The rupee has been yo-yo-ing around in tandem with the political barometer, and the now-you-see-it-now-you-don’t scope for genuine economic reforms.
On Tuesday afternoon, the rupee fell against the US dollar after the RBI retained its key interest rates, belying expectations of a snip in repo rates or at least in the CRR. Lower-than-expected inflation last month had revived expectations of a rate cut, although the RBI has indicated that the battle against inflation has not been wholly won.
A weaker rupee in turn compounds India’s problem of imported inflation, which in turn inhibits the RBI from lowering rates and reviving the economy. In that sense, the rupee is caught in a classic policy loop.
A revival of exports, on the back of the weaker rupee, would have helped it break out of this vicious circle. But, as economists Raghuram Rajan and Surjit Bhalla noted at an event overnight, a cheaper currency alone will not add to India’s growth story.
India, said Rajan, “is long past the stage where it could have used (rupee devaluation) to provide oomph to the growth story.” Bhalla too observed that although the fall in the rupee value for much of the past year was the result of the underlying weak economy, the RBI’s failure to check the erosion was a flawed decision.
Rajan’s and Bhalla’s views are sharply in variance with those of economic philosopher Amartya Sen, who reasoned when the rupee was plummeting last year that all the hand-wringing over the weaker rupee was unwarranted.
The rupee’s fall, Sen had noted then, isn’t quite the train wreck that it’s made out to be. It’s wrong to say that India is doomed on account of a falling currency, when in fact, countries like China, he noted, had gone to extraordinary lengths to artificially deflate their currency – and had profited from it in terms of higher exports.
Sen’s point about the boost to exports from a currency depreciation, of course, conforms to classic economic theory. However, there are other factors that determine a country’s ability to leverage an undervalued currency for higher exports, including, as is the case in China, labour productivity gains that far outstrip the wage price spiral we’ve seen in recent times. India has signally failed on that count, which is one reason why its gains in terms of higher exports have not been proportionate to the rupee’s fall.
As the Economist noted recently, particularly in the wake of the 2008 financial crisis, many countries are content for their currencies to depreciate – because it helps their exporters gain market share and loosens monetary conditions. And rather than taking pleasure from a rise in their currency as a sign of market confidence in their economic policies, countries now react with alarm.
Oddly, however, the old rule that high inflation leads to weak exchange rates no longer holds true, except in extreme cases such as in Zimbabwe, which witnessed a hyperinflationary phase. “A general assumption that countries with high inflation need a lower exchange rate to keep their exports competitive is not well supported by evidence – indeed the reverse appears to be the case,” it noted.
One reason for this is what the magazine called a version of the “carry trade”. Additionally, currency markets no longer punish “bad economic behaviour” – such as high inflation or poor exports. Which is also why governments are no longer fatally obsessed with currency market gyrations.
If, despite the long leash that currency markets have given weak economic performances, the rupee is still a laggard, it says rather more about the gravity of India’s economic weakness than about the RBI’s management of the exchange rate.
And until the economy claws its way out of the depths into which it has sunk, any effort by the RBI to prop up the exchange rate will only amount to throwing good money after bad.