With the rupee under pressure, what next
- Currency depreciation is a fall in the value of a currency in a floating exchange rate system.
- In simple terms rupee depreciation means that the rupee has become less valuable with respect to the dollar.
About Taper Tantrums:
- In 2013, the US Federal Reserve decided to reduce (taper) its quantum of a bond-buying programme that led to a sudden sell-off in global bonds and stocks.
- As a result, many emerging market economies, that received large capital inflows, suffered currency depreciation and outflows of capital.
- This became globally known as a ‘taper tantrum‘.
What are the causes for depreciation:
The rupee is falling on account of two factors.
- The first is the widening current account deficit, mainly owing to the rise in the price of oil triggered by the Ukraine war.
- And the second is capital outflows, driven by a strengthening dollar on the back of aggressive rate hikes by the U.S. Federal Reserve.
How the situation is different from taper tantrums of 2013:
- There was pressure built up in the exchange rate during 2013 whereas the exchange rate today is tracking fundamentals more closely.
- Second, India’s macro situation back in 2013 was fragile because of year-on-year high fiscal and current account deficits.
- Most importantly, India’s current foriegn reserves inspires confidence that India lacked at that time.
- India’s monthly trade deficit appears to have come off the peak, and capital flows are stabilising.
- The price of oil which was rising above $100 for a barrel has come down to $88 per barrel.
What are the concerns
- By far the most important vulnerability stems from the current account deficit (CAD) which is expected to widen to above 3% of GDP this year, higher than 2.5% that the RBI considers to be the safe limit.
- While India can withstand a one-off overshoot of the CAD beyond the safety zone, but there can be no assurance that it will go down soon since the Fed is seemingly committed to maintain the hiking rates until inflation in the U.S. is tamed.
- Another major cause of India’s vulnerability is the fiscal deficit.
- Even though the government has been trying to implement fiscal consolidation, the combined fiscal deficit of the Centre and the States is still above 10% of GDP.
The silver lining:
- The current crisis is not just an Indian problem but is a global problem.
- Also it must be noted that that the rupee has fallen much less than most currencies, including hard currencies such as the euro and the pound.