Mentor’s Comment:

Introduction should talk about the condition of rupee and ever falling in its value in comparison to dollar.

Further, the main body should discuss the points of reason for this free fall and its effect on India subsequently. For ex –  rising crude oil prices, tight supply and geopolitical concern, slowdown in foreign investment with the increase of rate by US fed (bring data), Rising trade war and effects on rupee, falling of rupee’s real purchasing power etc.

Next, mention why RBI should intervene to stop the freefall. For ex – RBI regulation will increase and decrease in rupee supply and hence will affect in currency scarcity and currency abundant, Change in interest rate will attract/detract investors, RBI can affect both interest rate and money supply from regulation etc. bring example to support argument.

Next, also mention why RBI should not intervene. Even with intervention, the rupee has appreciated, sustained intervention by RBI has brought India close to US currency manipulation watch, excess liquidity with banking system will lead to chaos with RBI intervention etc.

Next, mention way forward, RBI should work with government to use instruments like market stabilization scheme bonds and continue build reserves, increased reserves will attract more inflows, Issue of NRI Bond by Government of India may help in containing free fall of rupee.

 

Model Answer:

The Indian rupee touched a fresh record low of 68.89 against the dollar in opening trade, falling 26 paise from the previous close. In the previous session, rupee posted the biggest single session fall against dollar since June 19. This decline has seen many economists asking RBI to intervene to stop free fall of Indian currency. It’s not a black and white affair and needs detailed analysis.

Reasons for this free fall and its effect on India:

• Rising crude oil prices are putting pressure on the rupee as India imports more than 80 per cent of its crude oil requirement.
• Amid tight supply and geopolitical concerns, global crude oil prices breached the $80 dollar mark last week. In the past 12 months alone, crude oil prices are up 50 per cent, supported by supply cuts from major oil producing countries
• Foreign investment in Indian equities and bonds has slowed down too, with the increase of rates by US Fed.
• In the last three months, foreign portfolio investments stood at Rs13,260 crore, a fifth of the figure at the same time last year, data from National Securities Depository Limited show.
• The dollar’s strength against some currencies overseas weighed on the local unit. Dollar strength has risen against its major crosses.
• The rupee depreciated sharply against the dollar in the backdrop of the rising trade war rhetoric led by the United States.
• The fall in the value of the rupee means that buyers now have to shell out more rupees to purchase dollars.
• In the present case, the depreciation of the rupee is due to a fundamental change in investor attitude to the rupee for the worse. So it reflects a fall in the rupee’s real purchasing power.
• A stronger dollar will work to the favour of those who invested in the U.S., adversely affecting the returns of investors who were bullish on emerging markets. 

Why should RBI intervene to stop the freefall?

• One major factor determining a currency’s exchange rate is its relative scarcity vis-à-vis other currencies. Since central banks are the sole suppliers of national currencies, they can influence the value of their currencies by appropriately regulating their supply.
• Another factor that determines a currency’s exchange rate is the benchmark interest rate, which can be used as a tool to directly attract capital into the country and prop up the value of its currency. The Reserve Bank of India can affect both the money supply and domestic interest rates simultaneously through its monetary policy stance.
• Non-intervention or insufficient intervention would result in further appreciation of the rupee and affect India’s competitiveness.
• Markets sometimes tend to overshoot in the short to medium term. Therefore, there is no harm in quelling volatility if possible, and giving businesses a more stable economic environment
• There have been at least two instances in recent history that support the idea of intervention when necessary.
• First, on the back of strong inflows, the RBI accumulated reserves at an accelerated pace between 2006 and early 2008, which helped India deal with the consequences of the 2008 global financial crisis.
• Second, inadequate intervention in the years preceding the 2013 taper tantrum episode resulted in a higher current account deficit and India got pushed dangerously close to a crisis.

Why RBI should not intervene to stop the freefall:

• ·         Even with the intervention by the RBI, the rupee has appreciated by around 6% since the beginning of the year. So let rupee decide its own new normal value.
• ·         Sustained intervention by the RBI has brought India close to getting included in the currency manipulation watch list of the US
• ·         India has a trade surplus with the US but it still runs a current account deficit at the aggregate level and cannot be accused of currency manipulation.
• ·         The banking system has excess liquidity of around Rs3 trillion and currency market intervention will increase this.

Way Forward:

• RBI should work with the government and use an instrument like market stabilization scheme bonds and continue to build reserves.
• But, in this case, the cost would keep rising as higher reserves would attract more flows. Rising reserves will reduce the currency risk for foreign investors.
• The other option is that, now India has adequate reserves and stable macros, it reassesses the kind of foreign funds it wants.
• For instance, flows in the form of equity capital are more stable and less risky compared with debt. Policy rationalization on this front can ease the pressure on both the RBI and the rupee.
• With rupee continuing to be weak against the dollar, Government of India may issue NRI bonds to contain its free-fall that has already impacted the Indian economy.