Inflation is taxation without representation

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The Indian rupee, which was on par with the American currency at the time of Independence in 1947, has depreciated by a little more than 65 times against the greenback in the past 69 years.Every country exports and imports for its survival. As long as this equation of imports versus exports is balanced, it is good for the nation. But when imports become more than exports, the value of the currency starts declining. The country needs more from other countries while it has little to offer them in return. Indian goods are bought with Indian rupees. Hence if the demand for Indian goods falls, consequently the demand for Indian rupee also falls. 

India has dual challenges. While the demand for Indian goods seems to be waning due to export slippage, India continues to import crude (petrol/diesel) and other imports vital for the economy at high international commodity prices and an inelastic demand for gold and silver. Therefore, the demand for the dollars continues to be high. This situation puts further pressure on the Indian rupee, widening the current account deficit. 

What is the immediate fallout of the rupee depreciation? The price of petrol has gone up substantially. Also the price of diesel and LPG could spike. When the price of basic necessities goes up, the inflation goes up. As we have a current account deficit, rupee depreciation has an inflationary impact. Companies which are dependent on raw material imports or have imported components could see profitability and market capitalization take a beating. This is because its profitability may get hit by higher input costs.Foreign travel is set to get costlier. One would have to keep more rupees in hand to purchase dollars to fund foreign travel.Studying in foreign universities may get costly. This is the same in case of foreign travel; more rupees would be needed to funding foreign education.Several electronic goods which depend on imports and royalty payouts may get more expensive. On the other hand,NRIs and exporters are having an advantage as they can be expected to remit more dollars because they would get a higher price. Companies like IT software, Pharmaceuticals and BPO would gain from the dollars that they earn by providing goods and services abroad.

The devaluation of the rupee is inflationary in nature as we are net importers. There is a need for the Government to devise policies and tools to stem the fall of the rupee. In this context, it is important to examine the tools, both in terms of short as well as long term. Government can buy Indian Rupees from the foreign exchange market by selling its dollars. This would however reduce the foreign exchange reserves which are needed to fund our imports and hence is not considered as a sustainable solution for long. Government can mandate banks to increase their Cash Reserve Ratio and Statutory Liquidity Ratio which means banks would have to deposit morerupees with the Reserve Bank. Alternately, the central banks can issue bonds to the public. By these measures, the central bank would reduce the liquidity in the system and try and make the rupee dearer. However, these measures have the effect of increasing interest rates which hurts profitability of companies and thus adversely affects economic growth. When economic growth gets limited, the production of goods and services too gets unfavorably impacted giving rise to inflation.

The Government can ask companies who have dollar accounts to bring dollars back into the country and convert them into rupee accounts. This would increase demand for the rupee which in turn would stem the slide of the rupee. The Government can make it easier for companies to borrow in dollars from abroad. Companies would get more rupees for every dollar borrowed. This would help them finance their working capital requirements. If the rupee regains its strength over a period of time, the borrower could return to lesser rupees. However, if the rupee further slides, then business would be at a disadvantage. Hence businesses would take this route based on their outlook of the rupee.

The Government can attract NRI dollar deposits by offering attractive interest rates. It can also reschedule / delay in paying off its dollar debts with the hope that the rupee would regain strength subsequently. Thus at a later day, lesser rupees would have to be coughed up to repay the debts.Government can liberalize foreign investments in insurance, aviation and retail, infrastructure sector, agro-based businesses as well as reduce subsidy in various sectors. This would be one of the best moves as it would bring in serious long term money from abroad. The Government could frame policies to restrict the import of gold by raising custom duty and thereby making investment in gold less attractive.They could action some long standing economic reforms to induce both domestic and international investments. This would help in increasing production and productivity of the economy. Higher production along withproductivity would help in increasing supply of goods and services and thereby reduce inflation. This would be a better and sustainable method for tackling both the rupee crisis as well as inflation. Economic reforms would bring in “Foreign DirectInvestment”. Economic growth can improveinvestor confidence thus ultimately bringingback a higher trajectory of GDP growth.

 

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