What is the true value of Rupee?

Swadeshi Jagaran Manch
“Dharamakshetra, Sector-8, R.K. Puram, New Delhi
Ph. 011-26184595, Web: www.swadeshionline.in

October 13, 2018
Press Release

Round Table Conference on
What is the true value of Rupee?

The rupee has depreciated by nearly 8 percent since August 2018, from rupees 68.7 per US dollar to nearly rupees 74.72 per US dollar by October 10, 2018. The overall depreciation has been more than 20 percent during 2018.

While common people are worried due to depreciating rupee, those at the helm are making their own personal view which is sending conflicting signals. Recently, we have been hearing from many who are at the helm of affairs that rupee is overvalued and therefore it is expected to fall further. The former Chief Economic Advisor before leaving India had expressed similar views.

The depreciation of rupee means a burden on economy. Many of our companies have been borrowing abroad due to lower cost of borrowing. However, a weaker rupee will then lead to increased cost of borrowing. Cost of foreign travel and education also increases and so does the inflation. Also,input goods which are imported can get costlier which can also increase inflation. And therefore, rupee depreciation is not in the best interests of the economy. People of India, who have already been reeling under high petroleum prices, may face dual attack due to weakening rupee but RBI non-intervention is worrisome.

As Central Bank of the economy Reserve Bank of India, is the custodian and controller of foreign currency. Though the exchange rate (value of rupee in terms of foreign currency) is determined by the market forces of demand and supply, RBI’s interventions is also of great importance. If demand for dollars exceeds supply for dollar rupee depreciates, and more rupees are shed for every dollar. At present as outflow of FIIs and rising crude prices are causing increase in demand for dollars, leading to depreciation in rupee. If RBI intervenes and raises the supply of dollars picking from its foreign exchange reserves, it can stem the fall of rupee. Till a few months back RBI was not inclined to do the same. We should not forget that India is a managed floating exchange rate system which means during external shocks, intervention of RBI is necessary to reduce the volatility.

Approach of the RBI, not to intervene in foreign exchange market, does not seem to be appropriate for many reasons. When the present regime took over in 2014, foreign exchange reserves of India were hardly 312.4 billion dollars, which have increased to more than 400 billion dollars at present. In raising these reserves, net foreign institutional investment has a great contribution. It is interesting when FIIs bring money into India, the same is absorbed by RBI and rupee is generally not allowed to appreciate, while when they take their money out increase in the demand for dollars cause rupee to depreciate. The underlined concern of RBI has generally been that appreciation of rupee may impact exports adversely. However, when FIIs money outflows, RBI leaves the market forces on their own whims, saying that it will not intervene. This approach is fundamentally inappropriate, because if RBI absorbs dollars when FIIs bring money, why doesn’t RBI supply dollars when they go out?
FIIs don’t have any obligation on transfer of money overnight. The government can impose a minimum ‘lock-in-period’ on the investments made by these FIIs, to keep them invested in India. In some countries tax is imposed on conversion of currency by FIIs, which is known as ‘Tobin Tax’. This may also discourage the outflow of investment by FIIsand reduce speculation.Prior to 2009, there existed caps on the royalty payments to foreign companies which were removed since then. This has led to huge loss of foreign exchange to the extent of nearly $20 billion. The cap may go in a far way in bringing stability to the rupee. While Tobin Tax is known to be effective, other capital control measure such as caps on the allowed volume for the international sale or purchase of various financial assets, minimum stay requirements, requirements for mandatory approval, or even limits on the amount of money a private citizen is allowed to remove from the country should be revised to achieve stability in rupee.

In the past few days the major reason for the depreciation of rupee has been the net sale of securities by FIIs and taking the money out of India. In such a situation demand for dollars increase overnight and in view of generally low supply of dollars rupee depreciates. A small scarcity of dollars causes a big fall in value of rupee. However, if we see, India doesn’t have any deficiency of dollars per se. Today India is sitting at huge stock of foreign exchange reserves to the tune of more than 400 billion US dollars. Since the beginning of the year 2018 foreign exchange reserves have declined hardly by 11 billion US dollars, despite hugeoutflow of portfolio investment and rising crude prices. In the last one-month FIIs have sent hardly 1.3 billion US dollars abroad. Extra burden on the economy due to increase in crude prices has been nearly 10 billion US dollars since the beginning of 2018. Since our foreign exchange reserve are more than enough to meet additional demand for dollar due to above mentioned factors, Reserve Bank of India (RBI) can easily intervene in the foreign exchange market to stem any depreciation of Indian rupee. RBI needs to setup buffer stock of Foreign Exchange reserves and should be ready to intervene in case of external shocks. This will reduce the volatility of the currency and control the herding behavior among the investors.

The Round table conference discusses on thefollowing issues. Measuring of true value of currency has been tricky affair. We have Nominal Exchange rate which we look at on regular basis. Also, we have real exchange rate based on concept of PPP. The RBI calculates REER (Real effective Exchange rate) which is the weighted average of a country’s currency in relation to an index or basket of other major currencies, adjusted for the effects of inflation.According to REER, Indian rupee is overvalued recording 114.5 in August 2018.The Economist magazine also releases the Big mac Index which measures the value of the Big Mac sold by McDonalds across the world. Big Mac Index terms rupee as one the undervalued currency. So, what is the true value f rupee, needs investigation. Is REER applicable to India? This needs to be answered. Also, certain Economists have been claiming that rupee depreciation leads to increase in exports. The validity of the statement needs to be discussed.

It is important to stabilize the value of rupee, to save the economy from problems related to depreciating rupee. Today Indian economy is in good shape, as GDP is rising fast with both industrial and agricultural production increasing and inflation is also under control. Therefore, Reserve Bank of India does not need to worry on that account. RBI’s shying away from intervening into the foreign exchange market does not serve any purpose. Let’s hope that the good sense will prevail, and RBI will intervene to stabilize the rupee.

Dr. Ashwani Mahajan
National Co-convener, SJM