Let it fall

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When the uncertainty over the economic disruption caused by the coronavirus begins to recede, and economic activity begins to crawl back in, global funds will start flowing back towards emerging markets, including India.

With continuing uncertainty over the spread of the coronavirus and its economic impact, there has been a sell-off globally in risk assets as investors are seeking refuge in safe haven assets such as the dollar. Most emerging market currencies have fallen in this period, and while the Indian rupee has also fallen, it has fared relatively better than others. On Thursday, the rupee ended the day at 76.29 against the dollar, after touching a low of 76.54 during the day. Since March, the currency has fallen by around 5 per cent against the dollar. In comparison, over the same period, the Mexican peso has fallen by 26 per cent, the Brazilian real by 17 per cent, the Indonesian rupiah by 14 per cent, and the South African rand by 18 per cent. The Indian currency has fared relatively better despite a massive sell-off by foreign investors — FIIs have withdrawn around $14 billion in March. This situation is in stark contrast to the 2013 period when all emerging market currencies, and the Indian rupee in particular, fell sharply on account of talks of the US Federal Reserve slowly putting the break on its quantitative easing programme.

Through this period, the Reserve Bank of India (RBI) has been actively intervening in the currency markets. Foreign exchange reserves fell by $10 billion in the week ended March 20 — indicating the extent of the intervention. Presumably, the intervention was aimed at slowing down the pace of the rupee’s fall in order to prevent a self-fulfilling cycle. But, notwithstanding the intervention needed to iron out excess volatility, the evidence suggests that the Indian rupee continues to be overvalued and should be allowed to fall. The RBI’s 36-currency export-based real effective exchange rate (REER) stood at 119.47 in February, indicating significant overvaluation. The currency’s recent fall, to that extent, corrects for this overvaluation. But as the continuing overvaluation of the currency affects the country’s export competitiveness, this needs to be addressed.

When the uncertainty over the economic disruption caused by the coronavirus begins to recede, and economic activity begins to crawl back in, global funds will start flowing back towards emerging markets, including India. This would exert upward pressure on the rupee. While the RBI’s stated policy is that it does not target any particular level, at a time when countries will be fighting to grab export market share in order to boost growth, the central bank must ensure that the currency’s value does not affect the country’s export competitiveness.