Rupee at 66: Moving from text book economics to practicality

The rupee on Friday closed at 65.71 against the dollar, a heartening rally from the life low of 68.8 it had hit just two days earlier.

It opened at 66.12 against the dollar, slightly weaker than Friday's close.

The upmove in the rupee has been attributed to the Reserve Bank of India's decision to open a dollar swap window for oil marketing companies, the biggest buyers of the greenback.

The move is taking away demand for $8.75 billion from the market, helping the rupee arrest a further fall, an article in the Mint said. The article also notes that this has been one of the few sensible decisions taken by the RBI.



The latest step, according to the Mint article, has helped the central to deal with the non-deliverable forwards market. This market, which is driven by speculations, does not come under the RBI as it functions overseas and until recently the regulator has been reluctant to acknowledge even its existence.

The central bank's earlier steps had resulted in an increase in short-term interest rates in the economy. It was largely criticised as an ineffective text book strategy to deal with a complex situation where the economy is slowing even as higher inflation leaves no room to cut interest rates.

So finally, the central bank may be moving towards more practical solutions to deal with the currency market. However, we cannot say just how far will these steps work if the geopolitical situation worsens and the capital flight from the Indian markets intensifies.

Precisely because of such fears Indian stock markets are likely to remain volatile this week.

According to a Reuters report, traders remain wary of foreign flows after overseas investors sold over $1 billion worth of shares in the 10 sessions through Thursday ahead of June quarter GDP data later in the day.

The GDP data came in lower than expected and sending signals that the worst is not over yet for growth. This is because biggest the rupee fall against the dollar happened in August and not in the first quarter. So the impact of the currency fall will be reflected in the July-September GDP data.

"Unlike the sharp recovery from the Lehman crisis (V-shaped) in 2009, this time the growth is following an L-shaped trajectory and is likely to oscillate around the 5 per cent trough in 2013-14," Crisil said in a press release on Friday.

Private consumption growth weakened further to 1.6 percent during the quarter and investments fell 1.2 percent on year and it was government spending that drove growth.

It attributed the slowdown to lack of policy reforms, procedural delays and persistent supply-side bottlenecks.

Higher government spending lifted growth of community, social and personal services to 9.4 per cent from 4 percent in the previous quarter.

"If not for a sharp increase in government spending, community, social and personal services would have, at best, maintained its average growth rate of the past few quarters and GDP growth in the Q1, 2013-14 would have been even lower at around 4.0 percent," it said.

Given the weak finances, the government will not be in a position to continue with its spending spree. So the slowdown will bite harder unless there the government pushes for a faster reversal in the investment cycle.

The slowdown will further accelerate the currency slide and the economy will fall into a more vicious cycle.

If the latest RBI move suggests that it is moving to more practical economics, it is good news for the economy and the markets. A practical RBI will be in a better position to deal with such a complex situation.

In this context, it is significant that Raghuram Rajan is taking over as the RBI governor on 5 September.

Updated Date: Dec 20, 2014 23:49 PM

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