Let it fall

It makes economic sense not to press the panic button,or give in to exhortations to shore up the rupee

Written by The Indian Express | Published: June 11, 2013 4:23 am

It makes economic sense not to press the panic button,or give in to exhortations to shore up the rupee

The rupee has fallen further,prompting many to think it is time to press the panic button and do something. But before that is done,there are questions to ask: why is the rupee falling? What can we do about it? Should we do anything about it? The only answer is that,other than policies that support good growth and low inflation,or,as economists like to call them,strong fundamentals,there is very little that can or should be done about the rupee.

The rupee is falling because of a global “risk-off”. When Ben Bernanke suggested that the quantitative easing of the US Federal Reserve might taper off,or come to an end,it started a flow of capital back to the US and out of emerging economies. This “risk-on-risk-off” behaviour of global capital has characterised global financial markets after the financial crisis. When capital does not want to take risk,it flows to low yielding US dollar assets and so back to the US. When it wants to take risk,in what is described as a risk-on phase,money flows to emerging economies. In a risk-off,as is happening now,there is pressure on the currencies of emerging economies to depreciate.

Can India do anything about these global flows of capital and keep the rupee strong in the middle of these large flows? It would be foolish to try. The RBI has very sensibly stayed away as it cannot do anything. As a former RBI deputy governor once remarked,the RBI cannot manipulate the rupee. It does not have the ammunition to do so. In any case,when exports are growing at historical lows,a better option would be to think of it as a blessing. Exports will become more competitive with a weaker rupee,an argument made for years by those who wanted India to follow the export-led China growth model. The argument used to be that the RBI should buy dollars in the foreign exchange market and push the rupee down. Now this is happening by itself. Other emerging economies with floating exchange rates (often India’s competitors) are also depreciating. Why would we want the rupee to remain strong?

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