The rupee-dollar exchange rate has seen a sharp depreciation in the last few days. Is this trend expected to continue in the future? Does it signify a sudden crisis in the Indian economy? Should the government and the Reserve Bank of India do something drastic?
Anyone who is even vaguely familiar with foreign currency markets knows that exchange rates are not exactly market-determined. Most central banks use their own foreign exchange reserves to calibrate the movement of their currency against the US dollar. Sharp movements in exchange rates, barring extraordinary crises, are a result of central banks taking a relatively hands-off approach. To be sure, central banks cannot “manage” exchange rates infinitely, as their foreign currency reserves are finite.
This is not to say that RBI’s recent actions (or lack of it) alone explain the rupee’s latest slide. Multiple factors have laid the ground for this deprecation. The dollar, especially after the Federal Reserve increased interest rates last week, has been gaining vis-à-vis almost all major currencies. The dollar’s relative value is an exogenous factor which shapes exchange rates in almost all major economies in the world. To be sure, not everything about the falling rupee is unrelated to the Indian economy. India’s trade deficit has risen significantly and is expected to rise further. This has put pressure on the rupee.
Should the finance ministry and RBI hit the panic button? Not yet. Foreign exchange reserves continue to be adequate and there is no crisis of confidence in the economy.
What the government and RBI will have to balance though is the optics of their actions to protect both domestic growth and the stability of the external account. The forthcoming Monetary Policy Committee meeting of RBI will be the first demonstration of this balancing act.
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