From the Opinions Editor | Who gets the rupee right: Economists, market wallahs or moralists?

In times of crisis, advice, often unsolicited, tends to pour in from all quarters. This time is no different. Economists, market wallahs and moralists – all have given their two cents on how the ongoing crisis ought to be tackled. What they have proposed, though, has been largely at odds. That should not be surprising. After all, the advice that is given, as is often the case, depends on where you sit.

Economists have, by and large, stuck to orthodoxy — that the central bank should not defend the rupee. It should neither draw down its forex reserves nor should it raise interest rates to defend the currency. An inflation-targeting central bank should focus on inflation, not the exchange rate. The rupee should, instead, be left to find its own level. A weaker currency would, at the very least, help maintain the competitiveness of the country’s exports. It would also make Indian assets such as stocks and bonds cheaper in dollar terms, increasing their attractiveness for foreign investors.

Efforts to defend the currency are, in any case, likely to be futile as the rupee’s problems run deep. The energy shock that has exposed India’s vulnerability, the absence of a domestic AI play alongside the rapid global adoption of AI models that threatens India’s growth engine, the possibility of the China+1 dream fading away and the risk-return calculus on domestic investments souring even for Indian firms – all raise deeper questions about the country’s growth prospects. It is these concerns which have prompted a flight of capital and put pressure on the currency that need to be addressed, not the rupee’s decline.

Market wallahs, including some from India Inc, however, have a different view, with many in favour of supporting the currency. Some have even called for raising interest rates to defend the currency. Never mind that the economy isn’t overheating — core inflation (excluding precious metals) is around just 2.2 per cent. But, for them, “100” is not just another number. Worries of a vicious cycle – the decline in the rupee triggering more capital outflows, which in turn compounds balance of payment pressures and further weakens the currency – have gained traction. The Indian markets, which find little mention among global investors at the moment, are fearful of a further loss of investor confidence. The defence of the currency is, in some sense, also a defence of the markets.

The Indian central bank has often tended to side with this line of thinking despite its pronouncements to the opposite. There have been numerous episodes when, in the face of sustained depreciation pressures, it has intervened through various tools in order to defend the rupee — an approach it has pursued across governments of varying ideological dispositions.

But, if there is one thing that both economists and the market wallahs agree on, it is the need to facilitate foreign capital flows through various channels. While their preferences may differ, the proposals have ranged from eliminating taxes on investments of foreign institutional investors in markets to encouraging flows through FCNR deposits and/or ECBs, and facilitating greater FDI flows, among others. Some of these suggestions have been acted upon. On Friday, the government and the central bank announced a slew of measures to attract foreign capital. But the question is: In an environment where the India-US yield differential isn’t that large, how much can be realistically mopped up? And would it be enough to ease the pressure? If not, will the RBI follow this up with an interest rate defence as the market wallahs have argued for?

The moralists, on the other hand, have a different take. In times of distress, personal sacrifices must be made, and those profiting, the speculators, must be punished. So, there is a need for market interventions and restrictions on economic activities, demands for austerity and exhortations to curb the use of foreign exchange.

Of course, the distinction between these categories isn’t neat. Overlaps do exist. But all these groups are currently jostling to influence the direction of policy at this critical juncture for the Indian economy. At the moment, it does appear that the market wallahs and the moralists have the upper hand. They may well believe that their measures will help tide over this crisis. But any relief is likely to be short-lived. The focus should instead be on addressing the core issues facing the economy.

Till next time,

Ishan