What does rupee @60 mean

The usual response to a sharp fall in the value of the Indian currency is a wave of unwarranted national angst which clouds clear thinking. Photo: Mint

Live mint : 20 June 2013

It is hard to predict what will happen in the coming days; even forecasters have been caught on the wrong foot

The rupee has touched a record low against the dollar. This newspaper has argued earlier that a fall in the Indian currency is both inevitable and positive for an economy such as India that has a high current account deficit, high inflation and high dependence on volatile capital flows.

The usual response to a sharp fall in the value of the Indian currency is a wave of unwarranted national angst which clouds clear thinking.

What now? It is hard to predict what will happen in the coming days; even professional currency forecasters have been caught on the wrong foot. But one thing is sure: India is now an open economy which makes the value of the rupee against the dollar the single most important price to consider.

Here are some issues worth tracking.

1. A weak rupee will tend to raise the landed costs of imports. Fuel prices are the most important, but the broad sell-off may even bring down global crude oil prices. So the inflationary impact of the falling rupee will be the result of a complex balance of factors.

2. The Reserve Bank of India has already made it clear that it cannot cut interest rates as long as the rupee is under pressure (and till food prices remain high). All bets on a reduction in rates in July should be off till the rupee stabilizes. No central bank in its right senses reacts to a weakening currency with a rate cut.

3. Money market interest rates may climb if foreign institutional investors continue to pull money out of India, especially from Indian bonds. They have already sold $5 billion of Indian bonds since 22 May. Local liquidity could also be impacted in case the central bank decided to buy rupees to stabilize it. But it makes sense right now for RBI to let the rupee find its fair value, only intervening during episodes of very high volatility.

4. Indian companies have rushed abroad to borrow at low rates thanks to quantitative easing. The Indian government has encouraged this debt wish. Though exact data is not available, a lot of this debt in unhedged. The fall in the rupee will hurt the financials of many company with high unhedged dollar debt.

5. The long-term effects of rupee depreciation has usually been positive for the Indian economy, as the famous examples of 1966 and 1991 show. But the interim period could be choppy. So the coming weeks could see many skeletons rolling out of cupboards as the Indian currency stays under pressure.