The guardian of the Indian rupee – the Reserve Bank of India – has failed once again. The rupee (INR) touched new lows against the four major global currencies and particularly embarrassing is the fact that the beleaguered euro did better than INR.
The new low of the rupee brings the age-old issue of undisciplined monetary and fiscal policy back in focus. The continued deficit financing of the Indian government by the Reserve Bank has steadily eroded the value of the rupee. Remember, never has the money supply in India contracted. It has always expanded, sometimes maybe at a lower pace, but the trajectory has been up.
The new low of the rupee brings the age-old issue of undisciplined monetary and fiscal policy back in focus. Unlisted Sightings/Flickr
Deficit financing is nothing but printing rupees to finance the ever-growing needs of the Indian government – which cannot live within its means. Put simply, deficit financing increases the supply of rupees, resulting in its loss of value.
The Reserve Bank has exotic sounding monetary strategies like sterilisation, open market operations, etc, but they don’t seem to help the value of the rupee. The bank has also hiked interest rates to cut inflation and improve the value of the rupee – which is a non-serious approach.
What is the point of flooding the economy with money through deficit financing and then hiking interest rates to keep the price of money up? The first thing renowned economist Adam Smith taught me is that if there is more of something, its value will fall, never mind sterilisation, open market operations and the other stuff that central banks do.
Sometime back we had written a column criticising the Reserve Bank for its monetary foibles, to which the general reaction was it’s more the fault of the government. But the Reserve Bank is there to check the excesses of the government and protect the value of the savings and incomes of the citizens of the country. The Reserve Bank must realise deficit financing is not just an economic or monetary issue. It is a moral issue. One should not steal from ordinary citizens of the country by devaluing their savings and income.
As policy makers lack the will to solve one of the core problems of the weak rupee – deficit financing – the markets are punishing the currency. The dollar-rupee (USD-INR) pair touched a new low of 56.21 this week as did the British pound-rupee (GBP-INR) pair at 88.41, the euro-rupee (EUR-INR) pair at 71.30 and the yen-rupee (JPY-INR) pair at 0.7082. The rupee, however, recovered a bit later in the week after touching new lows.
The secular trend of the rupee has been bearish for quite some time with weak fundamentals breaking through technical support levels.
The technical support levels hold for some time like the 54 level for the USD-INR pair, but the fundamentals eventually push the rupee lower. Now, if the USD-INR pair comes into the 53 to 54 range it will be time to short the rupee again. If that level is broken the rupee can rally all the way up to 48.50, where one could short again.
One reason for the fall in the USD-INR pair is the strong rally in the US dollar. Last week we had mentioned that the dollar index, which measures the greenback against six major currencies, had hit a resistance level at 82. (See the dollar index chart below)
One reason for the fall in the USD-INR pair is the strong rally in the US dollar.
Prices often turn lower from resistance. But we had said the likelihood of the resistance being broken was high as the level had been hit earlier. The resistance level was broken in the week to 25 May, and the index seems headed to the next level of 83.50. If that level is broken the index can go all the way to 88. This will be bad news for the pair.
George Albert is Editor, www.capturetrends.com
