Sajjid Chinoy, Chief India Economist, JP Morgan and part-time member, PMEAC, on tackling challenges of rupee depreciation, getting rid of the obsession with the rupee-dollar rate and RBI’s role. The session was moderated by Executive Editor P Vaidyanathan Iyer
On how the rupee fared in the larger global perspective of currency markets
Before the global financial crisis, it was Rs 40 to a dollar. A year into the crisis, the rate jumped to about Rs 50 and then in the taper tantrum of 2013, the rate swung between Rs 55 and Rs 70. Then in 2018, the rupee moved down further by 10 per cent because of US exceptionalism, Fed rates and oil prices going up. In short, as the global environment gets more adverse, the rupee tends to gap down. But this is the narrow view because it concerns a relative price and we deal with hundreds of prices in the goods and financial markets. Yet this gets everybody animated.
First, the US dollar is the reserve currency of the world. The US economy has an exorbitant privilege and has actually strengthened 15 per cent over the last year against advanced economies. As a consequence of the strengthening dollar, all emerging markets and advanced economies have weakened. The dollar has strengthened because the US Fed got into a pretty aggressive rate hiking cycle. The notion that inflation was transitory in the US proved untrue and once market participants understood just how sticky and broad-based inflation was and how much work the Fed had to do, the dollar began to strengthen. I’m going to use the beginning of 2022 as a marker and you will see India is actually one of the better performing currencies against the US dollar. So, when we say we’re down six and a half to seven per cent, it’s against the backdrop of a dollar index that’s up 15 and you know most emerging markets, including China have weakened further.
Second, India’s trade basket is very diversified (we export and import from the European Union, China, the UAE and 40 countries), so why are we so fixated on the dollar? We need to look at how our exchange rate has done vis-a-vis all our trading partners. The US constitutes about 12 per cent of our trade weight and 18 per cent of our export weight. Now a lot of goods are invoiced in the US and maybe the weight of the dollar in the basket needs to be higher than the direct share but we should not get so obsessed with one currency. The rupee has moved down only as much as our trading partners have against the dollar.
Third, we need to be looking at real, not nominal quantities. Let me give you an example. Let’s assume a pen costs Rs 75 in Mumbai and one dollar in New York. Let’s assume, for the sake of argument, that India has a five per cent inflation rate and the US has zero inflation. After one year, the same pen in India will cost Rs 78.75 because our inflation rate is five per cent while in the US it’s still one dollar. Now you’d rather import this pen from the US, pay one dollar and not buy the Indian version. Put differently, India will be unable to export these pens because when converted to dollars, they will cost more than a dollar. Not only do you want to look at effective exchange rates, you want to look at real exchange rates which adjust inflation differentials. When you peel all the layers of the onion, on a trade weighted basis, the rupee has actually strengthened over 17 years.
The debate we should be having is about exchange rate appreciation in real terms, warranted by fundamentals. In 2013, India was easily the weakest-performing emerging market currency; the rupee had depreciated almost 20 per cent in four months. Today we’re talking about a seven per cent depreciation in seven months and we’re among the better performing emerging market currencies. There is no crisis that’s imminent given the quantum of reserves the RBI has and given the fact that India’s external debt is actually lower now compared to 2013.
On RBI interventions
Intervention is very much an art rather than a science. I think the RBI’s stated position is that it intervenes to reduce volatility. Now the trade-off here is that exchange rates typically overshoot. So, what central banks and emerging markets tend to do is lean against the wind because one of the worries is that if there’s runaway depreciation, weakness begets more weakness. If you worry that the rupee is going to weaken even further, you will have capital flows leaving to beat the depreciation. In doing so, you induce the very depreciation that you were wary of.
Exporters will stop selling and wait for the rupee to get weaker. Importers will front load and those very dynamics will cause more weakness. That’s why it’s perfectly understandable why central banks intervene and the RBI has done so. Now the balancing act here is to prevent overshooting without interfering with the currency’s adjustment to fundamentals. The RBI also intervened in 2020 when India had massive capital inflows to prevent rupee appreciation. This I thought was the right thing to do because the Indian rupee is not cheap on a trade weighted basis.
On trade deficit and imports outpacing exports
Let’s say the RBI estimates that with every one rupee depreciation of the dollar-rupee rate, inflation picks up by about eight to ten basis points. Of India’s current inflation rate of seven per cent, 50 to 70 basis points are attributable to the weaker exchange rate, a very small fraction. So just to get the magnitudes in order, these exchange rate pass-throughs may be bigger than we thought but are not driving half of India’s inflation at the moment. It is actually coming from commodities picking up.
Second, let’s assume the rupee didn’t move at all, that the RBI used all of its reserves, we kept the rupee at 75 and we never had the seven per cent move. This would mean four or five per cent real effective exchange data appreciation we’ve seen over time. This doesn’t happen instantaneously to hurt exports. Yes, there is higher inflation but the trade-off is if you didn’t have that, your exports could get hurt.
Third, the current account deficit last quarter was close to about four per cent of India’s GDP. Now, it will get significant relief from the fact that oil today is below 100 rupees. Now it’s okay to have a current account deficit of three per cent for a few quarters. But if you’re in a strong dollar environment, capital is not necessarily coming to emerging markets and you have a current account deficit of three per cent of GDP that needs to be brought down over time.
Either you let the rupee become the shock absorber and say a weaker rupee will over time help exports and over time reduce the discretionary component of imports. What if we don’t use the rupee, then how do we bring the current account deficit down? The only way, unfortunately, then is to really squeeze demand.
On a weaker rupee helping exporters who don’t pass on the surplus
One can never really prove that. It’s like saying if profits went up in the last year for corporates, how much of that was used as retained earnings, how much was invested and how many jobs were created. What we can show is export volumes did go up when the rupee depreciated and then think of the counterfactual that had the rupee not depreciated, maybe those export-oriented sectors would have shut down and people would have lost jobs. A lot of jobs are in labour-intensive sectors. I am not for a moment saying the exchange rate is the only thing that matters for exports, it is one of the many variables. Arguably what’s more important are productivity, growth, reforms, infrastructure, trade agreements and so on.