While trade flows affect the country’s current account balance, it is capital outflows that really hammer the rupee
There is no reason to believe that the rupee’s value is determined by the price of gold or crude oil in the international market, but it moves inversely with the prices of gold and oil and acts subservient to the US currency.
There is also no substance in the claim that a falling rupee will boost export revenues and thereby incentivise trade flows from the country.
The Indian currency, which has been on a par with the British pound and the US dollar, has been falling ever since the British left Indian shores. But this has only boosted India’s imports, which continue to far outstrip its exports!
The reason is that the western influence on Indian lifestyle has been far greater than anyone can fathom – the craze for anything foreign is the lifeblood of the Indian consumer.
And with more than 5,000 import-export companies in the country, Indians continue to enjoy the fruits of other peoples’ labour, employing all available resources, including whatever goods and services it can offer in return.
At least until recently, India used to import everything from bamboo sticks for making agarbathis (incense sticks) to jet engines and atomic reactors.
While this trend witnessed some change due mainly to government initiatives, Indians’ fad for foreign goods and precious metals like gold has not faded.
Government raised basic import duty on gold from 7.5 per cent to 12.5 per cent effective 1 July to disincentivise imports. But this has only helped to raise god prices in India while leaving imports unaffected.
In June this year, India imported 49 tonnes of gold valued at $2.61 billion, compared with 17 tonnes valued at $969 million a year ago.
However, India's overall gold imports were lower at 335 tonnes in the first half of 2022 against 493 tonnes last year.
If the trend continues, gold prices are likely to revisit their recent high of Rs55,000-56,000 in the medium term. Any surge in gold imports will continue to put pressure on the country’s current account deficit
The demand for gold like that of crude oil and coal is price inelastic, and this in part adds to the country’s overall import bill.
God and crude oil are not the only culprits. India’s imports of goods other than petroleum and gems and jewellery rose 38.30 per cent to $38.53 billion in June 2022 while exports of goods other than petroleum and gems and jewellery in June 2022 were valued at $27.94 billion, showing a growth of 8.65 per cent year-on-year.
Overall merchandise imports into the country expanded by 57.55 per cent to $66.31 billion in June 2022, while exports from the country increased by 23.52 per cent to $40.13 billion during the month, leaving a trade deficit of $26.18 billion.
While the trade deficit puts pressure on the country’s current account, it is capital flows into and out of the country that plays a major role in deciding the rupee value.
This also means that the US or any hard currency country can buy cheaper in India and, perhaps, export inflation to this country.
Indian rupee, the third-worst performer in Asia in the past month, weakened beyond 80 as foreign investors continued to pull out of Indian markets, including stock markets, amid rising interest rates in the US (but the US interest rates are nowhere near India’s rates). And, as investors continued to exit local markets total capital outflows from the country rose to almost $29 billion so far this year.
The timing of the pull-out is also critical as it plays havoc with the spot market for foreign currency.
What the economy badly needs is a mechanism to arrest sudden outflows of capital – something like a lock-in period for capital invested.
Capital market regulators should have a mechanism to regularly monitor the exit pattern of foreign investors and frame investment policies accordingly, so that investment flows do not affect the functioning of foreign exchange markets.