While the strengthening of the US economy and rising oil prices, the rupee has suffered a sustained fall this year, sliding from levels of 63 against the dollar in January to over 74 in October. Economist Ila Patnaik explained to P Vaidyanathan Iyer and select readers of The Indian Express how to read the slide.
Patnaik is a Professor at the National Institute of Public Finance and Policy, New Delhi. She has written widely on macroeconomics and monetary policy, and was Principal Economic Advisor to the Government of India from May 2014 to December 2015.
On whether the slide is worrying
Not particularly. Every currency moves; the exchange rate will move both in the long term and in the short term, because there are differences in productivity, inflation rates, etc. Thirty or forty years ago, the rupee was 25-30 [against the dollar], but it would not stay there. In the long term, the reasons are productivity differences; in the short term, it is demand and supply and inflation differences, and in the even more short term, expectations, and just what happens in financial markets across the world. So I would say it is very normal for a currency to move. In fact, I was getting worried when the rupee was not moving. For a whole year or so, the real effective exchange rate was actually appreciating. Our inflation rates were higher than the inflation rates of our competitors and trading partners, and because the nominal exchange rate was not moving, it meant that in real terms we were losing competitiveness. Our exports were more expensive than our competitors’, our imports were cheaper, so it would be cheaper to import things than to buy domestically produced things… The rupee was due for a correction, and yes, when there is a correction, there might often be overshooting, because expectations often determine the correction… So no, the fall of the rupee doesn’t particularly worry me.
On the ways to look at the slide
Let’s talk about the gainers and losers. So, while I might be happy with the depreciation, you might be unhappy. If you have borrowed in dollars, you’re certainly worse off, because you have to return a lot more in rupee terms than you would if the rupee had not depreciated. But if you are an exporter, you will be happier. If you are in an import-competing industry, you’re a gainer if imports become more expensive, because for the same cost of production, your products will sell more than they did when people preferred to buy imported products because those were cheaper. So whether you are worried or not really depends on where you are, what you are doing, what your dollar holdings are, what your dollar liabilities are, and what your assets are.
On how corporates avoid risk
There are usually two ways in which you hedge. The first is a natural hedge that every exporter has — so, if you have borrowed in dollars, your payouts are in dollars, but so is your income. But if you are not an exporter, you buy dollars in the forward market, you hedge through derivative products — there is a premium to be paid, but it allows the fixing of a price… So, let’s say I get a dollar borrowing at 10%, and I am able to hedge one year forward at 5%, so the cost to me is about 15%. Unfortunately, people often just take the exchange rate risk — they don’t hedge because they think kuchh nahin hoga (nothing will happen), that the central bank will intervene, that the government will feel bad about the rupee depreciation, and so the rupee won’t depreciate. And we find that in situations where a central bank intervenes too much, it actually creates a moral hazard where a lot of people start taking unhedged foreign currency exposure, which is dangerous for the system as a whole.
On RBI intervention to arrest the slide of the rupee
I think they have sent some signals in the market, but if the outflow of foreign capital becomes too much, I am not sure how much they will intervene. Because the larger the market, the more developed the economy, the bigger its GDP, the bigger its trade account. If it is a very small market and I buy something for a billion dollars, say, I sell dollars and buy rupees, then I can move the exchange rate by a larger amount; but as economies grow — and India is growing — the impact of the same billion dollars becomes smaller and smaller. So if there is too much outflow, I would think that they won’t go too far. Because then they could be losing 10 or 20 billion a day, they won’t want to do that because the moment that happens, it becomes a self-fulfilling prophecy, and everyone wants to run away before the currency depreciates further.
On government intervention by raising import duties
All these products [such as certain telecommunications equipment, refrigerators, washing machines, and ACs] put together constitute 2.6% of our imports. It’s really only signalling — like saying yes, we will do something, but we are not going to do an awful lot… It’s a gentle signal, not too strong.
On the oil import bill and weakening rupee
When global oil prices rise, we certainly have a larger current account deficit. Because in the short run, demand for oil is usually very inelastic. So we would expect our oil import bill to go up, and if the oil import bill is going up, then either we find ways to make up for that gap, or we let the rupee depreciate. And that makes oil more expensive, and the political economy of oil prices is such that people worry if it moves… In the short run, an oil price rise makes transport more expensive, and there is some pass-through into the rest of the economy, so it is inflationary. There is an exchange rate pass-through as well. The two put together is not a very happy situation to be in.
On the current account deficit and the sliding rupee
When you think of CAD, there is the oil price, of course, but it is also that other exports have not been increasing. Chemicals, metals, and so on, they have not been doing well. I would not worry as much about any sustainable or unsustainable levels of CAD as I would about doing some mismanagement somewhere else — because why are we losing our export share, why are we not competitive in world markets? Maybe these are just teething problems of GST, maybe they are part of the impact demonetisation had on small industry, maybe it is partly due to the strength of the rupee… it’s difficult to say. But imports are going fine, because the economy is growing fast enough, but exports are not doing well, and that would worry me. So it’s not really the trade deficit — rather, it’s why is it that we are slowing down, why are our exports not doing well… why are our exports growing slower than the exports of competitor countries? Are there structural problems? The outcome [of this situation] is the trade deficit, but if it was that exports were doing fine but imports were growing faster, I wouldn’t be worried…
On India’s inability to exploit its resources like coal
There are old problems with the coal policy. [Coal imports have recently surged, even though we have adequate coal resources.] But it has also to do with the quality of the coal we have, transport costs; there are many factors. And that’s why when you refer to structural problems, then I would say that if reducing our imports and increasing our exports are structural issues, then yes, we should be thinking of addressing those. And actually, regardless of what they do to the trade deficit, just to be a more efficient economy, we should be thinking of this.
On politicians’ fascination for a strong rupee
I am not sure politicians always want a strong rupee. There was a time when we were trying to keep the rupee weak, and we were actively buying up dollars, so from 1993-94, when we had a deluge of dollars after we opened up the capital account, up to 1996, the rupee was kept at 31.37… For 16 months, we built up reserves. Similarly, from 2001 to 2004, when there was huge pressure on the rupee to appreciate, what the government was trying to do, what RBI was trying to do, was keep the rupee weak. The entire East Asian model, China’s export-led growth, was a lot through keeping their currencies weak. In fact, China has often been accused of being a currency manipulator because they try to keep it weak. I think election speeches are one thing, but if you see the actual policy, despite the speeches that might have been made in 2014, the currency has been allowed to move. All over the world, currencies move, and politicians understand that there are pros and cons.
On whether only the market should decide rupee’s value
You could say what should be done or should not be done, and you and I can agree or disagree. But my question would be, what can you do? All you can do is maybe postpone the movement of the currency for some time, you really can’t stop it. If I have 100% inflation and you have 2% inflation, regardless of what you do, it will only be a matter of time before the currency moves. So, should or should not is a matter of opinion, but on what can be done, I think the options are limited. You can try to intervene, but if you are selling reserves, at the end of the day your reserves will finish. You could hike interest rates, but beyond a point, you will hurt your economy, and foreign inflows may slow down because you have hurt the economy — is that an option that you want to take?
On the option of raising interest rates
You should be hiking rates when your business cycle conditions are such that they require a rate hike. If your economy is overheating, or if you are trying to prevent further higher inflation, that’s when you should be hiking interest rates. If you start jerking rates around… let’s look at what we did in 2013, after the “taper talk” [indications that the US Federal Reserve might begin to gradually reduce its securities purchases from the then existing levels of $85 billion a month], we hiked interest rates so much that there was no liquidity in the economy, the cost of borrowing went up from 400 to 600 basis points. It was a temporary thing that happened between [Fed Chairman] Ben Bernanke’s May 22, 2013 speech [to Congress] to the next Federal Open Market Committee meeting [in September, when “the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its (securities) purchases], and the whole world was going through this. Our response was very aggressive, and we hurt ourselves. And by over-responding, we were actually the worst performing currency in the May to September period compared with all other emerging economies.