Event ReportsPublished on Jul 06, 2013
Theoretically the rupee cannot be traded because there is no capital account conversion for it. However many countries such as Singapore and the US sell the Indian rupee. This speculation pushes up share markets and plays around with exchange rates, according to a former Revenue Secretary.
Reasons for rupee depreciation more complex: Former Revenue Secretary
The Chennai Chapter of Observer Research Foundation organised a discussion on the 'Indian Rupee' on July 6, 2013. The interaction was initiated by Mr M R Sivaraman, former Revenue Secretary of the Government of India. Focussing on the 'less discussed aspects' of foreign exchange rate problems, Sivaraman detailed how the Indian rupee which was on par with the dollar (1:1) at the time of Independence has been sliding consistently, hitting a new low of ' 60 this year.

Sivaraman then analysed the importance of the foreign exchange market, with a daily turnover of $4.5-5 billion. India, he said, wasn't exposed to the vagaries of this external market before it opened up. He further explained how there was a tendency to under-value exports and over-value imports in economic terms. The country's GDP in 1998, for example, was undervalued by 40 percent.

Sivaraman also quoted statistics on the trade-gap, which is well over $100 billion, and gold accumulation, estimated between 25-40,000 tonnes, both of which distort the exchange rates. There has also been a depletion of foreign exchange reserves from $ 313 billion to $ 288 billion this year. He then examined some of the rupee- depreciation theories, namely, the Purchasing Power Parity theory, Asset Market approach, Covered Interest Parity and Fundamental Equilibrium Exchange Rate.

Purchasing Power Parity (PPP) was introduced in 1914 by Swedish economist Gustav Cassel and deals with the law of one price, ie, a commodity should be priced equally in every country. However, it doesn't take into account the differentiation and the variation that is available in the product market now. Under the PPP theory, bundles of goods are taken and compared across countries. The PPP became an important tool that changed the way development was measured.

The second theory Sivaraman delved into was the Asset Market approach. The Asset market deals with the demand and supply of assets in a country. However there are many real-world factors that affect these markets. In India, for example, a change in the law that allows companies to snap up their own shares, limits share-availability in the market for other investors.

In India, he said, a variety of decisions affect the asset market. Most people prefer to hold money rather than investing it in the market. Autonomy for regulators, speculation in the market, speed of judicial decisions and the political environment can all deeply influence the asset market. It is thus a dicey tool for judging the exchange rate. Therefore he surmised, the asset market isn't a perfect tool for estimating exchange rates.

The third exchange rate theory that Sivaraman elaborated was the Covered Interest Parity. Under this, the exchange rate is determined by the interest rate in both countries. If the interest rate varies between two countries, money will flow from the low-interest country to the high-interest one.

The final theory Sivaraman explained was the Fundamental Equilibrium Exchange Rate. Formulated by Nobel Prize winner James Meade in 1951, it explains how both natural and accelerating rate of unemployment can affect the exchange rate. In October 2012, the Indian rupee market rate was 53.4 per dollar. However the equilibrium exchange rate was 52.4. Hence it is clear that the rupee was under-valued.

All the years since the rupee was pegged to the dollar, it has depreciated except for a period when it appreciated. "There was apprehension that the rupee would appreciate to 30 per dollar but it was avoided because of inflation," he added.

Sivaraman also spoke about how technology impacts exchange rates. Economist Paul Samuelson came out with a theory that when a country isn't technologically developed, it has low productivity, a low price level and hence a low exchange rate. Technological improvements will lead to increased productivity, wages and exchange rates. He also said that if one took into account fundamental economic factors, the Indian rupee should appreciate. However the exchange rate is not based on just pure economics but other factors as well.

Sivaraman elucidated on India's financial specifics too. In 2002, the country had a current account deficit slightly above one percent of the GDP. In 2013, that has ballooned to almost five percent of the GDP. India also depends heavily on deposits from NRIs, who invest to the tune of $65 billion a year. After the financial crisis, there was a scramble among NRIs to withdraw money and this affected the economy.

He explained India has to reduce its interest rates, which is one of the highest in the world, to increase competitiveness. He also added that the rupee was an odd currency which adds to the exchange rate vagaries. Theoretically the rupee cannot be traded because there is no capital account conversion for it. However many countries such as Singapore and the US sell the Indian rupee. This speculation pushes up share markets and plays around with exchange rates.

Sivaraman said that in the last few years, world currencies have been moving in a surprising direction. Based on economic fundamentals, the euro should have risen while the yen fallen but the reverse happened. However some recent policies such as a ban on gold imports may substantially improve India's current account deficit. He also cautioned that with India one can't simply study the current account deficit of the Centre alone because many States have current account surpluses.

The discussion session too was informative. When asked whether India was losing by linking the rupee only to the US dollar instead of a basket of currencies, Sivaraman explained that the dollar was one of the most stable out of all the currencies nowadays. With regard to interest rates, empirical studies found interest rate differentials play a big part in exchange rate.

Sivaraman also explained debt repayability and how the Indian rupee was the worst performing currency in Asia. Indonesia, China and several other countries all have stable currencies. This is despite a country like China having 70 percent of its FDI deposits from Chinese abroad as compared to India's tiny 10-12 percent from NRIs. He reiterated time and again how the Indian economy was much larger than reported. Service activities in particular are underreported.

Sivaraman said the problem with the country today is that the Government is populated with 'I think' or 'You Know' economists while what she actually needs are the 'I will do this' people.

(This report was prepared by Karthik Shankar, II Year, BA Journalism & Mass Communication, S R M University, Chennai)

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