India’S Forex Policy: Beyond Just The Exchange Rate

Quiz questions:

Which was the last Indian crisis that led to a sharp rupee weakness?

Answer: The BOP crisis, back in 1991.

Rupee depreciation not home-grown

Surprised? After the BOP crisis of 1991, which led to rupee devaluation, there has been no crisis that has originated in India and has impacted the country’s external sector to an extent that would lead to rupee weakness.

Yet, the rupee has depreciated 492 percent — from Rs 13 to the dollar in 1991 to Rs 76.98 to the dollar in 2022. How come? There have indeed been a series of crises that have contributed to the rupee’s weakness, but they have all originated overseas: the Asian Crisis (1997), the Russian debt default and the LTCM meltdown (1998), Y2K (2000), the 9/ 11 attack (2001), the GFC (2008), European Crisis (2011), Taper Tantrum (2013), COVID-19 (2020) and the Russia-Ukraine War (2022).

During this period, Bharat’s economy has continued to grow, per capita income in dollar terms has grown (despite the rupee’s weakness), structural improvements have happened in the economy, the stock market has boomed, and most importantly, improvements have been made on several human development indices. Most recently, the International Monetary Fund (IMF) has commended India in pushing back against extreme poverty even during the pandemic years. We would have to be extremely churlish to say that overall our country is in a worse place than it was in 1991, when we had to ignominiously pawn our gold overseas.

Incongruously, however, the rupee is in a much worse position than it was in 1991. Why? Two explanations are commonly, almost axiomatically, offered by the cognoscenti. One, we have a chronic Balance of Trade deficit. Therefore, QED.

Two, we are an emerging market currency and all emerging market currencies have got the short end of the stick during all international crises. What’s the big deal? QED.

It is almost as if the question “Why” is to be given a withering look, or, rather, be given the fraction-of-an-inch-twitch-of-the-eyebrow treatment, to the Jeeves. However, these stock answers do not explain why have we had secular rupee depreciation (except for in 2002-2007) when we have also had Balance of Payment surpluses and why the Reserve Bank of India (RBI) has actively prevented rupee strength on several occasions .

Costs of the weak-rupee policy

There is no quantification of how much the synthetically manufactured chronic rupee weakness has contributed to Bharat’s systemically high inflation (through imported inflation) and thereby prevented interest rates from coming down systemically. There needs to be an objective attempt to calculate the cost of loss to Bharat’s competitiveness due to chronic rupee weakness. To press a point, the focus would be on competitiveness of the economy as a whole, not only on the competitiveness of exporters.

It is common knowledge that foreign buyers negotiate dollar prices lower for India exporters whenever the rupee weakens. It needs to be asked as to why the RBI persists with the policy of engendering rupee weakness when data has irrefutably shown that rupee weakness does not and has not contributed to export growth? Rather, export growth is achieved through enabling business conditions, not rupee depreciation. A case in point is that the $400+ billion merchandise exports figure in FY 2021-22 has been achieved not due to rupee weakness, but due to a combination of non-rupee factors such as the emerging China+1 preference in global supply chains, an infrastructural push and the PLI schemes in India.

The negative impact of a chronically weak currency on the effort to attract infrastructure capital would also need to be assessed.

It may also be asked as to why the RBI, as the regulator of the forex market, regularly intervenes in the market. Can we imagine the Securities and Exchange of India (SEBI) being in the market almost daily to nudge the Nifty in one direction or the other?

Internationalize rupee in trade

“You should sweat in peace so that you do not bleed in war,” is an old Indian Army adage. We have been found to be woefully lacking in the direction of promoting the Indian Rupee as a means of global trade and are suffering collateral damage because of that. The imposition of sanctions on Russia by USA and moves to restrict Russian banks’ access to SWIFT has made it difficult for India to conduct normal trade with Russia. This is a sorry pass compared to the time when the rupee was legal tender in the Middle East (till around 1959) and trade with Russia was largely rupee-settled in the 1970s. Mind you, while countries like Nepal have recently requested that the rupee be allowed as legal tender, it is India that has baulked at the idea!

This is in sharp contrast to China’s policy of actively promoting the use of the yuan in international trade.

Further, the Russia-USA stand-off calls into question the advisability of concentrating our forex reserves in the US dollar. There is more than a tail-end risk that the US might prevent any country of its choice from accessing its reserves.

Therefore, rather than focus only on the exchange rate, the RBI needs to get over its cold feet and make the rupee fully convertible, as per the Tarapore Committee recommendations, take steps to actively encourage the use of the rupee in global trade and diversify away from the US Dollar in the composition of India’s forex reserves.

Make the market work for importers/export

Like the SEBI works for the benefit of investors in the equity market, rather than for the brokers, the RBI, as the forex market regulator, should actively work for the welfare of the importers and exporters rather than shying away from dismantling the banks’ monopoly on the forex trade flows of their customers.This can be achieved through three measures:

  • To its well deserved credit, the RBI has empowered CCIL to create the very powerful FX Retail platform, which enables retail customers to access the interbank Spot Dollar-Rupee market online. The RBI should now make it mandatory for all banks to route all their customer trades through the FX Retail platform in order to increase volumes and promote usage. Also, while FX Retail allows companies to access the interbank Spot market, the Forward quotes to the customer are still given by single banks. Even the Forwards need to be competitive, multi-bank interbank quotes.
  • Allow corporates to transact forex with any bank of choice, and not be mandatorily tied to the bank through which the underlying trade transaction is routed.
  • Allow delivery against exchange traded currency futures.
  • We should also study whether the country might have been better off had the RBI allowed the rupee to trade on its own and find its own levels, whether weak or strong? Would not Corporate India have developed more robust risk management practices when forced to confront risk rather than being shielded from it?

    A lot has been written on the cross of the Impossible Trilemma that the RBI has to carry on, or maybe even be like Atlas Shrugged.

    — The author, Vikram Murarka, is Chief Currency Strategist, Kshitij Consultancy Services. Views expressed here are personal.

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