Ashwani Mahajan
The last five years have seen the rupee constantly appreciate in value. In the past, initially due to devaluation and later due to the so-called market forces, the rupee was weak. Our balance of payment used to be in deficit due to which there was always a shortage of foreign currency. This meant more demand and less supply of dollars, which made the rupee weak. We had to shed more and more rupees for every dollar. But in the last few years our balance of payment has seen a dramatic turnaround. Unprecedented increase in IT exports, remittances from Non-Resident Indians and capital inflow — from FDI and FII — have been the main reasons for this. As a result our foreign exchange reserves started overflowing and reached nearly 300 billion dollars, and the appreciation of the rupee vis-à-vis the greenback was an obvious outcome.
However, in the last few months the value of the rupee has started declining again. In fact, it has depreciated to around Rs 50 per dollar from Rs 40 in May 2007. This is because of the unprecedented outflow of foreign exchange brought on by the decision of Foreign Institutional Investors to pull out. This in turn has happened due to the shortage of liquidity in their own countries as a result of the global economic downturn.
Theoretically, depreciation in the value of the rupee may bring about an increase in the value of exports and decrease in value of imports, and thereby, could potentially solve the problem of balance of payment. The value of Indian exports may rise if the price elasticity of Indian exports to the rest of the world is high. However, if history is any guide we find that devaluation of the rupee has never brought about any significant increase in our exports. On the contrary, it has never given us any relief in the balance of payment situation.
Therefore, under the circumstances there is a need to ensure the stability of the rupee. Since the major cause of depreciation is the large-scale outflow of foreign exchange by the Foreign Institutional Investors, it is this that needs to be tackled. But the Government has not been able to do anything in the absence of a regulatory mechanism. Many foreign Governments — including that of China — have been trying to keep the value of their currencies intact. India also needs to adopt suitable measures to regulate FIIs. We can impose a minimum lock-in period for investments made by these investing institutions. Further, imposing tax on repatriation of profits may also be helpful in discouraging the outflow of foreign exchange.
