Govt should square up to growth against sliding rupee

The reason for the continued fall of the rupee against the dollar can be traced to the low level of credit generation reflected in poor GDP-to-credit ratio.

Despite crossing the threshold of 60 and fluctuating beyond that, the dollar exchange rate‘s relentless movement against the rupee has not abated. RBI measures have not been yielding results as can be made out from the higher breach level being crossed repeatedly on the rupee’s downward movement to 65 or 70.

If anyone poses a question as to whether the exchange rate prevailing now would stabilize and reflect the real exchange rate, the answer may not forthcoming. The exchange rate does not reflect the real value. The Real Effective Exchange Rate (REER) is actually a measure of the trade weighted average exchange rate of the rupee against a basket of currencies, duly factoring in the inflation differentials of the respective countries through an index number with reference to a particular base year. This is akin to ‘inflation indexed cost’ arrived at for the capital gains tax. The real parity of the rupee against the dollar, after factoring in inflation, may be around 55 to 58 and not the one ruling presently at nearly 66.

Falling rupee and rising CAD are the symptoms of the decline in manufacturing growth in India, but they are mistaken for a disease, like missing the wood for the trees. Policy makers appear to have misread the symptoms as disease itself.

Exchange rate implications

The weakness of the rupee against the dollar can be traced mainly to the widening current account deficit. While India’s imports are on the rise owing to mainly crude oil and gold demand, exports from India do not match up, resulting in a concrete trade deficit which reflects in the balance of payments. India handled and managed this shortfall through flows into its capital account, but these funds have also shrunk with the exodus of foreign funds out of Indian debt as well as equity markets. 

Inflation rates also play their role in the exchange rate movement as the former erodes the purchasing power that one currency can fetch against another currency. External debt of individuals as well as entities, inclusive of government and those abroad has a solid bearing on the rupee as the government and corporates access funds abroad, not to mention a good number of Indians taking up higher education abroad, necessitating borrowing arrangements to meet the cost. These aggregate to a substantial quantum of external debt getting magnified through exchange rate.

The government’s efforts to curb crude oil imports have not yielded desired results as the phenomenal requirement of crude oil for more than 40 years has had a direct impact on dollar exchange rate movement that has doubled in the intervening period.

RBI’s has tried to stem rupee depreciation, notwithstanding its limited ability to intervene by selling dollars to calm down the market. Thesewill increase foreign exchange flows to arrest the rupee’s fall.

While contradictions have prevailed between RBI and the government on economic management through policy transmission, in all fairness, it can be said that RBI’s vision has held India in good stead against many a global world financial crisis.

Growth against slide

Pushing economic growth and simultaneously arresting the rupee’s slide is a tricky situation as a stabilizing rupee may require raising interest rates which could severely impact economic growth. Cutting down on wasteful credit/ schemes and government expenditure will pave the way for growth and higher productivity, no matter how well informed these schemes are.

When the country facing a crisis on more than one front — exchange rate, inflation, CAD, adverse balance of payment —, to name a few, both RBI and the Finance Ministry should discuss and arrive at a consensus for a workable solution, without making the differences between them obvious to the world.

In the Indian political and governance scenario, periodical monetory policy initiatives have certain limitations as the components of production such as materials, labour, capital and land are fraught with operational risk and misgovernance, as could be made out from a number of scams emanating from the government’s end.

RBI Governor designate Raghuram Rajan’s impeccable credentials may not be adequate to place the rupee on strong ground. Rajan has already knitted a safety net by saying that he has no "magic wand" to handle the present dollar crises. Too much financial regulation coupled with too little financial innovation may be bothering the next RBI Governor. This has to be handled through banking and non-banking entities, on which the central bank presently has good control and influence.

The new RBI chief needs to address multiple objectives without losing focus. He needs to push banking reforms — with or without the new license policy — further, as the banking sector is saddled with many issues in human resources, leadership vacuum across layers, unnecessary or often bank-initiated restructuring processes (a tenth of which fall under the ‘stressed asset’ category). Other issues include bank consolidation, and stress on capital under international norms like Basel III.

(The author is a chartered accountant and financial analyst)