Depreciation in Rupee

• Recently, the rupee weakened against the dollar past the 81-mark to a record low.
• In recent months, the RBI has been intervening in the forex market to smoothen the decline.
• Due to this, Indian foreign exchange reserves have fallen by about $94 billion in 12 months to about $545 billion until mid-September.

Actions that could be taken by RBI to stem the rupee’s decline

• The use of forex reserves to curb currency volatility
• Using forex can make the rupee less volatile.
• However, there is also a limit to how much you can lean on the reserves.
• So, a multi-pronged approach is required.
  • Easing provisions for remittances
  • Allowing short-term foreign portfolio investments in government securities, etc.
• Letting the rupee depreciate in an orderly manner.
• Depreciation will partly help the export sector, as global demand is the key influencer of exports, and currencies of our competitors are also weakening.
• So, the vulnerability that stems from high current account deficit (CAD) can get addressed to some extent.
• The interest rate channel also needs to be used.
• The RBI is supposed to go in for a 50 basis point hike.
• Will address domestic concerns and part of it will also help mute the impact of the U.S. Federal Reserve’s rate hikes.
• Import cover
• One way to measure reserves adequacy, but it’s a very narrow one.
• Other measures such as the Guidotti–Greenspan rule that looks at external debt that is less than one year, i.e., short-term debt.
• MPC moving back to ‘neutral’ from an ‘accommodative’ stance
• Could be an effective way to target macroeconomic stability.
• Help in addressing the macroeconomic fundamentals.
• Interest rate lever
• Means that interest rates are being raised not only to control inflation, but also to address external imbalances.
• Aim now should only be to ensure that volatility is not too high, not to steer the currency in any direction.

Consequences if the CAD hits 4%

• If real interest rate (R) is going to be greater than economic growth (G), then we are in an unsustainable situation.
• The only way to address these concerns, such as fiscal consolidation, twin deficit crisis, given that the real rate of interest is negative, given the hawkish mode of the Fed, is to raise rates.

What should investors do?

• Investors should stick to the basics and not try to play in the market.
• Basics of asset allocation should be followed.
• Investments should continue through the SIP mode into equity markets, preferably through mutual funds.

Prelims Takeaway

• Current Account Deficit
• Twin Deficit
• Depreciation