No panic about the rupee

The rupee has hit historic lows against the dollar in recent weeks, leading to widespread expressions of concern about what that means for the Indian balance of payments and the economy more generally. Some of these concerns are overblown, and there is no need to panic. India's external accounts look far more secure than they did during the "taper tantrum" of 2013. One big reason for that is that foreign exchange reserves are definitely in the comfort zone. They had dipped below $300 billion in 2012-13, but in 2017-18 they were $424 billion. The current account deficit, too, remains manageable. It is true that the long low in commodity prices is over. Fuel prices, for example, have come off the depths that they had plumbed in the years following 2014. The prospect of a trade war is also seen as disruptive. While so far the merchandise trade deficit has been adequately financed in part by payments for services and remittances as well as strong capital inflows, there has been concern expressed about all those components as well. Many wonder, for example, if visa restrictions imposed following Donald Trump's election as US president will affect IT services revenue. But the data suggests that revenue from IT and ITeS has been range-bound around $70 billion. Meanwhile, rising crude oil prices mean that remittances from the Gulf have rebounded as well. These fundamentals of the macroeconomy appear to be strong. 

Net foreign investment is a tougher trajectory to predict as it depends on several factors. For one, the capital outflow from India Inc has been substantial, in spite of an investment crunch at home. Clearly, Indian companies are more interested in investing abroad. In addition, foreign portfolio investment is by definition swiftly responsive to major macroeconomic cues. In the case of geopolitical instability, there will be a rapid flight to safety. Even otherwise, the increasing strength of the US economy and the US Federal Reserve's stated intent to tighten monetary policy are inducing many to exit emerging-market assets, including those in India. It is worth noting, thus, that the Indian rupee's depreciation is not out of line with what can be observed to be happening with many emerging market currencies.

Yet the consequences of rupee depreciation need to be thought through carefully. Certainly, there will be increased inflationary risks. In response to this possibility, the monetary policy committee of the Reserve Bank of India may be more willing than it would have been otherwise to raise interest rates. This might hamper the nascent growth recovery. In the short run, the trade deficit will also find it difficult to respond to a depreciating rupee. Much of what India imports — including fuel and electronics — will not be easy to substitute since the demand for these is relatively inelastic. Yet rupee depreciation is an opportunity that must not be wasted. India must increase self-reliance and competitiveness. The former can come from further indigenising India's fuel mix — the government's large-scale renewable energy push should be seen as part of this effort. Finally, a sustainable external account that is less dependent on the value of the rupee would require sustained increases in the competitiveness of Indian exports. This requires domestic structural reform. For genuine macroeconomic stability, the government must return to the path of sustained domestic reform.

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