The Confusion About Rupee Depreciation

Posted on July 8, 2012 in Business and Economy

By Anuja Tandon:

After the international financial crisis of 2008, the great economic analysts of our country had promised a continuously increasing growth rate, thus bringing in disappointment. After the 8.4% growth rate of 2010, India faced a disheartening growth of 6.5% in 2011-12. The persistent inflation, continual depreciation of the rupee against dollar, has brought down our expectation for the growth of 2012-13 down to around 7.6%. It is like going back to the 90s again.

From the time of the British, we have been trying to depreciate our currency to support our exports. What with our increasing fiscal deficit, a depreciated (to an extent, of course) rupee and increased exports, we got a good new accelerated growth rate in the mid 90s and from 2003 to 2007. Then what is it about this current depreciation that is so bad for us?

Isn’t arguing that the depreciated rupee is good for our exports and thus good for our output production valid? So let us start taking everything step by step. It is like playing a macroeconomics game. To increase growth we need to increase our output production. For this we need Foreign Institutional Investment. But due to our persistent high inflation, two digits, since the last two years, our foreign investors are running away despite high interest rate in our country.

Now you could say that shouldn’t our government provide us with the investment required to improve our dilapidated infrastructure to increase production? But you have to keep in mind that the fiscal deficit of our government is already very high, what with all the subsidies like food, oil etc. Controlling this fiscal deficit is also crowding out domestic investment since the interest rate is high.

So to sum up the government investment (excluding their conversion of public sector enterprises to private sector enterprises) cannot be increased further and foreign investment is decreasing due to fall in confidence in rupee due to continuous depreciation and inflation. Encouraging domestic investors is also hard because of high interest rate and low infrastructure facilities.

Moreover, the thought that depreciated rupee could encourage our exports is true only to some extent as the international demand is low.

Also our huge import bills which include oil import and gold import (although it has reduced to some extent) are worsening our situation.

All in all it is not a good situation for our country. So this time depreciation is becoming a huge backdrop for India’s growth. To make it stable RBI is selling some of its foreign reserves but too much will further lower investor’s confidence in our rupee. Such a complicated scenario.

In my opinion, strengthening our internal economy is the best way to get back on the track. Reducing corruption will go a long way in decreasing our fiscal deficit! Also further privatization of public sector enterprises is the need of the hour! At least increased competition will improve efficiency. Decentralization that is dividing the central roles and giving it to the people who are actually living at the grass root level will also help. Proper working institutions selected competitively will work better in supervising that the various subsidies and their distribution is efficient. Also research and development in agriculture, alternative energy source etc should also be encouraged. So whenever you see an M.Tech or PhD in Engineering or related field, boost them up.

All this is very hard for such a big and democratic country like India but not impossible. Already the first steps have been taken. It is the continuation, side by side a turbulent outside world, that is posing a problem. But hopefully we will see get out of this bad weather with a more balanced and self- sufficient (to the maximum extent possible) economy.