The hue and cry over the Indian Rupee (INR) as it fell to record lows of Rs 54 to the USD is even more than India crashing out of a major cricket tournament. Calls for the RBI and the government to intervene to protect the INR from falling further are as high as baying for cricketers, selectors and administrators blood. The fact is India manages to come back in cricket and will manage to improve its macro economic fundamentals, which will actually be helped by a weak INR.
The reasons for the INR fall includes factors from inflation, fiscal deficit, current account deficit and global risk aversion and these issues have been well documented by commentators. INR fall is based on fundamental factors and the government or the RBI cannot stem the fall in the short term. Heavy intervention by the RBI will help only deplete a suddenly small looking foreign exchange (fx) reserves. Fx reserves at USD 293 billion is just enough to cover 7.7 months of imports as of December 2011 down from 11.1 months of imports as of March 2011. Short term debt with residual maturity of less than one year is over 43% of reserves, which exposes the country to roll over risk. Using fx reserves to protect the INR will be disastrous in the medium term.
The government cannot do anything, as it does not know what to do apart from easing restrictions on foreign investments into the country. The government had raised debt investment limit by three times to USD 60 billion in just over a couple of years. The government has allowed foreign nationals to invest in Indian equities and has also backtracked on GAAR (General Anti Avoidance Rules). However FII’s will come into the country only if they have risk appetite and as of now they do not have large risk appetite due to domestic as well as global issues such as Greece debt default, China slowdown etc.
The natural course for the INR is down and policy makers should let it follow the natural course. No country has ever been successful in preventing the course of a currency and India is no exception. Indians, whether it is the media, corporates, market participants or the average person on the street should learn to deal with the INR going down. If the markets want to take the INR down it will do so irrespective of egos and intervention. Indian economy will learn to adjust to a new level of the INR though the adjustment is painful for some and is actually positive for others. The country has to remember that India’s rise in the IT sourcing world was due to a weak INR. Even after the INR gained strength, India’s IT sector only marched forward not backwards as seen by the CAGR growth of over 20% in revenues over the last twelve years.
Japan is one example where the strong currency is hurting the export driven economy. The Yen has gained 42% against the USD and by close to 70% against the Euro over the last four years. Exports contribute to 14% of GDP for Japan, and the strong Yen is hurting the country’s growth. The Bank of Japan (BOJ) has not intervened to protect the currency except for a brief period when the Yen hit record levels of JPY 74 against he USD. BOJ has learnt its lessons from past interventions where it has largely been unsuccessful in its attempts to bring down a rising currency.
India has to learn its lessons from the falling INR that has fallen over 20% against the USD in the last nine months. The first lesson is that markets will either embrace or distance itself from a country depending on sentiments, just as the Indian public worship or criticize a cricketing hero. The second lesson is that India cannot jump about and shout that it is a growing country with a young, large population. Sound policies are a must to harness the potential and if policies are weak, the INR will feel effect. The third lesson is that ego has to be thrown away and work has to be done if the INR is to get back its strength. Shouting from rooftops that “it cannot happen to us” will do no good. It only helps expose the country’s immaturity in handling markets.