Concerns with Rupee depreciation

Why in news?

The Union government announced a list of measures to arrest the sharp decline in rupee recently.

What are the measures proposed?

• Imports - Steps would be taken to curb the import of non-essential goods and encourage the export of domestic goods to address the rising current account deficit.
• The non-essential import commodities will be decided after consultations with concerned ministries and will be WTO-compliant.
• FPI limit - Restrictions will be removed with respect to FPI exposure limit of 20 percent in corporate bond portfolio to a single corporate group or company or entity and 50 per cent of any issue of corporate bond.
• Masala Bonds - Indian borrowers will be encouraged to issue rupee-denominated ‘masala bonds’ to facilitate the inflow of dollars and de-risk the economy from fluctuations in the exchange rate.
• Also, the current withholding tax of 5% on Masala bonds issued till March 2019 and the restrictions on Indian banks on marketing and under writing of masala bonds would be removed.
• External commercial borrowing[ECB] – The manufacturing entities will be permitted to avail ECB facility with minimum maturity of one year, instead of the earlier limit of three years.

What are the fundamental reasons behind the decline of the rupee?

• Devaluation – It generally decreases the price of exports in foreign countries and provides a boost to exports by making them more competitive.
• Correspondingly, volume of imports in the domestic economy would be reduced by makingimports more expensive.
• But since several countries are devaluing at the same time, India is neitherbenefitting from their exports being cheaper abroad nor will there be a huge fall in imports.
• Alternate Energy –Failure in finding sustainable domestic sources of energy to address the over-reliance on oil importscreates tremendous stress on CAD.
• Inflation - The depreciating rupee is also a symptom of persistently higher domestic inflation in India.
• For instance, the rupee has lost about 60% of its value in the last 10 years against the dollarin line with vastly different inflation rates between the two countries.
• Ripple effects – Crude oil price hikes increases the cost of transportation of goods being transported by road, including food items, it creates ripple effects on rising food inflation in the country.

What can be done to overcome this?

• A long-term plan to remove policy barriers in the promotion of export oriented sectors needs to be framed.
• Excise duties could be lowered by the Central government when crude oil prices get high, so does the state governments in the form of VAT.
• The RBI could offload large amounts of dollars and increase its supply to check the appreciation of the dollar.
• Also RBI’s intervention in the foreign exchange market from time to time to manage a soft landing for the rupee has to be continued.
• A well thought out rate increase by MPC should be carried out since it could make FPI’s pull out of Indian stocks and affect the profitability of companies.
• Borrowing from NRIs by floating special NRI bonds with maturity periods of at least three years could also be made to address investment outflow.
• Thus, though the government has tried to incentivise debt creating capital inflows through its proposed measures, it does not augur well for the economy in the medium- to long-run.

Source: The Hindu