Thursday, December 29, 2011

RUPEE Depreciation – “A shock or an Inevitable Event”

Rupee depreciation in the recent times has created a panic situation in the economic environment of the country. People and the economists want the RBI to intervene and curb the forex reserve outflows but is it really a long term fixation of the problem or just a short term fix? That is the question which can be answered by the macroeconomic conditions of the country.
The rupee fall was inevitable, as the ingredients for the rupee plummet were present in the economic conditions for some time and rather they were getting stronger by the each passing stroke of time. For the last year, portfolio flows have slowed down or even partially reversed, current account deficit is about to shoot beyond  3% target, euro zone crisis has reduced global liquidity, a lot of borrowings from 2007 are due for repayment now, our inflation has been high that has been reduced now and FDI has slowed down drastically. So, rather than handling the “Rupee” fall we should look into the underlying factors and should try to manage them for the further degradation.
Now, data from the RBI for rupee’s trade weighted REER against a basket of six currencies reveals a different picture. Till end October, the rupee had appreciated by over 8% over the average of 2004-05 and over 6% over the average of 2009-10. So, the long standing fact is that the rupee was overvalued for quite a long time and its fall is a long standing adjustment.
And most of the underlying causes i.e. inflation, euro zone crisis or repayments are either beyond our control or the effective measures have already been taken. So what is that which can bring the momentum back on the positive track? Ans:  Boost Inflows and the confidence (intangible but extremely important aspect) and for these two factors to kick start;

·         We need fiscal control and easier interest rate scenario coupled with boosting inflows,
·         Initiate Supply-side reforms and get the confidence induced back into the system.

FDI has always been the weak point for the India’s economy and we need to correct it now. It represents long term forex reserves and to improve it we need to take some tough decisions in quick succession. So far policy ambiguity has led to the investors’ weakening confidence and if it is aggravated then it would really become an appalling situation.
Rather Rupee fall can be used as a catalyst to address these deeper economic issues and get India back to the growing trajectory.
We need to act now! 

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