Over the last several days, one has come across headlines about the rupee weakening. For the unaware, these headlines would convince them about the decline in the value of the rupee even as the rupee has strengthened against the Euro, UK Pound and Japan’s Yen. How does one reconcile with these two events?
Well, the rupee hasn’t weakened, but it has in fact, witnessed an appreciation against a broader class of currencies—the dollar not being one of them. In fact, more than this, it is the US dollar that has gained strength—a fact that is visible when one looks at the dollar–euro or the dollar–pound exchange values.
The extensive coverage of the USD-INR exchange values without any context seem to suggest a repeat of the taper tantrum episode. But it ignores the fact that during the Taper Tantrum, India belonged to one of the fragile five economies, and the rupee was weakening against a much broader set of currencies. This is precisely why commentary and headlines that mention “rupee weakens”, etc., are incorrect and, as a matter of fact, it ignores the value of the rupee and the global economic context. The rupee’s value is not to be measured just against the US dollar but against a broader basket of currencies that make up the Real and Nominal Effective Exchange Rate indices.
In fact, in percentage terms, both during the Global Financial Crisis and the Taper Tantrum episode, the rupee depreciated by 28%. During the Asian crisis, it depreciated by 22%. Since the Ukraine war, this depreciation has been at 7–8%. Therefore, even by historical standards, the rupee seems to have done rather well.
The dollar gaining strength has more to do with global factors, primarily as the Fed increases interest rates over the course of the coming financial year. It is, therefore, naïve to infer about the health of the rupee by looking at the India-US exchange rate. With considerable uncertainty regarding inflation and, therefore, the pace of rate hikes, there isn’t a case for interventions to support the rupee. More so, given that India has a managed float exchange rate regime. Interventions, if any, should be to prevent volatility and sharp movements rather than attempt to target the exchange rate at a particular level.
From a competitive exchange rate standpoint, several of our competitors have seen a substantial depreciation of their currency against the US dollar. Some of them have also witnessed depreciation against most reserve currencies. What this means is that their products are now cheaper in the international markets than Indian goods. It is not unusual for countries to tinker with their exchange rates during a growth slowdown year to generate greater exports. This is true for many export dependent economies. There is a threat of competitive devaluations under such a circumstance when several economies begin to devalue to maintain their competitive edge. Still, the costs associated with the same serve as a credible deterrent. However, interventions to strengthen domestic currency when competitors are witnessing a depreciation is not the desired strategy. In fact, this would be the other end of the extreme which too would impose a cost.
It is therefore desirable that the rupee depreciates in line with what the fundamentals and markets suggest at the moment. This depreciation should be consistent with that experienced by our competitors. That is not just desired but is also the best policy response to make the most of the volatile external environment.
It is equally important to remember that India’s overall macroeconomic fundamentals remain well equipped to enable policymakers to respond to volatility or any exogenous shocks. This makes the Indian economy far more resilient than its competitors, more so because most other emerging markets went overboard with their financial support in 2020.
Therefore, capital flows to India will likely be sustained as investors look for higher yields over the coming years. Stable fundamentals and credible policy frameworks would ensure investor appetite. Still, they won’t be sufficient in preventing many in the Indian commentariat from measuring the Indian economy’s health by looking at a one-dimensional market determined US dollar to India exchange rate.
Karan Bhasin
New York-based economist
(karanbhasin95@gmail.com)