The Indian Rupee has faced a steep depreciation in the recent times. Should the Reserve Bank of India intervene and defend the rupee against the strengthening of dollar? Comment (150 words)
Introduction: Indian Rupee has seen a decline of about 10 per cent in an year. This has been partly due to the strengthening of the dollar against world currencies which is reflected by the high dollar Index. The Reserve Bank of India has accumulated around $600bn of foreign exchange reserve which it can use to defend the Rupee against depreciation.
Advantages of such a move:
- Cheaper import: stronger rupee reduces the cost of imports, especially fuel and fertilizer, both of which are important of Indian Industry and the economy.
- Controlling domestic inflation: Cheaper fuel, fertilizers, cold, edible oil and pulses have huge impact on the domestic inflation.
- Reduces volatility: Less volatile currency is good for the businesses, as unexpected rise and fall makes it difficult to make business decisions and makes the economy unstable.
- Preserving confidence of the foreign investors in Indian Rupee: Cheaper rupee reduces the value of the foreign investments. A stable investment is good for long term foreign investors.
- Keeping External commercial borrowing affordable: Many Indian industries raise funds from foreign markets at a lower interest rates. However, they face losses when the value of rupee depreciates as they have to give more rupee as interests.
Disadvantage of the move:
- Depreciation of the foreign exchange reserve: The amount of foreign exchange reserve is necessary for long term stability of the country as was exemplified in the 1992 balance of payment crisis.
- Promotion of Imports: Stronger rupee makes imports more attractive, thus harming Indian Industries including the farmers that grow oilseeds and pulses.
- Loss of advantage for Indian exports: Indian exports such as IT exports, agricultural products and apparels face stiff competition from other developing countries like Vietnam, Bangladesh etc.
- Against long term stability of the Indian Rupee: Lower foreign exchange reserves can be risky in terms of dealing with economic crisis, as recently seen in Sri Lanka, where a massive surge in imports along with the lower foreign exchange reserve has led to a balance of payment crisis and a massive decline in the currency.
Conclusion: India practices the managed floating system wherein the price of the currency is largely determined by the market forces, however, still the central bank can intervene to manage the currency. However, the capacity of the central bank to manage the currency is limited and thus it is often opined that the economy is best managed when it is not managed. This is the philosophy that led to opening up of the Indian economy in 1991.
Therefore, the central bank should intervene only if it is absolutely necessary, otherwise the currency must be allowed to depreciate according to the market forces.
