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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
    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 ...
    1. V
      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.
      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.
        1. A
          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?
          1. A
            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!
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