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Is there a case for a strong rupee?

The Modi government has set an aspirational target of growing the Indian economy to $5 trillion in size by 2024. Will a stronger rupee help in achieving this dream? This idea is fast catching up, both in the corridors of power and among some industry leaders. A stronger currency, they feel, is a panacea for all ills plaguing the Indian economy.

But critics warn that any move based more on ideology (Right-wing supporters have always held that a strong rupee is a sign of a strong India) rather than sound economics will hurt the country badly.

The example of China

In fact, there are some who actually prefer the rupee to weaken. They argue that India will never become a $5-trillion economy in the next five years without an exponential growth in exports. Only a weaker rupee will help us achieve that.

They cite the example of China, which grew its GDP by an average of 10 per cent between 1980-2010 — and lifted over a billion people out of poverty — by steadfastly keeping the yuan weak. Only after 2005, that too after a lot of protests by the US and other countries, did it allow its currency to appreciate a bit. A weak currency continues to be the Chinese strategy to boost exports, so much so that in August this year, the Donald Trump administration labelled the country a ‘currency manipulator’.

What worked for China (in keeping its currency weak) may not work for India, as it imports much of its energy needs, especially oil. A weak rupee will make these imports costly. Higher fuel prices will also drive up inflation — and consequently, interest rates — which will smother the economic growth. Also, today, a bulk of Indian exports have a fair share of import components. A weaker currency, thus, may not necessarily make India export-competitive.

That apart, keeping the rupee weak will bring in associated problems of the kind that China faced. To keep the yuan weak, China’s Central Bank kept buying US dollars. This kept the yuan liquidity high domestically, and the lower interest rates that ensued forced Chinese entities to fund their growth through borrowings, which have since reached unsustainable levels. China’s debt to GDP ratio is at a high 266 per cent (more than double that of India). On the other hand, the Chinese Central Bank has ended up creating a $3-trillion reserve, which has remained largely unproductive.

Gradual strengthening

Does this mean a stronger rupee would be a better bet? Not really, but a marginally stronger rupee, which will not hurt exports, could help. It will reduce the cost of importing fuel, and thereby the inflation (a large part of the inflation in India is imported). Lower inflation will result in a lower interest rate regime, which should unleash the animal spirits in the economy, leading to a faster GDP growth.

Those for the move propose strengthening the rupee gradually. This, according to them, will not hurt exports as exporters will have enough time to become competitive, and it will domestically create the necessary conditions for a rapid economic growth. The rupee at a ₹55-60 level would be a sweet spot to start with, they reckon.

What they seem to miss is the fact that in today’s context, it is not easy to artificially strengthen a currency without raising the hackles of investors and trading partners. That is all the more the case when India has a Current Account Deficit (CAD) that is as much as 2 per cent of the GDP. Ultimately, the value of a currency is related to its CAD.

In fact, what is preventing the rupee from depreciating sharply is the high capital inflow (FPI/FDI) that is offsetting the effect of the CAD. Any move to strengthen the rupee by selling dollars will suck out liquidity from the domestic market, push up interest rates and slow down the economy. In other words, it will negate all the benefits that a strong rupee would purportedly bring in.

Reducing imports

The better and more sustainable way to strengthen the rupee is to address the issues that is causing it to weaken in the first place. The CAD has to be narrowed. For this, India needs to reduce its oil imports, and that can be done only by promoting alternate fuels and building strong public transport infrastructure.

The government also needs to find ways to tackle its citizens’ fetish for gold, especially as a safe investment option. Its efforts so far have not been rewarding, with both the Gold Exchange Traded Funds and the Sovereign Gold Bonds underperforming.

The import of electronic goods (read smartphones) is the next big challenge. Though local production of mobile handsets has risen sharply (imports have fallen from 216 million handsets in 2014 to just 20 million last year), thanks to the Phased Manufacturing Programme of the government, the value-addition is still very low. Unless the necessary ecosystem is built — including for producing semiconductor chips — the import content in locally produced mobile handsets will remain high.

The government must also ensure exports deliver in a broad-based manner. Its recent move to cut corporate tax for new investments to 17 per cent from the earlier 29 per cent should see some export-focussed industries setting up operations in India, especially those affected by the US-China trade war. Making in India for the world will help boost exports and reduce the CAD significantly.

That apart, the strong capital inflows need to continue, and this depends on the investors’ perception of India’s economic strength. A growth with stability will ensure this. This will mean a low fiscal deficit, low CAD and low inflation.

These efforts would organically strengthen the rupee without compromising its stability. A stable rupee will help India (including the government) benefit from the low interest rate regime abroad without significant currency risk. With a Baa2 rating (Moody’s), Indian entities can raise five-year funds at rates as low as 3.35 per cent.

Overseas borrowings will also prevent crowding in the domestic debt market and keep interest rates low. Foreign investors too, will be comfortable, as their returns will not be eaten away by sharp, adverse currency fluctuation.

In the end, it is good economics that will help India grow and achieve its $5-trillion GDP target.

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