For most of 2013, the Indian rupee, like the currencies of almost all emerging economies, has been steadily losing ground against the dollar. Over the last week, though, this drift has become a disturbance as the rupee has gone into free fall, repeatedly plumbing new lows and sending stock markets into a panic. The rupee fell by more than 2 percent against the dollar on both Tuesday and Wednesday this week, each time the biggest single-day declines in its value for more than two decades.
The rupee has been hard hit by a combination of adverse global and domestic triggers, including India's economic slowdown (growth is down to 5 percent annually), an unsustainable current account deficit, high inflation and the flow of capital away from emerging markets after the announcements from the U.S. Federal Reserve in June that it was tapering its quantitative easing program. At beginning of the year, the dollar traded at 55 rupees; it was just above 60 rupees at the beginning of August. It has advanced more than 10 percent this month to just over 68 rupees, and no one believes the end is in sight.
These events bring back memories of India's balance-of-payments crisis of 1991, the last time the rupee fell this steeply against the dollar, and suggest that hard times may be around the corner. Although India's foreign-exchange reserves are far more secure now, the rupee's infirmity has hogged headlines all month, spooking stock markets, derailing confidence in India's growth story, prompting the central bank to take a series of short-term measures to shore up the currency and sucking the government into a series of counter-productive measures to control capital flight.
Many middle-class Indians are enraged because they view the rupee's decline as a consequence of long-term economic mismanagement and political populism by the ruling center-left UPA coalition government, which has been in power since 2004. The prevailing consensus is that the UPA has privileged expensive social security measures with a populist tinge -- the latest being a Food Security Bill that allocates, less than a year before the next general election, $20 billion to subsidized food for the poor -- without taking care of infrastructure needs and the business environment. With the drying up of economic growth, large welfare programs look unsustainable.
Long part of the subterranean world of the Indian financial system -- a force, like gravity, acknowledged but indistinctly registered -- the dollar has suddenly jumped into prominence over the last month, a sign of how, in just a couple of decades, India has evolved away from a closed economy and a miniscule diaspora.
Some individuals and sectors have registered windfall gains from the dollar's rise -- such as the families of those nonresident Indians remitting money from the U.S., Europe and the Gulf, or the hotel and tourism business. Meanwhile, many middle-class families have had to put off plans for foreign holidays or education abroad, while also asking themselves if they should hedge against future depreciation by buying dollars now. And Indian manufacturing has been hard-hit by the rise in prices of raw materials and components. Most damagingly, the rising dollar is sure to have a knock-on effect on the economy as a whole because it will increase the cost of oil, the largest expense on India's import bill, and further raise inflation and worsen India's current account deficit. This prospect in itself would seem to be an adequate answer to Paul Krugman's question in a blog post on the New York Times website last week:
OK, the plunging rupee is the big economics story of the day, and I’m trying to get up to speed on the issues. My immediate question, however, is why the panic?
Where several Indian economists have been in implicit agreement with Krugman, though, is in urging the government not to privilege short-term measures to "defend the rupee" at the cost of more urgent fixes for the structural deficiencies in the economy. A lucid instance of this argument was provided by the popular economics columnist Swaminathan S. Aiyar in "India's Problem Is Exports, Not The Rupee." Aiyar argued that a depreciating rupee should make Indian exports much more competitive globally, but India's moribund manufacturing sector doesn't have the resources to exploit this opportunity. He observed:
A falling rupee is a political, not an economic disaster. The plunge raises import prices and exacerbates inflation in the run-up to the next general election, just eight months away. ...
The danger now is that dysfunction in the Indian economy will strangle any incipient export boom at birth. GDP growth slowed to 5 percent last year, after racing along at 8.5 percent for a decade. Industry and, until the recent uptick, exports have stagnated. Inflation has soared. The current account deficit is almost double what the Reserve Bank says is sustainable. ...
[India's Finance Minister] Chidambaram doesn’t have enough weapons to prop up the exchange rate. Rather, he should concentrate on converting cleared projects into actual physical investment and on converting the cheaper rupee into an export boom. If investment and exports begin to surge again, business confidence will return. That’s when the rupee will strengthen.
Aiyar was echoed in the Hindu by Raghuvir Srinivasan, who wrote:
The root cause for the problems with the rupee and the current account deficit (CAD) are not so much to do with monetary policy as with prolonged neglect of the real sector of the economy. The truth is the UPA II government has failed to create a conducive environment for investment in manufacturing. Even as inflation was raging all the action to control it was on the demand side and not on the supply side, where the problems were.
Chidambaram announced a series of measures this week to get the economy back on track, even as a cabinet committee on investment gave the go-ahead to 36 major infrastructure projects cumulatively worth $28 billion in a bid to restore investor confidence. But it's clear there's more pain for the rupee in the short term, with many analysts predicting a new equilibrium point above 70 rupees to the dollar -- a prospect that's now just around the corner.
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