Wednesday, Feb 01, 2023

Stick to your knitting

The government should let the rupee find its new level

The government should let the rupee find its new level

It has been proposed that the government should borrow dollars to shore up the rupee. But how much will the government borrow? With USD 280 billion as reserves already,the 5 or 10 billion being talked about will make little sense. What will it do with the money? Add it to the reserves or use it to intervene in forex markets? The former indicates the ministry of finance’s assessment that we have insufficient reserves,the latter that the government believes that fundamental problems of the economy will remain and the rupee will need to be shored up by RBI intervention. Either way,this involves two costs: the government will have to pay interest,and it runs the currency risk of repayment in the future when the rupee may have depreciated more. Is it worth pursuing this option? Three conditions have to be met. The economists at the MoF should know much more about the market,the global market for the rupee should be shallow enough to get manipulated using this hoard,and the two costs to the government should be justified by the benefits. It would make far more sense,instead,to stick to the knitting: for the RBI to combat inflation and for the government to take measures to increase productivity.

Economic fundamentals explain the decline of the rupee. India has high inflation,so a steady rupee depreciation is required in order to keep exports competitive. India presents a gloomy picture on the conduct of economic policy and governance,so a depreciated rupee is required to compensate for those mistakes. The world economy has done badly and the US dollar has appreciated,so inevitably the rupee has done poorly.

Any action the government takes now should be rooted in a statement of what it sees to be wrong with the market’s outcomes. But how likely is it that the government knows more than the market? Even if we assume it does,the next hurdle is that there is a vast currency market that trades more than $70 billion per day,and it is very difficult to manipulate it. Recently,the RBI has taken steps to reduce the size of the market so that it can manipulate it. This is bad economic policy. The government should simply let the rupee find its new level and not behave like a central planner that believes it knows better than the market.

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First published on: 16-07-2013 at 02:43 IST
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