Is the declining rupee a crisis or an opportunity?

There is an expectation of further depreciation, which can lead to further capital outflows

The rupee’s steep slide to the 79-to-a-dollar range is bound to impact importers, widen the current account deficit (CAD) and increase the value of India’s external debt burden. But how much of a problem is this going to be for the Indian economy, given that the rest of the world is facing economic challenges as well? Zico Dasgupta and Indranil Pan discuss whether the declining rupee presents a crisis or an opportunity, in a conversation moderated by Bharat Kumar K. Edited excerpts:

Zico Dasgupta: This is a matter of concern because the question of opportunity arises when one talks about the positive impact of the declining rupee on trade balance and net exports. That seems to be limited for two reasons. First, despite depreciation in the nominal exchange rate, the real exchange rate has not really depreciated in recent times and that is what matters for questions of trade balance and exports. Second, in the last two-three decades, the sensitivity of exports has been weak as far as changes in the real exchange rate is concerned. The depreciation is concerning — not exactly on the lines of the instability we have seen in Sri Lanka or other developing countries, but because it adds to the inflationary pressure and squeezes the purchasing power of those whose incomes are not linked to the crisis.

Comment | Using a rupee route to get around a dominating dollar

Indranil Pan: A broad indication that we are working with at this time is 3% CAD as a proportion of GDP with the assumption that oil is at about $110 per barrel. If oil is at $120, the CAD goes up to 3.3%. From the RBI (Reserve Bank of India)’s perspective, the moment CAD crosses 2.5%, red flags come up. More importantly, rather than only looking at the CAD, we need to find out whether we have adequate flows on the capital side to bridge the CAD. And if we do, then even if the CAD is at 3%, it might not be very strenuous for the economy. Currently, because of the changing landscape in terms of the monetary policy cycle globally, emerging market inflows have dried up. There are more outflows from emerging markets. So, the RBI has to sell dollars in the spot market to contain the depreciation. Depreciation pressures are relatively more contained than in 2013. I don’t mean it’s time to sleep over it; definitely, you need to see in what ways the capital flow can be improved — RBI has come out with certain policies on that — or determine how the current account gap can be closed by reducing imports. There can be a natural adjustment: the higher inflation and tighter monetary policy domestically would dampen local demand. So, non-oil, non-gold imports are expected to be softer. Fears of a global recession could also lead to a downward bias in crude oil prices; that could be positive for the current account. But global slowdown may also pull down exports and that is worrying from the CAD perspective.

Zico Dasgupta: Right now, it’s not a crisis as serious as Sri Lanka’s, but it’s a matter of concern. Whenever the rupee or any currency starts depreciating, there is always an expectation of further depreciation, which can lead to further capital outflows. In that context, the central bank needs to keep an eye on the situation.

Indranil Pan: In terms of how much reserves you need, there is no thumb rule to indicate that this is enough. Earlier, flows were adequate, the CAD was low and the RBI actually managed to mop up a lot of forex and built up reserves to about $635 billion. On the downside, again, there is no maximum extent to which you can reduce your forex reserves. But the RBI must watch the import cover of forex reserves; that has now fallen sharply as the import bill remains high and forex resources have depleted. The consequent impact on the rupee liquidity is another factor the RBI needs to watch.

Data | Why the rupee is under pressure — explained in seven charts