A similar situation is playing out in India right now. Foreign investors are looking to exit the country. They have sold off more than $5 billion worth of bonds since late May. They have also sold off stocks worth $1.39 billion in June, after buying stocks worth $4 billion in May. These investors are now trying to convert there rupees into dollars, and that has led to the rupee rapidly depreciating against the dollar. The RBI tried to halt this fall by intervening in the foreign exchange market and selling dollars. But as the South East Asian experience tells us, obsessing with a certain target against the dollar is not a great idea. So given that the RBI has got it right by not obsessing with the target of Rs 60 to a dollar. But the trouble is that a weaker rupee will have several negative consequences in the days to come (This is discussed in detail here). First and foremost will be higher inflation as India will pay more for imported products. Oil will become expensive in rupee terms. If the government passes on the increase in price to the end consumer, then it will lead to higher prices or inflation. If it does not pass on the increase in prices to the end consumer then the government will run a higher fiscal deficit as its expenditure will go up. Fiscal deficit is the difference between what a government earns and what it spends. It will also mean that the government will have to borrow more to finance its expenditure and that in turn will mean that the high interest rate scenario will continue.
Posted on: Thu, 27 Jun 2013 23:39:23 +0000
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