Indranil Sengupta, chief economist with Bank of America Merrill Lynch, believes the Reserve Bank of India (RBI) should use the current strength of the rupee to shore up foreign exchange reserves. Given how linked to the global economy India is and how fickle foreign flows can be, he suggests it might be in the interests of the economy to let the currency depreciate in the near term and enjoy the benefits of a sustainable appreciation once the reserves have stabilised to levels of around 10 months of import cover. In a conversation with Shobhana Subramanian, Sengupta observes that while there is no doubt a big fiscal cost to holding dollar assets—the cost of RBI buying $80 billion in the next two years could be $4 billion or 0.2% of GDP annually—the price of not doing this would be constant volatility, uncertainty and fear.
Where do you see the rupee headed?
Our view is that the rupee will trade in the range of 58-62 to the dollar and much will depend on where the dollar goes. Currently, it’s close to 1.37 against the euro and our house view is that it could strengthen to 1.3 by December. In India, gold import curbs have to go sometime and RBI clearly needs to buy dollars since forex reserves, at 7.5-8 months of import cover, are at a 16-year low and at half the level they were in 2008. RBI has made it clear it wants to build reserves but we need to wait and see what the new government wants.
What is your view on what the government should do?
In 2009, after the UPA-2 came to office, we saw RBI letting the rupee appreciate and you ended up halving the import cover. In contrast, then RBI Governor Bimal Jalan doubled the import cover between the earlier BJP years of 1998 and 2004, which led to a sustainable appreciation. If you have the patience, you will finally end up with the currency at 56. But if you rush to 56 with only a 7.5-8 month import cover, then there could be a problem later. We must remember the world today is very volatile. Also, even to maintain the reserves at an eight month cover, RBI will need to buy $80 billion over the next two years.
What could be the source of volatility?
The fact is that there is a tapering going on and liquidity all over the world