Indian rupee: Vulnerable as ever

Nov 11 2013, 20:04 IST
Comments 0
SummaryIndian rupee: Policy focus has to shift from funding the CAD to reducing it on a permanent basis

40% of GDP in FY13. This shows that there has been a rapid increase in the import content of the average consumption basket in the last 20 years. The rise in economic growth led to a greater rise in imports than in exports as the investments in the economy could not match the rising consumption rate, leading to a trade deficit reaching 10% of GDP in FY13. Further, the increase of the import content even in the export-oriented industries reduces the effectiveness of currency depreciation as a tool in correcting the external imbalance without an improvement in productivity.

*Oil: Oil is a politically sensitive commodity in India given the implication it has on inflation and the daily budgets of households. Hence the depreciation in currency strains the government fiscal balance since the burden is not passed onto end-consumers. Any rise in fiscal deficit without an increase in the productive capacity of the economy indirectly fuels inflation and reduces the effectiveness of monetary policy in maintaining the growth–inflation balance, primarily by the use of interest rates.

*Gold: As much as it is a tradition to buy gold in India, the investment in gold is a savvy economic decision by the Indian households as it is the only asset that strengthens the household balance-sheet in case of a depreciating currency and an inflationary environment. This, however, puts pressure on the financial savings in the economy and hold up investments (savings-investment-current account theory) as Investment is the sum of domestic savings and external savings (current account balance). The lack of investment to fund the infrastructure aggravates this inflation/inefficiency, leading to currency depreciation. Thus, the vicious cycle continues.

*Twin deficits: The deficits should be run only if they can pay for themselves in the future, else they reach unsustainable levels and stalls the development process and exert downward pressure on growth and upward pressure on inflation, creating a stagflationary scenario. The increase in fiscal deficit leads to higher government borrowings that crowds out the private sector, and hence investments in the economy, weakening growth and further fuelling deficit, and the vicious cycle continues.

Self-delusion is the first step towards disaster–we need to shift the medium- to long-term focus away from funding the CAD to reducing the CAD on a permanent basis, else we will continue to have large currency depreciation at regular intervals that can deteriorate the overall well-being of every citizen in the economy.

A stable currency

Single Page Format
Ads by Google
Reader´s Comments
| Post a Comment
Please Wait while comments are loading...