The rupee takes a pounding

Print edition : July 04, 1998

The Government sees the falling rupee as a blessing insofar as it pushes up the cost of imports and makes exports competitive. But the economic fundamentals that underlie the decline are far from rosy.

EVEN by the standards of foreign exchange markets - where notions of stability are as foreign as some of the currencies dealt therein - the last few weeks at the Indian foreign exchange market have been particularly exceptional. On June 9, the rupee breached the Rs.42-to-a-dollar mark; two weeks later, in the course of trading on June 23, it went below the Rs.43-level. Although it recovered a bit since then, there seems little prospect of the rupee gaining in strength in the near term.

There is nothing new about the rupee losing value against a host of stronger currencies such as the dollar, the pound sterling or the Deutsche mark. Ever since the policies of economic liberalisation were unveiled in 1991, there has been relentless pressure on the external value of the rupee, except for a brief period of relative stability during 1996 and the first half of 1997.

Currency traders hammer the rupee in Mumbai on June 10. Over seven months from August 1997, the rupee lost by about 11 per cent against the dollar.-SHERWIN CRASTO/AP

For instance, over seven months from August 1997, the rupee lost by about 11 per cent: it slipped from Rs.35.71 on August 19, 1997 to Rs.39.50 by March 31, 1998.

Given the pattern, the market response surrounding the recent decline would seem to be a case of over-reaction. But in a market that is driven by sentiment and confidence about future outlook, as the foreign ex-change market undoubtedly is, milestone events have more than ordinary significance. For the players, they offer occasions to take stock and decide on an assessment of the future direction of the market.

Thus, when the rupee breached the Rs.40-to-a-dollar level in mid-May, it caused quite a stir. There was speculation about the level to which the rupee was headed in the near term. The breach of the Rs.42-level and more recently the Rs.43-level, is undoubtedly an occasion for soul-searching.

COMPARED to commodity markets, the foreign exchange market is opaque to a great extent: identifying causal factors for market movements with any degree of precision is, therefore, virtually impossible. However, market sources have attributed the sharp decline in recent weeks to the activities of the Reserve Bank of India (RBI). Just prior to the decline, the RBI was believed to have acted as a steadying influence on the market by routing the supply of dollars through the State Bank of India (SBI) at an exchange rate of around Rs.41.80. A week later it stopped doing so, and the presence of the SBI on the buying side of the dollar added further pressure on the rupee.

The Government does not give the impression that it is particularly concerned about the rupee drifting lower down. There are a number of reasons for this. From the point of view of macro-management of the economy, it certainly sees a number of advantages from the development. A depreciating currency increases the rupee value of imports and thereby enlarges the base of landed value of imports for purposes of customs duty. After P. Chidambaram's so-called dream Budget last year ended in a fiasco, with the anticipated buoyancy in revenue failing to materialise, North Block is not taking any chances with revenue projections. In the event, the Government could do with help - from whichever direction it comes - in shoring up the revenue projections for fiscal 1998-99. Therefore, the decline in the rupee value is a welcome development.

The falling rupee should also see the "export lobby", which has seen its competitive advantage eroded by the currency crisis in South-East Asia and in the Far East, ease its pressure on the Government. A falling rupee means a larger export turnover, all of it tax-free.

Even the domestic industry sees some virtue in the development. A depreciating currency makes imports that much more expensive, thereby affording a higher degree of protection to those sections of domestic industry such as steel, chemicals and paper, where the mere threat of imports has eroded profits. Domestic industry has been pressuring the Bharatiya Janata Party-led coalition Government to demonstrate its commitment to a swadeshi policy in tangible terms. But the traditional options - hiking import tariff or imposing licensing restrictions against freer imports - are not available to the Government since the trade regime is based on commitments made to the World Trade Organisation (WTO). Also, with each country aggressively promoting and guarding its trade interests, such moves will invite retaliatory trade response from other members of the WTO. In the event, the Government would prefer to let the exchange rate do what it cannot do through tariff and trade policy measures.

From the Government's perspective, therefore, the falling rupee value presents it with a "win-win" situation. But in the current lexicon of politics, the rupee's external value is also a symbol of national pride. Any suggestion that the rupee is being mauled by rapacious foreign currency speculators, notably foreign banks, in the currency markets will do the Government's image no good. Therefore, Finance Minister Yashwant Sinha, in his reaction to the recent developments, made a fine distinction between speculation-induced volatility in the currency market and a decline in the external value of the rupee caused by normal forces of supply and demand. By holding out the threat of direct intervention against the former, he is clearly hoping that the nation would see the fall as being purely driven by economic factors.

Finance Minister Yashwant Sinha. From the point of view of macro-management of the economy, the Government sees several advantages in the decline in the rupee value.-SHANKER CHAKRAVARTY

ALL this is small comfort to foreign portfolio investors, who have seen even small fluctuations in the daily availability of foreign exchange sending the rupee value piercing through the floor. It is more so at a time when they have been facing redemption pressures from their overseas investors in the funds dedicated to investments in emerging markets, including India.

The Government wo-uld like these inflows to continue, or at worst to stem any outflow. It has therefore drawn overseas investors' attention to India's economic fundamentals which, according to it, are quite strong, Moody's assessment not-withstanding. In its view, the panic reaction witnessed in the case of South East Asian currencies in 1997 is hardly warranted.

The Economic Survey 1997-98, for instance, claimed that India was better placed than some of the Far East Asian economies on a variety of macro-economic parameters. It claimed that India's external debt at the end of 1996-97, at 26 per cent of its gross domestic product (GDP), was only half that of Thailand, the Philippines or Indonesia on the same count. What is more, India's external debt had also declined by September 1997. Of even greater significance is the size of its short-term debt, which is a significantly small component of its total debt. India's deficit on its current account of external transactions as a percentage of GDP too is considerably lower than those of its Far Eastern counterparts.

These numbers are significant from the point of view of short- to medium-term stability of the external value of the Indian currency. The Government is in effect telling foreign investors that their investments are proof against exchange rate risk. The Government has also introduced policy measures de-signed to make it easier for overseas investors to invest in Indian stocks. For instance, it recently enhanced the ceiling on investments by foreign institutional investors (FIIs) in the equity of specific companies by delinking it from the quantum reserved for non-resident Indians. It also permitted them to park their temporary investment surpluses in Government Treasury Bills, which it hopes will prompt them to invest the amounts that accrue from the current spate of selling of Indian stocks within the country instead of immediately repatriating them overseas. The earlier stipulation that required prior approval from the Securities and Exchange Board of India (SEBI) for undertaking investments in individual companies was done away with. But it remains to be seen if FIIs will take the bait.

With a burgeoning trade deficit, sluggish direct and portfolio investment flows and uncertainties on bilateral and multilateral credit flows, the outlook for the Indian rupee even on grounds of economic fundamentals is not too rosy. That it has not become a IMF basket case a la Indonesia is the only consolation.

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