Indian two thousand and five hundred rupee banknotes are arranged for a photograph in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

Government Should Let The Rupee Fall Further, Says Ananth Narayan

A drop in the rupee only goes to aid exports, a key parameter which can help lower the current account deficit. That’s according to Ananth Narayan of SP Jain Institute. He said the domestic currency is still overvalued and a further depreciation shouldn’t be a cause of concern.

“The rupee is still overvalued in real effective exchange rate terms by about 15 percent, and maybe, we should let the rupee relax a little bit more so that the balance becomes more sustainable,” Narayan told BloombergQuint in an interview.

The domestic currency fell 8 paise to trade at 69.03 against the U.S. dollar in early trade today on appreciation of the greenback overseas and sustained foreign capital outflows. This is the rupee’s third straight slide, which dealers said is mostly due to demand for the American currency and a lower opening in the domestic equity market. Yesterday, the rupee tumbled 21 paise to a fresh closing low of 68.95. The Indian currency is the worst performer among Asian peers so far this year. Narayan said there’s still room to let it depreciate.

“The dollar-rupee should be at 71-72 and its not a cause of alarm,” Narayan said.

Edited excerpts of the interview

Where does the rupee go from here because the bad news does not seem to stop?

There is a problem on the external front. We have a precarious balance. Our current account deficit for this fiscal year will likely be the worst than it’s been in the last six years at about $70 billion. Our FDI will not cover that permanent outflow, which means we need to borrow money. We already have seen the RBI intervene regularly to stop these flows. In fact, the permanent flows will be about $3 billion of outflow every month. To add to our problems, rather than flows coming in to bridge the gap, we are actually seeing reversals of hitherto put on carry positions. Putting together, it is not looking great.

I think one good news for the rupee is that the RBI still has plenty of reserves. They probably sold about $25 billion since April but they still have about $400 billion of reserves left and the chances are that the government, particularly in an election year, will not want to see the rupee depreciate too much and too rapidly. So they are still holding on to their guns. Second, the weakening rupee might improve the current account over the course of the year, exports should do better, not just because of the rupee but also because of the goods and services tax and demonetisation impact fading away. We may start to import and splurge less on smartphones from China with the rupee weakening, but nevertheless the problems remain. Frankly speaking, the rupee is still overvalued in real effective exchange rate terms by about 15 percent and may be we should let the rupee relax a little bit more so that the balance becomes a lot more sustainable.

That seems to be the view coming in the from the government as well. In the last week or so, we have heard Rajiv Kumar of NITI Aayog as well as Arvind Subramanian suggesting that a depreciating rupee is not a cause of concern and further depreciation would not be a cause of concern. How are you interpreting what they say, combined with the RBI action which i know is more to smooth out volatility than to defend it necessarily. But at what point do you see them wanting to defend? There are estimates of rupee moving to 70 or 72. Do you think those are realistic in any fashion ?

On the government front, I must admit I am confused. NITI Aayog and the outgoing CEA did talk about allowing the rupee to weaken. Finance Minister Piyush Goyal is a rupee bull. I don’t think he wants the rupee to weaken. More importantly, real politics dictates that in an election year, a headline of rupee weakness in a country which unfortunately associates the strength of the rupee with economic prowess. Plus the fact that it will immediately impact our petrol and diesel prices will likely make the government not wanting the rupee to depreciate too much notwithstanding what Mr. Rajiv Kumar said. So, I still believe that the pressure on the RBI from North Block or from Delhi would be to try and keep a lid on the rupee depreciation, which is kind of sad because on the one hand we have these sensational headlines about 70 and 72.

Frankly, the rupee at 70 is still overvalued. At 69, we are 15 percent overvalued, at 70, we would be 12.5 or 13 percent overvalued. So given the fact that the world has moved on and we have a differential growth where India grows faster, has a higher inflation than the rest of the world and our balance has moved against us, we are clearly having trouble with our exports, we are importing too much and our FDI is not growing fast enough to keep pace with this deteriorating trade balance. It’s a natural adjustment mechanism to allow things to fall into balance. It is not a question of national pride or just looking at the dollar-rupee in isolation, this is simple economic balance. If left to me, the dollar-rupee should be at 71-72, it’s not a cause of alarm, it’s not a runaway fall by any means, it’s an adjustment process which hopefully allows us to build a more sustainable external balance.

What impact does rupee fall have on the local macro? We just heard of the MSP increases and although they were largely in line with the expectations, but the inflation forecasts are now rising and there is a question of RBI doing two more rate hikes. It does seem that all of this could impinge on growth and  could feed into inflation in one way or the other given where crude prices. What does this mean for growth? If the rupee were to go to Rs 70-72 against a dollar, where it could be valued fairly, what impact would it have on the macro then?

In our imbalances, we talked about the external imbalance. I think there is also a growing internal imbalance while the overall fiscal deficit might not be worrisome, the quality of the fiscal deficit is not looking great. Even last year we saw the revenue deficit move up quite sharply, from 1.9 percent to 2.6 percent, whereas the actual capital spend came down in rupee terms not just the degrowth. It was a degrowth and not just a reduction in growth. And that trend unfortunately continues even this year where we are going to see more spending on MSPs, probably see the subsidies for fuel going up and probably sell more family silver to fund current expenses. The quality of fisc is not looking great. Our banking system is not looking great and we are kicking the can down the road as of now on the banking issues as of now. And overall global context with Mr. Trump tweeting something or the other every day is not looking great, either.

When you put all this together, the macros are not looking great at all for the country. In fact, they are worse off now than they were a year ago. That does not mean that the micros will look bad. Normally, when you have a fiscal expansion happening, it is normally good in the short-run for the micro companies. Look at the MSP for instance. I am sure a lot of companies will expect higher rural spending to happen and therefore improve their bottom-line. In a funny way, you could have worsening macros co-exist with improving micros for a while but in the long run the macros do matter a lot more. Unfortunately, as things stand right now, we are in a situation of imbalance which has to correct somewhere. We do need the external balance to correct, we do need the quality of our fisc to improve, and we do need to solve our banking problems and then pray hard that the rest of the world falls into place as well.

On the rupee valuation, it is not a question of where the rupee is rightly valued. Who knows that? Valuation is a different exercise all together. It is a question of at what value does the balance look a lot more sustainable. It is not about saying ‘this is where it should be and at current levels, clearly, we are borrowing short term money to pay for our oil, gold and for our smartphones. That is not a sustainable balance. You cannot borrow fickle money to pay for short term expenses. That is not how a household runs and that is not how a country should run.

Do you expect the RBI to see it the same way? So, should we now expect any aggressive intervention even if we were to move all the way to Rs 70?

The RBI has intervened already. I reckon they have intervened about $25 billion since April of this fiscal year. Now, obviously the RBI has its own thinking and they do not have an explicit - rupee policy besides the vague statement. They do not look at levels and only target volatility and some unstated measure of volatility.It is fair to assume that Delhi would want at some stage for the rupee to not weaken too much. It is a fair point. Let’s be real, there is real politic involved in this as well. You don’t want headlines on the rupee in an election year. So that might be weighing down on the whole eco- system as well.

But left to itself, I think the RBI would be very, very concerned about the financial stability situation. Make no mistake, this not a dire situation. We still have plenty of reserves, good growth prospects for the future. But as a conservative central bank, they have to prepare for the worst and they would look at the financial stability and saying this is not the time to be lax and complacent. So, yes, the monetary policy will have the pressure of being more conservative than complacent and being preemptive. They will not want to fall behind the curve in the current context.