Podcast 1st May 2015
Hi I am Arjun Parthasarathy speaking and this podcast is on “Weak INR Policy does more Harm than Good”
Policy makers from staving off a free fall in the INR in July 2013 on the back of Fed talk of stopping asset purchases are now clamoring for depreciation in the INR. The reason for wanting a weak INR is India’s export growth that turned negative in fiscal 2014-15. The rise of the INR by over 20% against the Euro and relative strength against the USD despite falling by 4% is seen as the cause of weak export growth. The Euro, Yen, Brazilian Real, Russian Ruble, Australian Dollar have fallen much more against the USD than the INR.
The government highlighted the strength in INR hurting exports in its Economic Survey released in February 2015. RBI cut the Repo Rate in March citing lack of export competitiveness of the INR as one of the reasons. The TAC (Technical Advisory Committee) of the RBI has sounded concern over the relative strength of the INR.
Is a policy of depreciating the INR to achieve export competitiveness a correct policy? The answer is a definitive NO. RBI trying to depreciate the INR by either lowering interest rates or by buying USD can lead to longer term repercussions that may be difficult to control. Lowering interest rates without fundamental backing of inflation and fiscal deficit will lead to low to negative real interest rates that can stifle savings in the economy. Buying USD leads to high liquidity infusion that can affect interest rates as well as cause long term inflation expectations to rise.
To be sure, the INR has weakened considerably against the USD over the last two years. INR is down over 14% against the USD. The weak INR prompted the government to adopt policies to control fiscal and current account deficits and to keep down inflation expectations, all of which have worked in strengthening the macro economic fundamentals of the economy. The weak INR has definitely not helped exports grow with export growth at just 4% in fiscal 2013-14.
A policy of weak INR may also stop capital flows as cost of hedging becomes expensive. FIIs could even pull out of INR bonds if INR depreciates, as unhedged exposures will cause losses. FIIs have invested a record USD 27 billion in INR bonds in fiscal 2014-15 and if they sell bonds then interest rates are likely to rise in the economy. Ironically, FII bond sales will help depreciate the INR and this could lead to a self fulfilling cycle of more FII selling and faster depreciation of the INR and this policy makers cannot digest.
The INR is best left alone and policy makers should concentrate on strengthening economic fundamentals that will lead to productivity gains, which in turn will lead to export competitiveness.