Context :- The rupee seems to be on a trajectory of decline, with its value relative to the dollar (as per the Reserve Bank of India’s reference rate) falling from Rs.76.4 at the beginning of April to Rs.79.1 at the beginning of July.
Cause:-
- India’s trade deficit has increased in recent months as export growth remained sluggish and imports registered a sharp increase (In June, with exports estimated at $38 billion and imports at $63.6 billion, the trade deficit rose to a new high of $25.6 billion)
- Foreign portfolio investors are pulling out of Indian equity and debt markets.
- High inflation across the world resulted in significant increases in policy interest rates by the US Federal Reserve and other developed country central banks, thus investors are booking profits that accrued over a two-year boom in Indian markets and exiting the country now.
- Spike in oil prices following the Ukraine invasion, which has inflated the import bill, and restrictions on exports for India.
However, there is another observation:-
- Even as the rupee has depreciated vis-à-vis the dollar, it has actually strengthened against other hard currencies such as the euro and the yen
Thus, Duvvuri Subbarao, a former RBI Governor advocates:-
- The RBI should lean towards non-intervention rather than intervention, and allow the rupee to gradually depreciate.
- And it should not be a cause of worry as forex reserve is around $600 billion.
Nonetheless, there are some causes to be worried about:-
- High import bill is not on account of higher oil prices alone but also because of increased imports of commodities varying from gold to coal.
- Coal Crisis:- Coal imports were unavoidable because stocks with the thermal power plants had touched unsustainable lows, raising concerns about large-scale power outages
- India’s coal crisis is the result of the failure of policies aimed at restraining the public sector’s role in coal production and getting the private sector to step in.
- While the objective of curbing public sector growth worked, the drive to get the private sector to fill the gap was a failure
Conclusion:-
In recent years there were three episodes of sharp rupee depreciation: in August 2019, March 2020, and over May-June 2022. In all three instances, a common and important driver of the depreciation was the outflow of capital.
Seen from this angle, the recent and rapid depreciation of the rupee vis-à-vis the dollar does give cause for concern. The drivers of the depreciation are not all short term. The trade deficit threatens to remain high for quite some time. And the excess inflow of capital that propped up the rupee even when deficits widened has all but dried up.
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.