Sitharaman’s Excuse Offers No Comfort as US Fed Continues its Rate Hikes 

There is no room for complacency as long as the US Fed continues to aggressively tame inflation.

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Predictably, Union finance minister Nirmala Sitharaman has become the butt of jokes for her astounding claim that the rupee is not weakening, but actually the dollar is strengthening.

“I will look at it, not as rupee sliding… but as dollar strengthening incessantly,” she said at a press briefing during her US visit. She was trying to explain the recent sharp slide in the rupee, which crossed Rs 82.50 to a dollar.

Reacting to her statement published on NDTV, one reader responded, “Actually, India has not slipped in the global hunger index, but others have moved up!”

Another said, “Actually, the price of onions has not gone up but you are getting less onions for the same price!”

When citizens start making such jokes it is time to rethink your political messaging. PM Modi himself made numerous jokes during the 2013 taper tantrum, about the rupee falling “as rapidly as UPA’s popularity”. The boot is now on the other foot.

Seriously, the finance minister must choose her words carefully when explaining currency dynamics. The FM wanted to say that all currencies are depreciating against the dollar but the rupee has depreciated less than many other emerging economy currencies.

While that may be true, it is also a fact that India has sold more dollars from its forex reserves than any other emerging market, to defend its currency. Forex reserves have fallen over $100 billion over the past year to about $ 540 billion. Much of the fall occurred this year, especially after the Ukraine conflict broke out.

Earlier this year, a report in the Economic Times quoted unnamed official sources claiming that the Union government and RBI would not let forex reserves fall below $600 billion. It was a clear misreading of the situation. Now, the official narrative is that India can afford to spend another $100 billion to stabilise currency markets. This means RBI may be looking at the possibility of forex reserves falling to $440 billion over the next six months.

So by the end of March, forex reserves could be enough to cover seven to eight months of imports. The rupee, meanwhile, will remain under pressure and the RBI can at best only curb sharp volatility, but will not be able to stem the gradual slide, along with other emerging market currencies. This was admitted by the FM in so many words when she said the RBI would only address volatility but would not try to determine any particular level for the rupee’s exchange rate.

So if the local currency slides to Rs 86-87 to a dollar over the next six months, the FM can continue to claim that the rupee has weakened along with other emerging market currencies, which may have slid more.

This is inevitable as the Federal Reserve continues to raise interest rates until it brings the US inflation rate down to 2% from the current 7% plus. This is a long haul, and will hurt emerging market currencies and their economic recovery in the medium term.

A falling rupee would also transmit more inflation into India as some of its large items of imports ― crude oil, edible oils and fertiliser ― cannot be avoided. Prime Minister Narendra Modi has emphasised the challenge of the high import bill on account of fertilisers and edible oils. “We have to resolve to be free from importing edible items,” the PM said.

There are alarming reports of wheat stocks down to minimum buffer levels and the prospect of having to import wheat for food security. Many other EMs in Africa and Latin America are struggling to import more expensive food items from the global market and the strengthening dollar is not making it easy.

India is better placed on food stocks than many EMs but we still can’t rule out higher imports over the next year. There is no room for complacency as long as the US Fed continues to aggressively tame inflation.

The resulting currency dynamics in the developing world could have a profound impact on food and energy security across the non-OECD regions. This cannot be wished away by blithely stating that India’s currency is doing better than those of other EMs. In fact, this issue must be accorded the highest priority at the forthcoming G-20 summit. Currency coordination today is even more imperative that it was after the 2008 global economic meltdown.

In the Financial Times, Ruchir Sharma, chairman of Rockefeller Capital Management, has suggested that the US, while aggressively raising interest rates, can simultaneously intervene in its currency markets to prevent undue strengthening of the dollar, to give relief to emerging economies and help in faster global recovery. Remember emerging economies now account for possibly over two thirds of incremental world GDP growth. The US is certain to benefit if it intervenes to stem its relentless currency appreciation. Such unorthodox solutions must be discussed at the G-20 summit.

This article was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been republished here. To subscribe to The India Cable, click here.