Rupee depreciation: Piyush Goyal was not cherry picking data, only highlighting economic reality

"Rupee has only depreciated seven percent in the last five years. This is the best period for the Indian rupee. It's a golden run," said Union Railways minister, Piyush Goyal while speaking at the Hindustan Times Leadership Summit on Friday. This statement caused consternation and a Firstpost column called this statement by Goyal a cruel joke. The column mentioned that the Rupee (INR) is down 26 percent since 2014.

Unfortunately, unlike media commentary and election cycles, economic cycles do not perfectly overlap with the political cycles. Goyal was absolutely correct in taking the 2013 INR reference against the US Dollar (USD) as the benchmark for how the currency has performed.

The reason is quite obvious: India was a fragile five economy in 2013. The fiscal deficit was high, inflation was in double digits, economic activity had stalled, and the government had little room to maneuver any macroeconomic parameter. That reflected in the USD-INR levels, with the INR touching a low of 68.86 against the USD. That particular USD-INR movement was due to abject economic management by the UPA-2 government and its inability to manage the oil shock with a firm political will. While the government itself could not do much on the fiscal side, the Reserve Bank of India (RBI) had then stepped in.

In September 2013, the RBI announced a two-month window for banks to swap fresh Foreign Currency Non-Repatriable (FCNR) deposits. The banks could swap these deposits at a fixed rate of 3.5 percent per annum as long as the deposits were mobilised for three years. The swaps encouraged banks to attract foreign currency deposits for mid to long-term, and their exposure was hedged at the RBI denominated rate. This measure attracted almost $34 billion in new deposits.

File image of Piyush Goyal. PTI

File image of Piyush Goyal. PTI

However, there was a simple catch. These deposits had to be repaid at maturity. In fact, this was managed without any crisis over the second half of 2016 and first half of 2017. The USD-INR rates then had fallen too with INR trading between 66.5 and 68.5 for about six months while the repayment was on. The RBI measure of raising these deposits had obviously kicked the can down the road or else the rupee would have collapsed in 2013 September.

By the time the Narendra Modi government was sworn in May 2014, the INR had stabilised. But that stability came at a known price -- of funding the FCNR deposits. So, starting the clock on May 26, 2014 to baseline the USD-INR conversion rate and then comparing the present rate of 74 makes for extremely naïve economic analysis, when a known market clause was going to take effect in 2016-17.

Let’s take Real Effective Exchange Rate (REER), which is a wider measure for the value of INR, as it factors in major currencies which form India’s trade basket. The RBI uses a 36 currency REER to measure how the INR is performing. The analysis by former Chief Economic Advisor to the Government of India, Arvind Virmani has shown that the INR has been overvalued on a REER basis and has only now started to approach the long-term REER trend. The current INR depreciation will bring down the REER closer to the base.

Economist and author Niranjan Rajadhyaksha has pointed out in his 8 October Livemint column titled “Is the rupee undervalued or is it overvalued?” that even using purchase power parity (PPP) shows that INR is fairly valued. Rajadhyaksha cites data from 41 countries tracked by The Economist newspaper, which uses the relationship between average income levels and price levels.

There is a need to differentiate between the volatility in the USD-INR trade and sudden depreciation of INR and an “optimal” level of the INR itself. The recent sudden depreciation of INR to 74 levels against the USD has been caused by global factors and a balance of trade problem. Indian imports have spiked with oil prices shooting through the roof. The United States (US) fighting a trade war with China has hurt global trade sentiments. The US Fed has been increasing the interest rates. As INR adjusts to these realities, the markets have witnessed capital flight as foreign investors liquidated their portfolio investments to guard against currency risk. The crisis in the Non Banking Financial Companies (NBFCs) came at the wrong time, further spooking the investors and markets alike.

But the Indian macro fundamentals remain strong. Despite the Goods and Services Tax (GST) collections remaining under target for two months, India’s Tax to GDP ratio continues to be around 12 percent. The government has said it is committed to hold the fiscal deficit in line with the budget projections. The economy has been growing and the credit offtake had stabilised before the NBFC issues cropped up. Once the INR trade volatility settles down, the equity markets will see fresh inflows. This may take 6 to 12 months assuming the macro factors stay stable.

The government does have a balance of trade issue to resolve and resolve fast -- there is no doubt about that. Other options would be to attract new foreign currency deposits or attract new foreign direct investment via more sector-specific liberalisation. These are the real issues to talk about rather than getting fixated with a specific USD -- INR conversion level.

When Piyush Goyal pointed out that between the previous economic crisis and the current headwinds, INR had only depreciated about 7 percent, he was not cherry-picking data. He was just stating an obvious economic reality. Maybe in his next media interaction the questions will move away from symptoms -- INR at 74 -- to causes - balance of trade position and shoring up foreign currency reserves.

(The author writes on public policy, politics, and current affairs. He is based in Pune.)

Updated Date: Oct 08, 2018 19:06 PM

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