Former Deputy Chairman of the Planning Commission of India Montek Singh Ahluwalia on Friday endorsed a policy of allowing the rupee to depreciate against the dollar in line with the market conditions, cautioning that attempts to artificially keep the currency up could weaken the economy further.
He also called for policies that will support capital inflows, given the weakening of capital account surplus over the last two years, and called for faster commercial dispute resolution and removal of arbitration hurdles to inspire confidence among foreign investors.
Speaking at the Indian Express Idea Exchange, Ahluwalia also said India must seriously consider joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership.
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The rupee has fallen 7% against the dollar since January this year, with sharper depreciation in the current month than in the previous two. It closed at 95.69 on Friday.
Ahluwalia said that the current rupee movements are correcting an earlier mistake when authorities used reserves to prevent the currency from weakening, and that’s the reason why the latest fall is steep. “The appreciation that took place in the previous years, I think it was a mistake. We were using currency reserves to prevent depreciation. Had we allowed the market process to work (then), I don’t think we would have seen such a large shock,” he said.
Twin Challenge
Ahluwalia said that India now faces a twin problem of a widening current account deficit (CAD) and weak capital inflows. He said higher crude oil prices, geopolitical tensions and supply disruptions could push India’s CAD to around 2.5% of GDP in the current financial year.
“Till recently, we had a CAD of around 1%. Thanks to the rising oil prices, that deficit will certainly become 2.5%. In the past, the CAD was financed by capital account surplus. In the last 2-3 years, the capital account surpluses, including foreign direct investment (FDI) and portfolio inflows, have come down, and are now virtually zero. A 2.5% CAD coupled with weak capital account surplus will put more pressure on the rupee unless we want to use up the reserves,” he said.
Ahluwalia maintained that India’s forex reserves remain comfortable enough to absorb moderate current account pressures. With reserves around $690 billion, he said, India could “easily” finance a 2% CAD. “It’s not a bad idea to let the market determine (the rupee’s value). If the market pushes the rupee above 100, at some point people will say that this is overdone,” he said.
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Resolving Legal Hurdles
Ahluwalia noted that the problem is not particularly about the deficit itself but the policy environment surrounding FDI, which is far from satisfactory. Ahluwalia said that weak FDI inflows result from concerns among global investors over commercial dispute resolution and arbitration hurdles in the country.
“A key risk for foreign investors is that if they get into a commercial dispute with their Indian partner, it can take 20 years to resolve. If the dispute involves Indian government, even if they win in the lower court, the government will never agree, and they will go all the way to the Supreme Court which will take 15 years,” he said.
The veteran economist noted that the recent free trade agreements (FTAs) signed by India were steps in the right direction, though their impact on the actual exports would take time to materialise. He also said that even though India missed a “golden opportunity” to join the Regional Comprehensive Economic Partnership (RCEP), “we must seriously consider joining the CPTPP.”
“We need to think about East Asia. It is already the center of economic gravity for the world. If we are concerned about China, then we should just apply to join the CPTPP because it doesn’t include China, and it’s a major East Asian block. We should get in early before they change their mind. Broadly, we need to remain open, and I think it’s good to have a weak exchange rate,” he pointed out.
TOPICSrupeeRupee vs us dollarThis article was first uploaded on May twenty-two, twenty twenty-six, at forty-nine minutes past seven in the evening.