USD at Rs 60? Why govt should let the rupee fall

As the rupee heads south, the right questions for the Reserve Bank and the Finance Ministry to ask are the following:

One, should we artificially try to prop the rupee up?

The answer is no. No power on earth can stop the rupee from going down if it wants to, especially when the current account deficit (CAD) - the gap between our external payments and receipts - is so bad. The RBI Governor has said the right thing by emphasising that his only job is to manage volatility, not find the right price for the Indian currency. He should stick to this stand despite pressure from North Block to do something. Doing nothing is best.

Two, should the government be trying to induce more inflows, to counter the rupee’s fall, by hook or by crook?

Again the answer is no. The reason is prudence. It is possible to get more short-term and volatile capital flows by tweaking norms and changing tax rules favourably for foreign investors. But the only result of past action in this regard has been to make the long-term external situation worse. Excluding gold, the ratio of our foreign exchange reserves to external debt is now just 68 percent. For every dollar owed, we can repay only 68 cents. Or even less, for the debt figures relate to December 2012, and in the meanwhile we have borrowed even more. If the world wants to recall its loans, India won’t be able to pay back without a crisis.

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So what should India do?

The answer is: let the rupee find its own level.

It could be Rs 60 to the US dollar, or more, but for the RBI and the government to try and put it where they think it should be is folly.

If the government wants to do something, it should go with the sentiment and actually devalue the rupee to Rs 60. This may shock the markets, but would be more in tune with reality than anything else. It would show the government is bold, not manipulative.

There are, of course, negatives to any decision. Devaluing the rupee will push up the rate of imported inflation and slow down growth, but when you have a serious imbalance on the trade front, should you be trying to push up growth or imports? When you have high fever, do you do more rigourous exercise or take it easy and wait for the body to fix the problem?

Letting the rupee decline is a good way to correcting a worsening CAD - which could be around 5 percent in 2012-13, twice the level of the official comfort level.

As we noted before in _Firstpost_ , the rupee should be anywhere in the 60-70 range against the US dollar in terms of its real purchasing power. SS Tarapore, former Deputy Governor of the Reserve Bank of India, wrote in Business Line newspaper, “With the inflation rate persistently above that in the major industrial countries, the rupee is clearly overvalued. Adjusting for inflation rate differentials, the present nominal dollar-rupee rate…should be closer to $1 = Rs 70. But our macho spirits want an appreciation of the rupee which goes against fundamentals.”

[caption id=“attachment_856975” align=“alignleft” width=“380”] Wisdom lies in either allowing the rupee to find its own level so that imports can be cut and exports boosted, or in actually going with the flow and reducing the value to Rs 60 (or wherever) to tell the world we mean business. Reuters[/caption]

Rajeev Malik of CLSA, writing earlier in _Firstpost_ , had this to say: “The worsening CAD is partly signalling that the rupee is overvalued. But the RBI and everyone else are missing that clue. That is because policymakers further open up the tap to attract more volatile, risk-driven foreign capital to finance a worsening CAD. Indian policymakers are making a simple mistake to think that as long as capital inflows finance a worsening CAD, the rupee is appropriately valued. This is incorrect. India’s high inflation differential will contribute towards making the rupee overvalued even if capital inflows are adequate to finance a bigger CAD.”

To make matters worse, the government is trying to get interest rates down faster - which is an open invitation to foreign investors to flee, since it now makes sense to invest more in dollars than in rupee, given our interest rate differentials. Foreigners are already fleeing Indian debt.

Wisdom lies in either allowing the rupee to find its own level so that imports can be cut and exports boosted, or in actually going with the flow and reducing the value to Rs 60 (or wherever) to tell the world we mean business.

A consolation prize for P Chidambaram: gold imports would also come down if the rupee falls.

But, of course, this is politically inconvenient. Governments see a strong currency as evidence of the correctness of policy and the future of economic performance. Which is why they want to shoot the messenger.

What’s good for their egos is not good for the country.