Arshad Shaikh checks the reasons for the falling rupee and the growing current account deficit (CAD). Rupee breaching a historic 80 mark against the dollar has set the stage for fresh economic challenges. The virtual economic collapse in neighbouring Sri Lanka and the resulting political turmoil has put the government on high alert and the RBI is actively intervening in the market in a bid to prop up the rupee. There are suggestions to go for big bang reforms and make the rupee fully convertible while others are prescribing renewed focus on the CAD. The situation is grim and will test the will and skill of our policymakers in steadying the rocking boat of our economy.

The Indian rupee has breached the 80 mark for the first time against the US dollar. In other words, one US dollar is now equivalent to 80.02 rupees in the money exchange. The rigorous intervention of the RBI in the currency markets to try to stop the rupee from sliding beyond the psychological Rs 80 to the dollar has clearly failed. The Fed (US Central bank) is expected to carry out another interest rate hike of 100 basis points (a full percentage) sooner rather than later. This is bound to apply further pressure on the rupee and the CAD.

A current account deficit (CAD) implies that a country is importing more than it is exporting. According to a Finance Ministry report, India’s CAD is expected to deteriorate in FY23 on costlier import and sluggish merchandise exports. Currently, the CAD stands at 1.2% of the GDP but is expected to enlarge to 3% of GDP in the current financial year. The expansion in the CAD has led to a depreciation of the rupee by 6% against the US dollar since the beginning of 2022.

The vicious cycle of the growing CAD and the falling rupee can be seen in the light of reports, which indicate that the depreciating rupee along with the rise in global commodity prices have made price-inelastic imports (like petrol and diesel) costlier, making it very challenging to rein in the ballooning CAD.

The virtual economic collapse of Sri Lanka was primarily due to an ever-expanding trade deficit the largest component of a current account deficit. Our southern neighbour nearly exhausted all its foreign exchange reserves (the amount of foreign currency held by a country’s central bank to maintain the exchange rate of its currency and maintain liquidity during an economic crisis) inhibiting its capacity to import and driving domestic prices. With an unserviceable $51 billion debt burden and defaults on massive debt payments led to a total collapse of the economy with its attendant political ramifications.

The Indian rupee fell by over 7% against the dollar in the current financial and the RBI is desperately trying to shore up the rupee by spending $40 billion thus far and predicted to spend another $100 billion (a sixth of its foreign exchange reserves) in the near future. Those eyeing the current situation to be utilised for big-bang reforms are suggesting that this is the right time to “internationalie” the rupee or make it fully-convertible.

According to Investopedia, “Full convertibility would mean the rupee exchange rate would be left to market factors without any regulatory intervention. There may be no limit on inflow or outflow of capital for various purposes including investments, remittances, or asset purchases/sales.”

Proponents of the move say a fully-convertible rupee would result in increased liquidity in the financial markets leading to easy access to capital and investment boosting the real economy. Critics cite higher volatility, increased foreign debt, a negative effect on exports. Navigating the economy will be critical as elections are fast approaching and any mismanagement is bound to hurt the government politically.

WHY A BALLOONING CAD IS WORRYING FOR INDIA?

A huge and growing CAD is a political hot potato. It gives credence to allegations by critics of the government that it is mismanaging the economy, as the CAD is one of key factors that contribute to a country’s macroeconomic stability. Some of the problems of a bloating CAD include the increased claim of foreigners on domestic assets, reduced ability to control its growing size, creation of an unbalanced economy that has short-term consumption rather than long-term investment in the export sector.

Further, a large CAD leads to cost-push inflation and a fall of the domestic currency in the exchange market. There is an increased risk of flight of capital, a scenario that is reminiscent of the 1997 Asian crisis. CAD also has a direct relation with the country’s foreign exchange reserves, as the trade deficit is the biggest component of the CAD.

A well-known economist recently tweeted, “In 2020-21 India’s FX reserves covered 18 months of imports. In 2022-23, FX reserves likely to cover about 7 to 8 months imports. Because imports going up 45 to 50% & forex reserves falling due to capital outflow. Reserves need monitoring”.

FALLING RUPEE BLUES

Why is the falling rupee worrisome? In simple mathematical terms, if the rupee were Rs 70 against the dollar then we would have to pay less for all the crude oil and other critical imports that we import from the international market and the payment for which is in US dollars.  Thus, the first thing that a depreciating rupee does is inflate the import bill.

Although it has not reached worrying levels, there has definitely been a loss of confidence of foreign investors. It is estimated that in this fiscal, foreign investors have withdrawn around 30 billion US dollars. A falling rupee also implies an increase in the money supply without a corresponding increase in the number of goods and services produced. This will lead to inflation that will have to be controlled by increasing interest rates reducing investment that will affect production and employment.

Some say that the percentage fall in the rupee has been less than that of other currencies like the Japanese yen or the British pound sterling. However, they fail to realise that these are developed economies and such frivolous comparisons can only result in a manufactured reassurance.

WAY OUT

India’s share of merchandise exports is around 1.9% of the global market while the share of commercial service exports is around 3.5%. WTO data shows that manufactured goods continue to dominate the world trade with a share of more than 65%. This is followed by fuels and mining products that take up around 20% of the total share. Unfortunately, we rely on mineral fuels, mineral oils and products followed by semi-precious stones and metals and machinery parts for our exports.

Again, a majority of our exports was made up of primary and low technology goods. For example, our exports in electronics are worth around $11.8 billion in a $2.8 trillion market. Poor infrastructure, unreliable power supply, inadequate labour skills, corruption, red-tape and fossilised government procedures, all contribute to poor export performance.

Moreover, the entire focus of the government towards favouring the corporate sector over its core responsibilities of providing world-class education, nutrition, healthcare and housing citizens results in a sub-normal human resources pool that is incapable of competing in the global market from its backyard. The same Indians continue to shine and flourish when they go abroad.

India’s CAD and depreciating rupee issues are a symptom of the misplaced priorities of our governments and policymakers. Amartya Sen said, “Economic growth without investment in human development is unsustainable and unethical”. Our leaders can focus on human development only after they rise above narrow partisan politics and shed their obsession with minority baiting.

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