Never miss a great news story!
Get instant notifications from Economic Times
AllowNot now

You can switch off notifications anytime using browser settings.
The Economic Times

Policymakers running out of time & options on rupee

MUMBAI: When the house is on fire, it makes little sense to be quarrelling on which way to run. It hardly inspires confidence in investors when the chief of the central bank and the head of treasury sing from different song sheets when the currency is testing new lows.

The rupee was close to finding new lows on Wednesday versus the US dollar after the RBI governor Duvvuri Subbarao said he won't defend the direction of the rupee, but intervene only to smoothen out the volatility. He also declared that the sovereign bond issue to save the rupee was a bad idea. Even as Subbarao was conveying the same message to economists on Wednesday, a thousand kilometres away finance minister P Chidambaram was saying the bond sale was still on the table. He promised many more measures to stabilise the rupee, but did not specify.

"The government's policy response during the next few months may not satisfy investors that fundamental, sustainable solutions are being put in place,'' says Sonal Varma at Nomura Securities. The currency that fell to a low of 61.17 to the US dollar, rose to 60.39 at close. It had touched a life low of 61.21 on July 8.

Ever since the currency tested 60, policymakers have been reacting in many ways. Restrictions were put on gold imports and interest rates were raised to prevent currency speculation. Even bond sales and relaxation of investment norms are seen as short-term ones rather than fixing the fundamental problem which is high imports. A bond sale for non-resident Indians is also uncertain given that State Bank of India is against such a proposal since legal structures in the West provide little room for such an issue unlike a decade ago. It is not clear whether a bond issue in any form will happen or not.

High current account deficit (CAD), the excess of spending overseas than earnings, is the root cause of the currency weakness. Consumption of fuel, coal, BMWs, i-pads, and other smart phones are funded by overseas portfolio investors instead of earnings from exports. Now, overseas investors are wary of investing more because the cost of borrowing the US dollar is rising as Federal Reserve will reduce printing of currency. Now the trouble is who will fill the gap?

A sustainable solution is to cut consumption of overseas goods and promote exports. Increasing exports is a long way off since creating an atmosphere for it will take a year or even more. The immediate choice is curbing imports, mainly of electronic items which accounted for $32 billion of imports last year. "If you want to bring down imports on an immediate basis, one way is reduction of imports of items like electronic goods or bringing some clarity on opening up iron-ore exploration,'' said Samiran Chakraborty, managing director, head of regional research, South Asia at Standard Chartered Bank.

Another option is to raise interest rates further to attract funds from overseas that can fund CAD. But that could kill the growth that everyone is longing for. The longer it takes to raise dollar resources, the longer RBI will have to keep in place the so called short-term measures like keeping interest rates high. Of course, RBI is not committed to either 'short term' or 'temporary.'

"There will be consequences for this,'' said Subbarao. "There will be pain in the economy. Somebody will have to bear the cost for this. Those costs are inevitable and unavoidable.''

It will be better if policymakers conclude soon whether citizens pay through higher interest rates or high import costs.
Stay on top of business news with The Economic Times App. Download it Now!