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Some band aid

RBI-Sebi measures don’t address the fundamental problems the rupee’s slide points to

Written by The Indian Express |
July 11, 2013 4:23:22 am

RBI-Sebi measures don’t address the fundamental problems the rupee’s slide points to

The RBI and SEBI have taken a number of measures to curb the size of the rupee market. In a large and liquid market,the RBI’s intervention has little impact. So the RBI has taken steps to reduce its size. Now when it intervenes,its intervention will have greater impact. It can shore up the rupee and make it stronger for some time. But will the RBI’s moves have an enduring effect? Or,will it be that when the immediate impact wears off,the rupee will start weakening again? No country gets a strong currency by shutting its markets or squeezing them for long. These are short-term measures that shoot the messenger,in this case,the rupee,which is telling us something about the fundamental weaknesses in the economy,like high inflation and low productivity growth. These problems will simply resurface on another occasion. Instead of moving on fundamental issues where there is evidence of policy paralysis,the government,by directly addressing the rupee market,gives an appearance of doing its job.

If,by the measures the RBI and SEBI have taken,we are able to get a stronger rupee for a few days,it could do more harm than good in the long run. Indian companies that have recklessly borrowed in dollars,in disregard of the lack of a natural hedge as their revenues are in rupees,such as in infrastructure,would now think that if the rupee starts depreciating,the government will step in. This would encourage them to continue to borrow. But for the health of the economy,companies should either have a natural hedge or they should spend money to hedge when they go for cheap dollar borrowing. By serving up a signal that the RBI will step in to save them,they are encouraged to take foreign currency exposure on their balance sheets. Instead of taking steps to make the economy and agents more self-reliant,and thus genuinely resilient,where they understand the risks and knowingly take decisions,such measures encourage agents to rely on the state despite the fact that the state has limited capacity. By not letting markets decide the value of the rupee,the state indicates that it knows better than the market. Where has this superior knowledge come from?

When a country has a large current account deficit,a high domestic inflation rate and falling growth,its government needs to wake up to the fact that there are weaknesses in the economy that it needs to address. Directly taking measures to prop up the rupee will not solve any of those problems,and only take away any competitive advantage the rupee may have got out of its weakness.

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