On two Mondays the RBI has demonstrated two techniques to keep the rupee form toppling over. Last week,when the rupee touched a lifetime low of 61.21 to a dollar,it used a sledgehammer to block banks from carrying out any proprietary trading in the currency markets. The currency market was crippled by the weapon.
On this Monday,however,RBI used textbook techniques operating through the markets to make its presence felt. It raised interest rates selectively. The method employed has been healthy for the markets. The questions are,instead,about the results sought to be achieved by the RBI intervention. It is important to note that the value of the rupee measures the health of the economy.
Had the Indian economy been in great condition the rupee would have behaved likewise. The rupee has slid to a position where it reflects the capacity of the economy to compete with the rest of the world. An economy that is borrowing from the markets to pay a subsidy of over Rs 2,20,971 crore (13 per cent of the total government expenditure) and still planning to add a food subsidy bill will in all likelihood see the purchasing power of its currency evaporate. This will cause short-term pain as imports become costlier. Plants planned on such machine imports will see their financial strength hammered. The cost of raw materials imported like oil,gas and now coal rips the viability of power and other plants built with them as feedstock.
This will cut investment and employment. But then a currency depreciation starts doing wonders. A weaker rupee helps every segment of the service sector earn larger profits. An early indication of this was provided by the Infosys results. It has released earnings in line with forecasts,the first time after several quarters buoyed by a 9 per cent dip in the rupee since June 2013. Indian manufacturing faces high labour and capital costs. A cheaper rupee can chip away at a lot of that disadvantage. A sustained dip in the rupee can be a game changer for the Indian factories. It will convince entrepreneurs the rupee will stay thereabouts creating cost advantage vis-a-vis other Asian economies. For the government,this is far better alternative than having to offer tax advantages which get siphoned away. One cant siphon away a currency. Yet all this is difficult to do in an election year. And so a game-changing opportunity for the Indian economy was wasted.
Subhomoy is a deputy editor based in New Delhi.