Falling rupee – A dual-edged sword?
Of late, there has been a lot of talk on depreciation of the rupee. Unless you’re Marx incarnate, you better be concerned!
But is it really a bad thing?
- How does it impact us?
- What’s the RBI doing to check it?
Let’s take the help of two mind maps and attempt to solve this mystery…
And now some positives
Got that? Let’s try to figure out why China is devaluing its currency, Yuan
China doesn’t let its currency trade freely in financial markets as the US does. Instead, it links the yuan’s value to a basket of currencies. The composition of this basket is a secret but is believed to be dominated by the US dollar. Then it restricts trading to a band 2% above or below a daily target set by the People’s Bank of China.
The People’s Bank of China affirms that it acted so because the yuan has been rising even when market forces say it should be falling!
Worried Chinese have been moving money out of the country, putting downward pressure on the yuan. Yet the yuan has remained up anyway because of its link to the dollar, which has been rising. An overvalued yuan has hurt Chinese exports by making their products more expensive overseas.
This is exactly why China is going for competitive devaluation.
But a falling rupee doesn’t always mean an export windfall…
Anup Pujari, director general of foreign trade (DGFT), calls it a myth that the depreciation of the rupee necessarily results in massive gains for Indian exporters.
For 2 reasons:
#1. India’s top 5 exports — petroleum products, gems and jewellery, organic chemicals, vehicles and machinery – are so much import-dependent that the currency fluctuation in favour of exporters gets neutralised.
In other words, exporters spend more in importing raw materials, which in turn erodes their profitability.
#2. As buyers are aware of the currency fluctuation, renegotiation is becoming a trend now.
The moment the rupee falls sharply against the dollar, foreign buyers try to renegotiate their earlier deals. As most exporters give in to the pressure and split benefits, advantages of a weak rupee disappear.
However, despite these risks, we need not worry in the CONTEMPORARY context.
Really? India has nothing to worry about! How so?
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
- Foreign exchange reserves in case depreciation gets out of control to become a free fall
- Impacting corporate balance sheets
The latest economic data tell us each of these risks has receded.
Let’s see how…
#1. A falling currency can be inflationary since it raises import costs.
That is less of a worry now, thanks to declining domestic inflation as well as the sharp correction in global crude oil prices. The RBI has met its January 2016 inflation target of 6% and is planning to bring it down to 5% in first quarter of 2016.
#2. The FOREX hoard has grown
RBI 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. In other words, there is more reason to let the market determine the value of the rupee.
#3. Corporate hedging has improved
One fear, recently, 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.
RBI data show that 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.
Ergo, Indian policy makers have more room than before to let the currency drift down to maintain competitiveness.
Published with inputs from Swapnil