The Sunday Times Economic Analysis                 By the Economist  

Continuous fall of Rupee
There is considerable concern about the depreciation of the Rupee and its consequences. What has attracted public attention has been the Rupee value of the dollar crossing what has been described as "the psychological barrier" of one hundred. For sometime the value of the dollar was hovering around Rs.100.It edged to more than one hundred rupees to the dollar about two weeks ago.

Now there is fear that the depreciation of the Rupee might gain momentum. Interventions in the market by the Central Bank are expected to restrain this trend. However, ultimately it is market forces that would determine the extent of further depreciation of the Rupee. The performance of exports, imports and net capital flows would determine the pressure on the Rupee.

The Rupee has been depreciating for the last 26 1/2 years from November 1977, when it was devalued from about Rs.5.95 to the US dollar to Rs 16 to the Dollar.It reached about Rs 76 to the dollar at the end of 2000, Rs. 89 at the end of 2001, Rs 96 at the end of 2002 and Rs 96.52. at the end of last year. This week its buying value had reached around Rs. 102 to the US Dollar. The Pound Sterling was Rs 187.

The underlying reason for the depreciation of the currency is the balance of payments difficulties. The rise in price of crude oil imports created a severe strain on the trade balance and is likely to result in a balance of payments deficit this year. This is despite an export growth of about 14 per cent in the first four months of this year.

The fundamental issue is whether the depreciation of the currency would correct the balance of payments problem. Our import -export structure makes it very unlikely that we could correct the current balance of payments problem through depreciation.

The nature and character of our imports and to an extent our exports make it unrealistic to expect an improvement in our balance of payments in the short run. That is why, despite the continuous depreciation of the currency, we have had trade deficits every year since 1978. We have also had a deficit in the current account of the balance of payments in most years. In some years, the capital inflows have offset this deficit. For instance in the last three years, despite sizeable trade deficits we have had an overall surplus in the balance of payments.

The inflow of capital may also dwindle this year owing to the halt in the peace process, political instability, and lack of clarity and certainty in economic policies. Therein lies the anxiety that there would be a continuous depreciation of the Rupee.

The depreciation of the currency will not solve this problem to any appreciable extent. The increase in the price of imports as a consequence of the depreciation will not reduce imports. Export earnings are expected to rise through increased export volumes. However, these expectations are not likely to materialise owing to the structure of our imports and exports. The main consumer imports do not give much hope for a reduction in imports. It is unlikely that wheat flour or sugar imports would be drastically curtailed owing to higher prices, as they are essential consumer items. In any case, the total expenditure on consumer imports is small (22 per cent in 2003) compared to the imports of intermediate and capital goods.

The bulk of our imports are raw materials or intermediate goods. These account for over one half of our imports. Most significant among these are imports of textiles for the garment industry, crude oil imports and raw materials such as chemicals for our manufactures. Last year textile imports constituted 36 per cent and oil imports 22 per cent of total imports and oil imports increased owing to higher crude oil prices.

Import costs of oil are much higher this year. Since the government has decided to stabilise oil prices by a subsidy, neither the rise in import costs nor the depreciation of the currency will lead to a curtailment of crude oil imports. Similarly, other intermediate or raw material imports too cannot be curtailed, as they are vital for our manufactures and agriculture.

The prospects of increased earnings from exports are better. This is especially so with respect to our manufactured exports. The depreciation of the currency is likely to reduce export prices that would give exporters a competitive edge that could increase export volumes. However, there must be an increase in export volumes sufficient to compensate for the reduced dollar prices and be in a position to increase the supply of the exports to compensate for reduced dollar prices. These gains could be limited owing to the high import content of our industrial exports. The devaluation would increase the costs of production of most exports through higher input costs and possibly increases in wages necessitated by the higher living costs.

It is optimistic to expect a large increase in exports or a significant curtailment of imports through the depreciation of the currency. The danger in a continuous currency depreciation is that it could set off a spiraling inflation, which itself could wipe out any advantages that the depreciation may have in the short run. The incapacity of the government to respond to this crisis and take timely corrective measures, as well as poor governance, have sapped it of international credibility. The continuing depreciation of the Rupee is a huge cost to the community as prices of essential consumer items are likely to keep rising. The government's attempt to put a lid on prices is only a short term palliative.

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