Managing the rupee

Finance Minister Nirmala Sitharaman has been meeting industry representatives over the past few days, giving rise to expectations that the government will announce measures to revive economic activity. It has been reported that industry is looking for a stimulus package worth over Rs 1 trillion. Though the details of a possible plan are not yet public, it is important to note that the government does not have the fiscal space to do so and should think through carefully before committing additional spending or tax concessions. For instance, sectors such as automobiles are demanding a reduction in the goods and services tax. But at a time when the problems are structural, a quick-fix solution may not be the ideal solution.

Instead, it should focus on some macro challenges, such as trade, to boost output. It is correct that the global trade environment has become more challenging, but, as the Economic Survey rightly noted, “India’s share in global exports is so low that it should focus on market share”. The external environment has become more testing with the possibility of competitive devaluation by large economies. China allowed the yuan to weaken past the psychological level of seven to the US dollar. US President Donald Trump has expressed his discontentment with a strong dollar.

Although going for a deliberate currency depreciation through market intervention like emerging market countries may be difficult for the US, lowering the interest rate by the Federal Reserve — something that Mr Trump has been demanding for long — would have a similar impact on the greenback. Though devaluation or wilful weakening of currencies is a zero-sum game and all countries cannot do it at the same time, India should look at protecting its interests in this environment. Moreover, the rupee is overvalued and is affecting India’s trade balance. As economist Sajjid Chinoy highlighted in these pages on Monday, the rupee has appreciated by 18 per cent in real terms against the Chinese yuan over the past five years. This partly explains India’s higher trade deficit with China. And now with rising trade tension, the yuan could weaken further. In fact, the rupee has appreciated in real terms against a number of currencies. The 36-currency export-based real effective exchange rate index was at 118. 54 in June, showing significant overvaluation. The rupee overvaluation has affected exports, which have remained virtually stagnant over the past few years.

The stated policy of the Reserve Bank of India is that it does not target any particular level for the rupee and intervenes in the currency market only to quell excess volatility. However, in the given global backdrop, the central bank, in consultation with the government, may need to devise an approach to avoid persistent rupee overvaluation. It is possible that near-zero or negative interest rates in advanced economies and the search of yields will bring in more foreign inflows over time and push up the rupee. Therefore, the currency market will need careful management. To be sure, India needs to address multiple problems to push up exports. Addressing currency overvaluation could be a good starting point in the short run.