Comment: The strong-rupee policy must end

Updated December 01, 2016

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The rupee has weakened over the past few days against the dollar, with the kerb market trades being reported as weak as Rs108. Meanwhile, the interbank market is still quoting the dollar price near Rs105. The increase in the gap between the two rates is a sign of market pressures building against the rupee.

Since coming to power, the incumbent government has overtly — and by some accounts, covertly — intervened in similar periods of pressure to shore up the local currency versus the greenback.

This implies the use, or the threat of use, of foreign currency reserves to sell dollars into the market to meet foreign currency demand.

This policy must end.

Even to the extent interventions in currency markets can be justified for the sake of macroeconomic stability, inflation control, or the pursuit of other economic goals, the single-minded focus of our government on dollar rates is misguided.

Since the government took office, the dollar has strengthened only about 6pc versus the rupee. In that same period, the dollar has been on an epic tear against other major currencies of the world.

The trade-weighted dollar index — the dollar measured against America’s major trade partners — is up nearly 27 per cent since the day our prime minister was sworn in.

This means we have been trying to stay constant versus a currency that is racing ahead of the currencies of the rest of the world.

It follows that during this government’s tenure, the currencies of our biggest trade partners have weakened considerably versus our own. Against the mighty rupee, the euro is down nearly 13pc and the yuan is down nearly 7pc. The pound is down over 16pc.

In an inversion of Alice and the Red Queen’s race to stay in place from Through the Looking Glass, we are actually moving quite fast while we feel like we are standing still.

Dig a bit deeper and things get even more alarming. The most widely quoted index of emerging market currencies is down over 30pc in the same period. So not only are our export products to developed markets getting more expensive and less competitive, those of our competitors are swiftly moving in the opposite direction.

It is, of course, no surprise that under this government our balance of trade has actually worsened even as the price of oil, our biggest import, has plunged.

Despite this, the government apparently continues to believe that the rupee’s rate versus the dollar must be maintained. To be sure, there are benefits of having a strong currency: cheaper access to imported goods, low inflation and improved broader living standards.

But if the currency is being kept strong by artificial means, these benefits are transitory and unsustainable. Essentially, we are following a policy that is difficult even for massive trade-surplus countries, like Saudi Arabia and the United Arab Emirates, to pursue indefinitely.

A combination of the end of IMF inflows and the possibility of a protectionist wave across developed markets are going to make this policy a lot more difficult and expensive.

It would be more prudent to allow the currency to slide in an orderly fashion towards a fairer valuation without any further intervention.

This will allow trade and investment to take place at undistorted prices, and also avoid epic fallout down the line akin to what Egypt and Nigeria saw in recent months after being forced to allow their currencies to float freely.

The writer has previously served as a director in the global markets division of a European investment bank. He is currently CEO of Elgin Road Partners, a financial services start-up.

Published in Dawn, December 1st, 2016