The recent sudden increase in dollar value of rupee ruffled quite a few feathers. At least, my roomies who regularly send money to India have lost their sleep. In last month or so, the Rupee value of Dollars decreased from around Rs. 44 to Rs. 40. It means, Rupee is getting costly. There are bunch of reasons behind it. Most of the people believe that monetary policy is solely responsible for this hike but it is much more complex. And, getting perceptive on this issue will help us to understand the rising inflation in India too. If Government Of India failed to act on either inflation or on rising rupee, the over heated Indian economy will come to screeching stop. Of course, the effects won’t be too pleasing !
India became a service sector giant in last few years. More than 50% of India’s GDP is contributed by service sector. Instead of making standard transition from agricultural based economy to industrial and then to service sector, India jumped straight from agriculture to service sector. Thus Rupee is in heavy demand in international market as India’s exports of services are rising. Also, Indian expatriates are sending unprecedented amount of money back to their home land. That’s why Rupee is getting costlier i.e. it is taking less Rupees to buy a dollar. But if Rupee becomes costlier then we will loose our export advantage. For example, it will be expensive for American software companies to outsource to India and they will scale back on outsourcing if Rupee continues to gain strength. But populist policies is forcing Government of India to making Reserve Bank of India (RBI) to put more money in the market and dilute the Rupee value. It was doing that for all most an year but such forced treatment on an all ready sick patient is surely going to have awful side effect. So, we have rising inflation as there is more supply of money than demand.
In short - : As India’s exports are rising (service sector) Rupee value increasing in international market and to keep it artificially down RBI is printing more money which in turn is increasing inflation.
But recent increase inflation can’t be attributed solely to the lax monetary policy. Sustained GDP growth of last 25 years or so is more related to internal consumption than export based economy. There are various reasons for continuing increase in internal consumption. Of course, easiest of them is huge population. But other reasons are quite subtle India’s middle class is burgeoning and their apatite for luxurious goods is increasing rapidly. In the mean time, India is slowly catching up industrialization too. All though, government is waking up slowly to the realities of shabby infrastructure, the projects such as golden quadrangle road is consuming lots and lots raw material. But sadly, the supply side is unable to keep up with this rapidly rising demand. The second step of green revolution never took place. Hence, rising population is straining food supplies. Rigid labor laws and strict government control stunted the manufacturing industries. And now they can’t provide enough of cement, steel or tar. Thus inflation has more to do with demand than monetary policy.
All these signs are pointing towards over heating of the economy. Instead of loosening the bottle necks of the economy, government, admittedly because of useless leftist parties, is forcing more and more populist policies down economies throat. We need more fuel to keep economy running at this pace otherwise it is fast hurtling towards some serious trouble.
4 comments:
the statement ...." That’s why Rupee is getting costlier i.e. it is taking less Rupees to buy a dollar" is ambiguous as best.
Rather you should put it as , because of influx of $$ into India, it is affecting the market via simple demand-supply equation. There is an abundance of $$, supply is more, then the value of $$ is less, the converse effect of which is value of Rupee is more. This way of putting things makes it clear that the $$ influx was and is the prime factor in this phenomenon.
You have correctly pointed out that rising rupee hurts the exports. Hence it not in our best interest to let Rupee rise way too much. But the next statement : "As India’s exports are rising (service sector) Rupee value increasing in international market and to keep it artificially down RBI is printing more money which in turn is increasing inflation"
is only half-truth
The Rupee has appreciated at almost 9% this year alone, and the reason being, as pointed above - more $$ chasing lesser Rupees. So there are more $$ in the market . So RBI buys $$ , there by increasing the supply of Rs with respect to $$. As you also pointed out , more Rs in the market essentially translates into increase in domestic inflation. Domestic Inflation essentially means an imbalance in the money and the goods the money can buy viz. more money to buy lesser goods. So then what RBI does it what are knows as 'sterilization'. RBI then mops up that excess money by issuing bonds in the market. Now the $$ it had bought from the market, it invests it by buying US treasuries, yielding them , roughly 5% on that investment. Trouble is , RBI has to pay more interest ( 8-10% interest rate ) on its own issued bonds. So this becomes a 'loosing-business' for RBI. Hence RBI does it only periodically and on short terms , since it cannot continue doing it for long.
China also implements this 'sterilization'. But it is not such a money-loosing business for them, since the central bank floats the bonds with only 2% interest rates on them and earns 5% on the US $ invested bit of it.
I want to know one thing, who decides the rate of dollars against rupees. is there any such agency?
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