Though not occurring for the first time, the rupee’s sudden and sharp depreciation in relation to the dollar has caused all round concern. A major reason has been the sheer unpredictability of the currency movements at this juncture. Not long ago, the problem seemed to be centred on rupee appreciation. There were many who had advocated Reserve Bank of India intervention to preserve export competitiveness. The fact that in the January-March quarter, India’s export performance was slightly better than in the previous quarters lent support to that view. Yet, without any significant change in external demand — Europe remains in the doldrums while the recovery in Japan and the U.S. is uneven and beset with many problems — India’s external economy faces a great deal of uncertainty. The sharp decline in the rupee’s external value is one of the important manifestations of this. Since May the rupee has fallen by 5.3 per cent. It fell below 57 to the dollar on Thursday and continued its slump Friday. It is small consolation that the currencies of almost all emerging market countries have declined. The argument that it is not the rupee’s weakness so much as the dollar’s strength that is driving down the home currency does not really help India’s currency managers.

The dollar appears to have gained on the belief that the Federal Reserve will end its controversial quantitative easing programme. Once that happens, the large capital flows that have come to India and other emerging markets will flow back to the U.S. to meet investment needs there, dangerously exposing India’s vulnerabilities in its balance of payments. The unacceptably large current account deficit — estimated at around $100 billion — crimps exchange rate management in several ways. It restricts the scope of RBI intervention, which in any case cannot count indefinitely on previously accumulated external reserves for its ammunition. In fact, reserves now estimated at around $292 billion have come under stress recently. When compared to India’s mounting external liabilities — in the region of $300 billion and growing — the level of reserves no longer gives the cushion it used to. It goes without saying that a depreciating rupee makes imports costlier. The benefit of the likely fall in global oil prices will be negated. Nor has the seemingly insatiable appetite for gold dimmed despite the administrative and tariff measures adopted recently. There is a danger of domestic price levels flaring up again in the wake of the rupee’s depreciation. Ironically, it is the slowdown in GDP growth that has become India’s last line of defence against imported inflation.

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