Why is the rupee falling:
- Widening current account deficit, mainly owing to the rise in the price of oil triggered by the Ukraine war.
- Capital outflows, driven by a strengthening dollar on the back of aggressive rate hikes by the U.S. Federal Reserve.
The risks Indian Economy faces:
- Current account deficit (CAD) — a broader measure than the trade deficit because it takes into account invisibles such as, for example, travel and tourism — is expected to widen to beyond 3% of GDP this year, higher than 2.5% that the RBI considers to be the safe limit.
- The combined fiscal deficit of the Centre and the States is still above 10% of GDP, possibly higher if the contingent liabilities, especially of the States, are also brought to the book.
- The (foreign exchange reserves to GDP) ratio which stood at 21% in March 2022 as a proportion of FY22 GDP has since declined to about 17% of expected FY23 GDP.
- Recessions in the U.S. and Europe look much more likely today than they did a couple of months ago…India’s exports, already struggling, will be further hit. A recession in advanced economies will hurt the country.
Suggestions for RBI:
- The RBI may consider allowing some depreciation of the rupee. The real effective exchange rate (REER) of the rupee, which is a broader measure of its value against the currencies of India’s trading partners, is overvalued, suggesting some room for depreciation. If that movement towards equilibrium is allowed, it will support exports, restrain non-oil imports, and help narrow the current account balance.
Former U.S. Treasury Secretary John B. Connally famously told his G-10 counterparts in 1971 that “the dollar is our currency, but it’s your problem”. That is even truer today because of deepened financial globalisation and the continuing hegemony of the dollar.
Categories: POINT IAS