Relevance: GS-3: Indian Economy, mobilization of resources.

Key Phrases: Balance of Payments, Human development, Trade Deficit, Rupee Depreciation, Benefits, Economic Growth, Foreign investment, Import substitutable, Imports Inflation, Uncompetitive, Internationalise rupee, Collateral Damage, Legal Tender, Cross-Border Trade, Central Bank.

Why in News?

• Keeping the rupee weak hasn’t helped boost exports or India’s competitiveness. Using the rupee in global trade must be promoted.

Background:

• After balance of payments crisis 1991, which led to the devaluation of the rupee, there has been no crisis originating in India that has impacted the country’s external sector to an extent that would lead to rupee weakness. Yet the rupee has depreciated 492 per cent since — from ₹13/$ in 1991 to ₹76.98/$ in 2022.
• 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 these periods, following thing remains.
  • India’s economy continued to grow.
  • Per capita income in dollar terms rose (despite the rupee’s weakness).
  • There were structural improvements in the economy.
  • The stock market boomed.
  • Human development indices also improved.
• Recently, the IMF has commended India in pushing back extreme poverty even during the pandemic years. It would, therefore, be extremely churlish to say that overall the country is in a worse place than it was in 1991, when we had to pawn our gold overseas.

Why rupee is in a Much Weak Position?

• Rupee is in a weak condition due to two reasons.
  • One, we have a chronic balance of trade deficit.
  • Two, we are an emerging market currency and all such currencies have got the short end of the stick during all international crises.
• However, these stock answers do not explain why we had secular rupee depreciation (except during 2002-2007) when we have also had balance of payment surpluses, and why the RBI has actively prevented the rupee strengthen on several occasions.

Benefits of a Weak Rupee:

• The obvious benefit is to the exporter, which in turn would revive economic growth. Textile sector is among the first off the block. The sector has witnessed strong growth which is reflected in the numbers disclosed by the ministry.
• Foreign investment both through the secondary market and direct investment into sectors which are relatively sheltered from a weak currency can yield better returns over the long run. A stronger dollar would give the investor more rupees in his hand and thus an opportunity to buy more shares.
• Though India does not attract the massage seekers, a weak currency can make the destination attractive for in-bound traffic. Medical tourism can get a shot in the arm.
• Import substitutable products get an indirect shelter on account of a weak currency. Metals, especially steel was affected by imports from other Asian countries, but a weak rupee has increased the landed price of these products. A number of sectors and companies that price their products on import parity basis will benefit.

Cons of a Weak Currency:

• India imports key inputs like oil which is the fuel for its growth. Rising imports will increase the current account deficit.
• A weak rupee imports inflation as it increases the cost of imported goods. This will further reduce RBI's ability to lower key policy rates.
• Students looking to study abroad are severely hit as they have to shell out more rupees to meet the cost.
• Certain sectors which are dependent on imports become uncompetitive. With government discouraging imports of non-essential goods like Gold, a weak rupee can lead to rising unemployment.
• It affects those companies who have raised debt abroad and have not fully-hedged their position.

Internationalise Rupee in Trade:

• There’s has been a lack of effort in promoting the rupee as a means of global trade and the country is suffering collateral damage because of that. The imposition of sanctions on Russia by the US and moves to restrict Russian banks’ access to SWIFT have 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.
• 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-US stand-off calls into question the advisability of concentrating our forex reserves in the dollar.
• Internationalisation means the currency can be freely transacted by both resident and non-residents, and be used as a reserve currency for global trades.
• It can lower transaction costs of cross-border trade and investment operations by mitigating exchange rate risk, but “makes the simultaneous pursuit of exchange rate stability and a domestically oriented monetary policy more challenging, unless supported by large and deep domestic financial markets that could effectively absorb external shocks”.
• Internationalisation can potentially limit the ability of the central bank to control domestic money supply and influence interest rates as per domestic macroeconomic conditions. The most important prerequisite for internationalisation of a currency is price stability.

Way Forward:

• 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, and as per the Tarapore Committee recommendations take steps to actively encourage the use of the rupee in global trade and diversify away from the dollar in the composition of India’s forex reserves.

Source: The Hindu BL

Mains Question:

Q. What is the advantages & disadvantages of a weak Indian Rupee? Why the RBI has actively prevented the rupee strengthen on several occasions? Examine.