In the middle of 2002, a US dollar was equivalent to 49 rupees. Comes May 2007 and dollars comes down to around 40 rupees. In the last five years rupee is constantly getting appreciated. In the past initially due to the devaluation and later due to so called forces of the market were making the rupee weak. We must keep in mind that though the rupee has appreciated vis-a-vis all other international currencies, but it has appreciated more with respect to US dollar.
In the past our balance of payment has always been in deficit, due to which there has always been a shortage of foreign currency. This meant more demand and less supply of dollars, which was making the rupee weak. We had to shed more and more rupees for every dollar. In the last few years our balance of payment has turned into surplus. Unprecedented increase in IT exports, remittances from Non Resident Indians and capital inflow (FDI and FII) have been the main reasons for balance of payment turning into surplus. As a result of all this our foreign exchange reserves started overflowing and reached near 300 billion dollars. Appreciation in rupee vis-a-vis dollars was an obvious outcome of fast rising foreign exchange reserves and thereby increased supply of dollars.
For the last few months the process of decline in value of Indian rupee has again started. Rupee has depreciated to around rupees 50 per UD dollar (exchange rate even reached rupees 52 per US dollar some time back), after reaching rupees 39 per dollar in May 2007. In the past decline in value of Indian rupee has been basically due to adverse balance of payment on current account. But in the present circumstances it is not due to this reason. In fact the last few month have seen an unprecedented outflow of foreign exchange by foreign institutional investors. This has happened due to the unprecedented shortage of liquidity in their own countries as a result of recessionary situation globally and in developed countries particularly.
Theoretically depreciation of rupee may bring about an increase in value of exports and decrease in value of imports and thereby could potentially solve the problem of balance of payment. But theory also puts a condition on this remedy. There condition is known as Marshall-Lerner condition. According to this condition depreciation of home currency could solve the problem of deficit in balance in payment provided price elasticities of demand of imports and exports are sufficiently high, such that their sum total exceeds one.
Under the situation value of Indian exports may rise if price elasticity of Indian exports to the rest of the world is high (more than unit). If history is any guide we find that devaluation of rupee has never brought about any significant increase in exports. Our experience has been such that depreciation of rupee has never given any relief in the balance of payment situation. Rupee was first devalued in 1966, but our balance of payment situation continued to remain grim. In the decade of 1990s, rupee was made to depreciate again, but our trade imbalance, instead of declining continued to increase. This happened because the condition as set forth by Marshall and Lerner about elasticities of demand of exports and imports could not be fulfilled. In 1990-91. Our trade deficit was US $9438 crore, which increased to US $63171 by the year 2006-07. In fact unprecedented rise in exports of software and call centre services helpful in keeping our balance of payment deficit law. But this is also a fact that depreciation of rupee could neither reduce value of imports nor increase the value of exports significantly. In fact software sector came to the rescue of the nation. If exporters are happy due to depreciation of rupee it is only for the reason that they expect greater profit as same amount of dollars would bring more rupees to their kitty.
But our national policy should not be guided by interests of any particular section. If we look at our imports we find that price elasticity of demand of imports is very low, as our imports constitute mainly of petroleum products, raw diamonds, essential imports of machinery and defence goods. Demand for such goods is not very elastic. Thus we can not expect any fall in their demand as rupee depreciates. Therefore as a result of depreciation of rupee our oil import bill in rupee terms would get inflated. This would affect our domestic cost of petroleum products and thus would escalate our cost of production as well as cost of living. This may also cause deterioration in our competitive strength internationally.
Under the circumstances there is a need to ensure stability of rupee by stalling further depreciation of rupee and ultimately strengthen the rupee. It is surprising that though the US economy is receding, the value of its currency is appreciating. In fact major cause of depreciation of rupee is large scale outflow of foreign exchange by the foreign institutional investors. In the last few years FIIs have been responsible for large scale upheavals in the exchange rates. But the Government has not been able to control these FIIs in absence of regulatory mechanism. Many governments (including China) all over the world have been trying to keep in the value of their currencies intact. India also needs to adopt suitable measures to regulate FI. We can impose a minimum lock in period for investments made by these FIIs. Further by imposing tax on repatriation of profits may also be helpful in discouraging out flow of foreign exchange by these investors.
