Forex policy must go beyond exchange rate

Dayana Jones

Quiz question: Which was the last Indian crisis that led to sharp rupee weakness? Answer: The balance of payments crisis, back in 1991. After the crisis, which led to the devaluation of the rupee, there has been no crisis originating in India that has impacted the country’s external sector to an extent that would lead to rupee weakness. Yet the rupee has depreciated 492 per cent since — from ₹13/$ in 1991 to ₹76.98/$ in 2022. How come?

There have indeed been a series of crises that have contributed to the rupee’s weakness, but they have all originated overseas: the Asian crisis (1997), the Russian debt default and the LTCM meltdown (1998), Y2K (2000), the 9/11 attack (2001), the GFC (2008), European crisis (2011), Taper Tantrum (2013), Covid-19 (2020) and the Russia-Ukraine war (2022).

During these periods, India’s economy continued to grow, per capita income in dollar terms rose (despite the rupee’s weakness), there were structural improvements in the economy, the stock market boomed and, most importantly, l human development indices also improved.

Recently, the IMF has commended India in pushing back extreme poverty even during the pandemic years. It would, therefore, be extremely churlish to say that overall the country is in a worse place than it was in 1991, when we had to pawn our gold overseas. Incongruously, however, the rupee is in a much worse position than it was in 1991. Why?

Two explanations are commonly, almost axiomatically, offered by the cognoscenti. One, we have a chronic balance of trade deficit. Two, we are an emerging market currency and all such currencies have got the short end of the stick during all international crises. What’s the big deal?

However, these stock answers do not explain why we had secular rupee depreciation (except during 2002-2007) when we have also had balance of payment surpluses, and why the RBI has actively prevented the rupee strengthen on several occasions.

Costs of weak-rupee policy

There is no quantification of how much the synthetically manufactured chronic rupee weakness has contributed to the country’s systemically high inflation (through imported inflation) and, thereby, prevented interest rates from coming down. There’s a need to calculate the cost of loss to India’s competitiveness due to chronic rupee weakness.

It is common knowledge that foreign buyers negotiate dollar prices lower for India exporters whenever the rupee weakens. Why does the RBI persist with the policy of engendering rupee weakness when data has irrefutably shown that a weak rupee has not contributed to export growth? Rather, export growth is achieved through enabling business conditions, not rupee depreciation.

A case in point is that merchandise exports of $400 billion-plus in FY 2021-22 has been achieved not due to rupee weakness but due to a combination of non-rupee factors such as the emerging China+1 preference in global supply chains, infrastructural push and the PLI schemes. The negative impact of a chronically weak currency on the effort to attract infrastructure capital would also need to be assessed.

Also, why does the RBI, as the regulator of the forex market, regularly intervene in the market? Can we imagine SEBI being in the market almost daily to nudge the Nifty in one direction or the other?

Internationalise rupee in trade

“You should sweat in peace so that you do not bleed in war,” is an old Indian Army adage. There’s has been a lack of effort in promoting the rupee as a means of global trade and the country is suffering collateral damage because of that. The imposition of sanctions on Russia by the US and moves to restrict Russian banks’ access to SWIFT have made it difficult for India to conduct normal trade with Russia. This is a sorry pass compared to the time when the rupee was legal tender in the Middle East (till around 1959) and trade with Russia was largely rupee settled in the 1970s.

While countries like Nepal have recently requested that the rupee be allowed as legal tender, it is India that has baulked at the idea. This is in sharp contrast to China’s policy of actively promoting the use of the yuan in international trade. Further, the Russia-US stand-off calls into question the advisability of concentrating our forex reserves in the dollar.

There is more than a tail-end risk that the US might prevent any country of its choice from accessing its reserves. Therefore, rather than focus only on the exchange rate, the RBI needs to get over its cold feet and make the rupee fully convertible, and as per the Tarapore Committee recommendations take steps to actively encourage the use of the rupee in global trade and diversify away from the dollar in the composition of India’s forex reserves.

Make the market work

Like SEBI, which works for the benefit of investors in the equity market rather than for the brokers, the RBI, as the forex market regulator, should actively work for the welfare of importers and exporters rather than shy away from dismantling banks’ monopoly on the forex trade flows of their customers.

This can be achieved through three measures:

To its credit, the RBI has empowered CCIL (Clearing Corporation of India Ltd) to create the powerful FX Retail platform, which enables retail customers to access the interbank spot dollar-rupee market online. The RBI should now make it mandatory for all banks to route all their customer trades through the FX Retail platform in order to increase volumes and promote usage.

Also, while FX Retail allows companies to access the interbank spot market, the forward quotes to the customer are still given by single banks. Even the forwards need to be competitive, multi-bank interbank quotes.

Allow corporates to transact forex with any bank of choice, and not be mandatorily tied to the bank through which the underlying trade transaction is routed.

Allow delivery against exchange traded currency futures.

Lastly, there’s also a need to study whether the country might have been better off had the RBI allowed the rupee to trade on its own and find its own levels, whether weak or strong. Would not Corporate India have developed more robust risk management practices when forced to confront risk rather than being shielded from it?

A lot has been written on the cross of the Impossible Trilemma that the RBI has to carry on its shoulders. Maybe the RBI would do well to heed the Beatles and just “ Let It Be”? Or, maybe, even be like Atlas Shrugged.

The writer is Chief Currency Strategist, Kshitij Consultancy Services

Published on

April 27, 2022

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