The Narendra Modi government’s penchant for quick heals to solve complex economic problems is evident if one assumes that Thursday’s rupee devaluation rumors were true. Else, it was just a bad day out for the Indian rupee. The unit touched 67 level against the US dollar after media reports (Read here and here) that said the Union commerce ministry and finance ministry are planning to meet soon to devalue the currency.
The news sent shivers in the local markets prompting investors pull out funds. The rupee recovered a bit after the government immediately swung into action for damage control. Commerce minister Nirmala Sitharaman and economic affairs secretary Shaktikanta Das denied any plans to devalue the currency. Things aren’t that bad in the currency market at the time of writing this on Friday.
Before looking at the merits and demerits of a government-initiated rupee devaluation scheme, let’s first look at why the world is so perturbed with the rumor on government intervention in the rupee value. The reason is simple.
Unlike China, the exchange rate in this country is not artificially controlled or pegged by the state, but is determined by the market in line with the inward/ outward capital flows on a daily basis. The Reserve Bank of India (RBI) is the authority in managing the exchange rate market, not the government. Even the RBI doesn’t fix the rate of the rupee’s float value. It only intervenes when there is high volatility in the currency market. Such intervention happens through state-run bank treasuries, which are the major participants in the Indian currency markets.
These lenders intervene in the currency market either by buying or selling the dollar at the cues from the central bank to avoid wide fluctuations in the rupee rate. When banks sell dollar in the market, the action supports rupee value and when they buy, put pressure on the unit. So, in a way there is already a tacit understanding between the central bank, the government and the currency market on how the rupee should behave in a particular period.
That isn’t a daily exercise though. It’s a speculative move and plays a crucial role in reversing the rupee value when the unit is in difficulty, such as the time when it touched all-time low of 68.85 per dollar in August, 2013. That’s how broadly the currency market works.
Going by the earlier cited media reports, the commerce ministry had circulated a cabinet note exploring the opinion of other ministries about possible devaluation of the currency. Firstpost hasn’t independently verified these reports, but there is a fair possibility that the commerce ministry doing so given the condition of Indian exporters, who are fighting an overvalued domestic currency and global slowdown simultaneously, even though the government has denied any such attempts. If indeed the government wants to devalue the currency, the idea is to aide exporters to maintain their edge among competitors in emerging markets. One should hope that all the devaluation talk was nothing but a rumor.
There are few reasons for this:
For one, such an action will have a major impact on the very credibility of India’s economy. A note issued by Singapore-based DBS Bank economist Radhika Rao on Friday morning cites a few reasons why the government shouldn’t opt for the short-cut.
“Such an attempt would run counter to recent efforts by the Reserve Bank of India and the government to establish macro-stability, transparency and policy predictability to attract and retain investors. Not only could such a shift harm investment interests and trigger capital outflows, but also dilute the boost from the ongoing reform agenda. Memories of China’s attempt to devalue its currency last year and resultant spike in volatility will also be a deterrent for the Indian authorities,” Rao says.
Rao’s comment is significant since such an action will send a message to the investors that the Indian rupee value is no longer transparent but is something which can be altered by the government at any point artificially. That would mean there is no market-determined transparent pricing of the exchange rate. For an ambitious economy, which is hoping for the image of a transparent, open economy in terms of economic policies and investment-led growth, such an action can have catastrophic impacts. It can act as a big turn off for investors and a compelling reason to pack up their moneybags and fly.
Secondly, forced devaluation of the rupee will go against the spirit of economic reforms pursued by the Narendra Modi government. Rating agencies and international economy watchers will look at India with fair amount of suspicion and the skepticism then. It will be termed as step backward in the long-term reform progress of the country.
Thirdly, it will make the RBI look like even more a weaker institution and the independence of the Indian central bank a joke. Presently, the RBI is the authority which manage the currency market. And it has been doing fairly a good job to mange the volatility in the market, including exigency measures such as the one we saw in the 2013 to save the rupee from a free fall, by incentvising inward capital flows and putting timely restrictions on capital outflows. Even rumors of the rupee's devaluation is particularly damaging, when there is a new governor at the RBI, who has just taken over charge and there is a radically different new monetary policy mechanism is being prepared jointly by the government.
Fourthly, there aren’t too many takers for the theory that a devalued rupee can indeed help exporters. Most experts agree that it isn’t the currency value but the quality of exports and global demand that’ll help boost exports. As currency expert and head of Mecklai Financial Services, Jamal Mecklai said in this Business Standardreport, the government’s reported move is “more political than anything else". He feels it could be a way of pushing the RBI for a rate cut.
The other side of this is that a devalued rupee can break the back of importers and result in a wider trade deficit. It can also add to the inflationary pressures. To be sure, the rupee has always been overvalued compared with the Real Effective Exchange Rate (REER) (the weighted average value of the rupee arrived by the RBI in comparison with other major currencies and adjusted to the effects of inflation).
The bottomline is this: Instead of looking at short-cuts, the Modi government should work with exporters towards improving the quality of Indian goods in the international trade market. The very thought of achieving export competitiveness by devaluing the rupee is a self-destructive, regressive idea. It lacks logic in the very same manner commerce minister Nirmala Sitharaman sought a 200 basis points rate cut from the RBI to help small firms. Let the devaluation rumor die as just that.
(Data inputs by Kishor Kadam)