Sleep tight, don't let the ₹@90 bug bite

Synopsis India's chief economic adviser is unconcerned about the rupee's recent slip past 90 against the dollar. The Reserve Bank of India also maintains a calm stance. This approach allows the RBI to focus on controlling inflation and fostering economic growth. The rupee's gradual depreciation is expected for an economy with persistent deficits. We're delighted to learn that the chief economic adviser isn't having sleepless afternoons over the rupee, which slipped past ₹90/$ for the first time on Wednesday before hovering just under, at ₹89.96, on Thursday. And he's right to believe his siesta isn't under threat. RBI, too, should chill. Like any other central bank, it confronts an impossible trinity of a fixed exchange rate combined with free capital flows and independent interest rates. The way RBI goes about it is by imposing controls on outward capital movement and letting the rupee float within acceptable limits. These measures free up policy space to focus interest-rate moves on inflation control and, consequently, economic growth. For an economy running persistent fiscal and trade deficits, this approach results in a gradual depreciation of the rupee, and RBI's intervention is required to smoothen currency market volatility. This is the best course of exchange rate management available to RBI. Were it to target a specific value for the rupee, it would have to tighten capital controls, or surrender independence over interest rate movements. There would also be little to gain from a fixed exchange rate. Pegged low, it would favour exports while disfavouring imports. Any gains in the trade balance would be offset by adverse effects on the fiscal balance. Pegged high, the fisc would gain at trade's expense. These are the guard rails within which India's exchange rate policy must operate. Following the efficient market hypothesis, freer capital movement would achieve similar outcomes. But it would make interest rates rigid, while amplifying exchange rate fluctuations. Adjusted for inflation and sovereign risk, the interest rate differential yields positive returns for foreign investors in GoI securities after considering exchange rate movements. So, RBI isn't diverging too much from the free-float exchange rate. The variance will narrow as India is included in more global bond indices. There are no psychological levels to defend for INR, and RBI won't be unduly perturbed about any dent to India's prospects or image with ₹@90. (Catch all the Business News, Breaking News, and Latest News Updates on The Economic Times.) Subscribe to The Economic Times Prime and read the ET ePaper online. ...more