing the CAD and taking advantage of the recovering global trade

 


News

Context-

  1. The article talks about steps to manage the currency volatility and how to avoid 2013 like phenomenon.
  2. It says that excessive exchange rate volatility could affect investment and growth possibilities in tradable sectors.

Capital flows: Capital flows refer to the movement of money for the purpose of investment, trade, including the flow of capital within corporations in the form of capital spending on operations and research and development (R&D).

 Background-

  1. The latest World Economic Outlook report by the IMF shows that it has been tough for the central banks to manage currency market.
  2. The exchange rate volatility has become a significant problem from the year 2013 when the US Federal Reserve hinted that it could reduce its interest rates. This led to sudden capital outflow from the emerging markets including India. In 2015, the devaluation of renminbi also had a similar effect on the international economy although India was insulated from this shock.
  3. Capital flows are fairly volatile, non-intervention from the central bank can affect economic activity and could be a potential source of risk to financial stability.

 

Way forward-

  1. The central bank should continue to intervene in the market to protect the competitiveness of the rupee. This means the RBI should undertake purchase of foreign currencies.
  2. Now that India has adequate reserves, the government and the RBI should review the composition of foreign flows. Equity investment is more stable compared to debt which sometimes flows in only because of interest rate arbitrage.

 


Back2basics

  1. Current Account Deficit: A capital account deficit shows that more money is flowing out of the economy along with increase in its ownership of foreign assets and vice-versa in case of a surplus.
  2. Real Effective Exchange Rate: The real effective exchange rate (REER) is the weighted average of a country’s currency relative to an index or basket of other major currencies, adjusted for the effects of inflation.
  3. Market intervention by the RBI: Purchase of foreign currencies will lead to decrease in supply of the same. This will increase the rupee supply in the market and help appreciation of foreign currencies leading to increase in competitiveness of Indian rupee.
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