Let the rupee slide

The economy is best served by lowering interest rates and blocking protectionism.

Written by Ila Patnaik | Published:February 3, 2016 12:20 am
rbi, rbi rate cut, repo rate cut, rbi repo rate cut, rbi governor raghuram rajan, rbi basis point cut, rbi loan rate cut, rbi news, reserve bank of india, business news, economy news, indian economy, indian express news RBI Governor Raghuram Rajan during a press conference announcing the RBI monetary policy at RBI Headquarters in Mumbai on Tuesday. (Source: PTI Photo)

In its monetary policy announcement on Tuesday, the Reserve Bank of India (RBI) decided to keep the policy interest rate unchanged. One of the implications of this decision is for the rupee. High interest rates have helped in keeping the rupee strong in recent years. It appears policymakers wish this to continue.

But the recent slowdown in China and the depreciation of the yuan means India’s external environment has changed significantly. While two years ago it might have seemed like a good idea to prevent the rupee from weakening, a rethink is now warranted.

In recent months, Indian industry has been facing sharp competition from falling international prices. As the budget-making process starts, demands for tariff hikes will get stronger. Accepting protectionist demands could impact downstream industries and have implications for India’s international treaty obligations. Favouring certain sectors, especially those with a few large companies, can make the protection politically difficult.

One example of this is the steel industry where the world’s largest producer of steel, China, has seen a slump in demand and has an industry suffering from overcapacity. The Indian steel industry is faced with an onslaught of cheap imports. It has, in response, been pressing for hikes in import duty on steel, imposition of a minimum import price and anti-dumping duties.

It can be argued that the government should do nothing, and allow the Indian consumer to benefit from lower Chinese steel prices. However, it is difficult for the government to ignore the state of the steel industry and job losses. The consequent higher probability of defaults on bank loans by steel companies may also push banks into further trouble.

Already, India is ranked No 1 in imposing the most protectionist measures since 2008. In 2015, India imposed the second highest number of protectionist measures, after Russia. For the fastest growing economy in the world, the policy of greater protectionism is becoming untenable.

We expect that in 2016 the pressure for protectionist measures may increase. Global trade has slowed down to nearly zero per cent growth. As the Chinese economy and Chinese exports slow down, Chinese authorities may to try to help push exports.

For one, the Chinese renminbi was devalued. For years, the Chinese currency had seen pressure to appreciate. The slowdown, the pressure on exports and China’s decision to depreciate seem to have set off an outflow of dollars from China. Today, the pressure is for greater depreciation. The pace of depreciation has been slowed by foreign exchange intervention. China has been selling dollars. We have seen a decline in its foreign exchange reserves by $513 billion in 2015. In the month of December 2015 alone, China’s reserves fell by $108bn. With higher pressure to increase exports, China may allow the yuan to depreciate more.

The most likely direction of the yuan is downwards. In response, other emerging economies are also weakening their currencies. It is not difficult for an emerging market (EM) to do a currency depreciation in today’s environment. It does not require cutting interest rates, out of line with macroeconomic conditions. Global growth has slowed down and commodity deflation is putting downward pressure on prices. Following the increase in US interest rates by the Federal Reserve, emerging economies have been witnessing outflows of capital. This is putting pressure on EM currencies to weaken. Indeed, today it is harder for an EM central bank to prevent a depreciation than to allow it.

If other currencies depreciate, it will further make India’s imports cheaper and increase the demand for trade protection. However, tariffs are not the only way to protect domestic industry. As is being seen globally, an alternative approach to raising tariffs to tackle the loss of competitiveness of domestic industry is currency depreciation. In the above example, the impact of a 10 per cent depreciation is equivalent to a 10 per cent tariff on all steel imports. Depreciation increases the price of imported goods.

Last week, when Japan adopted a negative interest rate strategy, currency considerations are understood to have played a significant role. While deflation has been around in Japan for a while, the challenge from the yuan and the decline in commodity prices is new. The cut in Japanese policy rates will, it is hoped, depreciate the Japanese yen and increase import prices.

Today, when other countries are protecting themselves by allowing currency depreciation, should India lean against the wind? Should we combine a strong rupee policy with protectionism?

Allowing the rupee to depreciate has further benefits: It makes all imports more expensive. The government does not have the politically difficult job of increasing tariffs case by case. A weaker rupee would also help push Indian exports.

From 2009 to 2013, in the period of high volatility in the global economy, India had a largely flexible exchange rate policy. Since May 2013, India’s exchange rate policy has been to prevent significant appreciation or depreciation. Since the taper talk and expectation of rupee depreciation in May 2013, an increase in interest rates and liquidity tightening have prevented any significant weakening of the rupee. Debt flows have been large as the differential between domestic and international interest rates remains high.

Everyone does not want a weak rupee. Foreign investors applaud the strong rupee policy as it protects their returns. Rich Indians like cheap foreign holidays and imported goods. For some people, a strong rupee is a matter of pride. However, the policy of keeping the rupee strong and combining it with protectionist trade measures is unsustainable. Exchange rate policy and strategy for 2016 cannot be the same as it was before the Chinese story started unfolding. The RBI and the commerce ministry need to be on the same page. The government must take a holistic view of the policy strategy on protectionism, the exchange rate and interest rates. The Indian economy would be better served by lower interest rates, blocking protectionism and letting the market determine the price of the rupee.

 

The writer is professor, NIPFP, Delhi.

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  1. S
    Sirius
    Feb 3, 2016 at 8:00 am
    The economy needs lower taxation and freedom from 'inspector-raaj',including the activist triggered SC and NGT kind. A higher interest rate can be tolerated if we have determinism on completion of projects and persistence of policies. Sadly,do we see that today ? Ban Maggi, ban above 2000cc diesel vehicles, ban liquor, 14 stages of real estate clearance , all eateries to register, social impact essment are just a few examples . Taxation hurdles are overbearing e.g., whether within service-tax/VAT net will be determined in court many years after transaction, onus on deducting tax on the payee(TDS) , PAN/TAN/Service tax returns for the small trader who gets distracted from growing his business . Even Germany's economic prowess is based on its small businesses, not just the huge companies. And,in India we don't encourage the small entrepreneurs who have the potential in them to scale the economy . First let their business grow then think about how to bring them in tax net , and,not the other way around ...
    Reply
    1. V
      Vish
      Feb 3, 2016 at 4:01 pm
      One wishes the writer of this article, and other similar advocates of lower interest rates a very long life, as Alamo to their friends and relatives. They will then see their retirement savings losing returns, value, amidst rising medicine prices and hospitalization costs, and food expenses and isted living, as senior citizens. This atude is also the downside of earlier Janata Govt in 77-78, NDA goats of 96-2004, and the present NDA govt.
      Reply
      1. K
        K SHESHU
        Feb 3, 2016 at 10:48 am
        China is going throuh a deep crisis, especially its steel industry is facing job cuts. The experience of chinese industry must be a learning curve for India too as it is already teeming with scores of unemlo.
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        1. A
          AARAAM
          Feb 3, 2016 at 4:55 am
          "'SHOCKING'!''- is the least that can be said about this article by someone (as per Resume given above), taking steel-industry to task. Does she go around steel plants?- Has idea about efforts needed to put-up any steel-works?- Difficulties in even getting an iron-ore mine started? - About mive investments that had gone in?- Or, that are stuck now in some projects?= Or, about many mini-steel plants concepts prevalent basing upon recycling which not only SERVES to recycle but also give jobs to many? We can go on and on. She has that PET-Idea of lowered value of currency - or depreciation to be emplo- against providing for tariff-walls to safe-guard our steel-works."Will she prescribe aspirin for all ailments? Now, depreciation is NOT going to affect just steel- but the w Indian economy- Can such preposition be just-like-that slapped on all of India? I pray to this learned Author to really visit at least one large steel plant- to know first hand levels of capitals, man-power emplo, mulude resources that are used and for which - again- lots of investments had gone in and so on. PLEASE do not take China's example at all- It sucked w world all these years of vital resources AND funds and hogged ALL- and now is playing with our lives. I pray- please think and formulate something for us- INDIANS. Lots of misconceptions on technology too are doing rounds- If after having invested in one technology in steel-making, can we easily switch-over just-like-that to another? Responsible people MUST talk with all responsibilities. To me, w spectrum of calling each and everything as technology is a JOKE! Imagine- mobile-phones have become smart-phones. Yes, there is technology but how much of them are needed and how much REDUNDANT?- Fanciful? ''Real technologies are backbones!" When technology vastly goes to provide abundant food to our people AND help to export multiple argi.produce of all types- that is to be supported with full-might. SMART-PHONES can be seen as shot-time TOYS. I mean, there are lots of garbled ideas and meaningless propositions and present times are so fluid, they are quite understandable too! Please, may I plead for calm, well-thought out principled steps to tackle our economy from experts- or ONLY knee-jerk ones like the Author's DEVALUATION idea, which is going to affect all, across-the-board without exception?
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          1. A
            Atul
            Feb 3, 2016 at 2:49 am
            The previous interest rate cuts have not been ped on to the consumer. Why is the governor not bringing the real interest rates down. Why is he not able to control the bank cartel. why does he not enforce that the floating interest rate should be based on central bank parameters and not on the individual bank's base rate. The banks simply do not change their base rates!
            Reply
            1. A
              am
              Feb 8, 2016 at 12:35 pm
              Slide in Rupee will hurt the economy more than anything. We compare with China and Yuan, however China has created a good surplus with Yuan kept appreciated. A slight depreciation and dollar ran out. It is to think of new ideas were in we keep Rupee appreciated and change other laws. Exports are out as we no longer have the benefits of cheaper wages. Try to reduce the other components of cost like (raw material, marketing) for which appreciated Rupee is advisable.
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              1. B
                Bgooddogood
                Feb 3, 2016 at 2:15 pm
                What a lousy argument. If the interest rates go down, the borrowers benefit. The prudent, the pensioner and the elderly suffer. With Oil prices at record low, if Modi is not able to hold the rupee value he had no business complaining about the rupee fall under UPA rule. Nations cannot devalue their currency as a way to prosperity.
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                1. K
                  Karunakaran
                  Feb 3, 2016 at 12:11 am
                  India's economy under the baniya leadership has gone to the dogs. 200 million Dalits have woken up from the baniya promises. So no Dalit votes to BJP. No Muslim votes to BJP. No Delhi votes. No Bihar votes. No Gujarat votes. No south India votes. There is no point in blaming Congress. Mr Nitish Kumar is the PM in 2019. The selfie-hunter will be thrown back to Gujjuland, to enjoy his Rs 98,000 crores Bullet train (to be paid for by all Indian taxpayers).
                  Reply
                  1. K
                    Karunakaran
                    Feb 3, 2016 at 2:18 am
                    The photoshopped selfie-chaser dokhlabhai has two things to his credit: getting the Vallabh bhai statue made in China, and the Bullet trian to Gujjuland for Rs 98,000 crores. On everything else the photoshopped selfie-chaser dokhlabhai and his equally neducated cabinet colleagues have miserably failed. India's economy is gone to the dogs. The only people who praie the photoshopped selfie-chaser dokhlabhai are Gujjus based abroad. Get ready to welcome Mr Nitish Kumar as the next PM. Mr Nitish Kumar has style and he has substance.
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                    1. D
                      Dillip Patnaik
                      Feb 3, 2016 at 4:57 am
                      The basic idea behind the monetary policy is that the lowest interest rates generate more consumption and more investment; therefore the following could be included in the cur of demand: Lowest interest rates stimulate spending of consumption by making it more attractive to get loans to buy things such as housing and a car. The lowest interest rates stimulate expense of investment and the businesses become profitable because a greater number of them have potential investment projects. In other words if the interest rates are at ten percent, the companies would only be willing to get money in a loan to invest in projects with return rates that are higher then ten percent. But if the interest rates fall to five percent, all the projects with return rates that are over five percent become variable, and this makes the company solicit more loans and start up on new projects. Government need to introduce low interest to improve current economic situation. The domestic industries will gain benefit and able to invest in new equipments to increase production and people can by goods and houses in cheaper rate. A lot of people can be absorbed in employment. On the government side there should be fiscal responsibility not to expand government and government bureaucracy, unnecessary quota systems and social engineering, and stonewalling economic policy.
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                      1. K
                        Kunal
                        Feb 3, 2016 at 3:57 pm
                        The Keynesian economics of flooding the world market with cheap money by the US Fed through QEs and 0% interest rate for 7 years is the root cause of all malaise in the world market today. The central bankers of the world have printed $10 trillion USD out of thin air since the 2008 financial crisis. Since there was 0% interest in the US, these money flooded the Emerging Markets (EMs) in search of high returns. It increased the et and commodity prices, and the companies incurred huge debts because of the inflow of this cheap money. The author would be advised to read work of Friedrich Hayek and other Austrian economists who have been critical of the role of the central bankers. The hedge fund managers like Kyle B, and Peter Schiff have been predicting the financial crisis accurately using these theories, and in return profiting from it. I would advise the readers to search YouTube videos of these two guys. You will be surprised how accurately they predicted the 2008 crisis. And how clueless the Keynesian economists - Ben Bernanke, Janet Yellen, Christian Lagarde and others were! Rajan is very sound economist, and he understands this way too well compared to Ms. Patnaik. I encourage readers to read his book Faultlines.
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                        1. K
                          Khetesh Bhatiya
                          Feb 9, 2016 at 6:31 pm
                          Rajan bhai have other idea.
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                          1. K
                            kulaputra kulaputra
                            Feb 3, 2016 at 1:10 am
                            Interest rates are kept high to stop looting of this country by crony capitalism. Than God for Shri Rajan. Look at the NPA promoted by previous Governments. We now have to pay for all of it as most of it is to state owned banks or from people's deposits. Rajan should not allow one penny to be lent unless there is a great chance that it will come back and the person borrowing is of strong character determined to return it. These are quick fix solutions by uninformed who have no knowledge of how economies are built. Hard work and integrity of approach is required, not lower interest rates.
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                            1. M
                              Man
                              Feb 2, 2016 at 7:10 pm
                              Not sure what makes people write foolish articles like this. Improve productivity and invest in innovation, cut down the government - In US and other developed countries they want their currencies to go down and so where would it end?. Sliding rupee will be dangerous if commodity prices were to rise again.
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                              1. R
                                Ramesh Nittoor
                                Feb 4, 2016 at 12:38 am
                                The Indian economy would be better served by lower interest rates, blocking protectionism and letting the market determine the price of the rupee --- The inference is on the dot; if Indian economy transforms to an open architecture, then inflation rate is likely to come down due to cheaper imports, enabling RBI to can maintain a low interest regime. Letting INR to be market determined is a sound advice, but to make it a policy, several other facets have to fall in place. The stability of INR is also a critical factor in instilling market trust, and to put systems in place, and make legal changes for regulating and monitoring inflows and outflows, is not easy. Mr. Chidambaram, as Finance minister had tried to make money flows traceable, and market tanked; fearing this BJP is still unable to risk this measure. Financial experts perhaps have a road map to reform, and may be at the end of this traverse, INR would be market determined.
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                                1. R
                                  Ramesh Nittoor
                                  Feb 3, 2016 at 4:11 am
                                  Atul, In free legal market economy, it is compeive forces which drives down the rate differentials charged by the banks, it can not be prescribed. Ministeries have been known to pressure whom to lend, if not the rates. And even this has had pretty bad consequences in form of NPAs. Moving from command economy to market economy is what the new set of reforms all about. Once the NPAs of about 50 billion Dollars in Indian nationalized banks are transferred to a separate clearing insution, the rate-differentials will most probably reduce.
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                                  1. R
                                    Ramesh Nittoor
                                    Feb 3, 2016 at 1:12 am
                                    Concur with what you say. improving long term investment climate for India to emerge as a global-scale manufacturer has to be the goal. This requires gradual appreciation of INR as the projected long term scenario. Inflation targeting is a sound policy framework which is seen as a key element in Indian transformation to a developed legal market economy. Interest rate is set more per this criteria. The focus has to be to make banking operations more compeive, such that their productivity and safe lending practices drive down interest differentials, and reduce prevalence of black money, particularly its outflow from India. Following China, an economy which may well end up in a tail spin is not wisdom.
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                                    1. R
                                      Ramesh Nittoor
                                      Feb 3, 2016 at 1:28 am
                                      INR value, interest rate and inflation rates form a triad, if you control first two, the third becomes uncontrollable. Productivity gains come not by hard work, mostly by scaled-up operations, mechanization, automation, retail modernization, transportation infrastructure, etc. There is no magic wand to fix these matters. The idea that by fixing one or more of the money related parameter you can fix economy is valid only in the sense that it is only a small set out of a very large set of parameters in play in making of an economy.
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                                      1. R
                                        Ramesh Nittoor
                                        Feb 3, 2016 at 3:32 am
                                        Indian education edifice surely needs a mive investment and total opening up, but it has to come about only via political consensus, else becomes counterproductive. The basic shift in Indian security architecture which is coming about has deep political consensus. Next, economic policy consensus is in making. After this is set, indications are, perhaps from next year, education policy changes will get articulated. The expansion of IIT/IIM/AIIMS structure, and strengthening select universities are too small to make a deep impact on Indian education. Big changes are required to tackle education issues, as you have very well said, heart of the woes.
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                                        1. R
                                          Ramesh Nittoor
                                          Feb 3, 2016 at 4:41 am
                                          Think quality of rule of law matters to where both good and bad money get eventually parked, and actually made. The equation, if it is ever found, would probably like a relativisitic one. The manner in which m increases disproportionately as it approaches speed of light. In like fashion, the quality index of rule of law increase prosperity in a society disproportionately. India will do well to instiute a legal, free market economy, as the route to long term success. If this legal criteria is a valid inference, China will never make it past the intermediate stage of development, but India can; eventually.
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                                          1. R
                                            Ramesh Nittoor
                                            Feb 3, 2016 at 3:15 am
                                            Thomas, you do make a valid point, but there are other factors. There are money inflow/outflow via capital markets, including bonds and derivatives. There is also surgical mopping by RBI, International borrowing by government as well private Indian companies, all these impact currency value, and can be factored as partly dependent on interest rates. Think it is not a honesty issue, but sensible policy issue and putting right systems in place. Believe this government is well placed to deliver wonders for India.
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