Sharp falls reveal that the value of the rupee is vulnerable to net currency outflows
In the second week of May, India’s foreign exchange reserve shrunk to $595 billion from $635 billion in September 2021. Existing reserves are about 18% of nominal GDP, which is a comfort zone. Despite this, the value of the rupee against the US dollar fell by almost 6% to 77.4 in May 2022 from 73 in September 2021. Such a steep drop reveals that the value of the rupee is vulnerable to net outflow currencies. Historically, India has been in deficit in trade (goods and services) and hence foreign exchange reserves are usually built up from “capital revenue” in the form of debt and equity. The net ‘inward remittances’ in the current account is around $60-65 billion which is consumed in partial financing of the trade deficit and mainly India was in ‘current account deficit’. The trade deficit is somewhat similar to the “trading loss” and the current account deficit is similar to the nation’s “net loss” in international trade. This is not a good scenario for the stability of the rupee. Ideally, India should be in “trade surplus” for a stable rupee. For an appreciation in the value of the rupee, India should have a “current account surplus” on a consistent basis. The import of energy (oil and coal) must be partially replaced by national production. India has sufficient coal reserves and its production needs to be increased through reforms in the mineral and coal sector. India also has good oil and gas reserves, as cited by ex-petroleum minister VeerappaMoily as well as Anil Agrawal of Vedanta. However, this requires huge prospecting expenses. To replace imports of electronic and defense items, the government has taken good measures; which can be pushed. Similar steps are also required for other major imports. The government should present a white paper to boost exports and replace imports with domestic production. In addition to this, there is a vast scope for exporting services in the field of tourism, consultancy (legal, accounting and engineering), maritime transport, education and the health sector; which also needs a separate white paper.
India’s financial savings are not sufficient to fund investment needs and hence the dependence on global fund inflow will continue for some more years. As a stopgap measure, the physical savings in gold must be reduced to almost zero through financial innovation, as the author suggests in his book “Turn Around India”. The huge import of gold is indeed a drag on the trade balance. In 1992, the fixed exchange rate regime was abolished. Thereafter, the value of the rupee was almost stable from the year 2000 to 2010 as shown in the table below. It means that; it is possible to maintain the stability of the rupee. Simultaneously, the reasons for the subsequent decline in the value of the rupee must be analyzed and resolved. Total financial assets in the world exceed $200 trillion. Global investors are looking for those destinations that offer them a high return in US dollar terms. In case India succeeds in stabilizing the rupee, global funds will rush. In this case, it is imperative that global funds are used primarily for investment in productive assets and not for consumption. Otherwise, inflation could get worse and servicing global funds could be a problem. To stimulate investment in productive assets, regulatory relaxation and simplification of tax laws are the prerequisites. External risks, if any, resulting from currency outflow and rupee depreciation will be totally eliminated. On the contrary, due to excess foreign exchange reserves, India’s diplomatic relations will improve, especially with neighboring countries. And so, India will inspire great respect in the world brotherhood.
(The author is an economist and author. Opinions expressed are personal.)