External vulnerabilities: Time for a rupee review
PremiumOur record trade deficit in May portends trouble. As oil pressures are unlikely to ease soon, RBI should weigh the option of bridge support for the rupee in aid of broad macro stability
India’s latest export data would please trend watchers. Outward shipments in May were up 15.5% on last year’s figure. Though a less exciting rise than April’s 30%-plus increase, cumulatively for the first two months of 2022-23, exports are up more than 22%. On this upbeat momentum, we could see another year of robust exports, beating the $418 billion record set in 2021-22, itself a leap from the previous peak reached in 2018-19. Covid effects have been put in the past and India’s efforts to attract global supply chains could help sustain the incline. But we also have high oil prices to thank for this year’s data, at least partly, since petroleum products made up a big share of our overseas sales. They were up more than 52% in May, making them our second largest export category. But therein lies a whammy. While oil on the boil yielded gains, costlier oil inflated this sector’s import bill even more, by 91%. Overall, our trade deficit—or the excess of what’s paid for imports over export earnings—widened to its widest ever gap of $23.3 billion. Pressure on this front isn’t likely to ease anytime soon.
Oil dependence has always held our external imbalances in its thrall, but the current shock is particularly bad. Global price levels are up about 55% this year. With the Russia-Ukraine war now past 100 days with no end in sight and Europe set to choke off most of its Russian intake, we cannot count on a cool-off in the near term. Cheaper oil from Russia, meanwhile, faces logistical and insurance burdens that negate some of its savings. Throw in the impact of climate action, which could result in a tighter Opec grip as non-Opec output slows, and the scenario portends swollen bills for months to come. Energy costs on the whole are rising globally. Coal imports spiked 167% in May to feed a power shortage; domestic supply of the black stuff is poor and our appetite for it is growing. We can thus expect India’s trade gap to yawn wider and the rupee to weaken as dollar demand gets the better of it. Capital markets have already seen a sell-off by foreign investors, whose exit via rupee conversion into greenbacks pushed its value down. Rising US interest rates and rupee erosion due to local inflation could see even more money pulled out of India. In a world unsettled by war, ‘safe haven’ assets are luring investors away.
Should the Reserve Bank of India (RBI) respond? And, if so, how? Its usual practice is to buy and sell dollars to contain volatility but otherwise let the exchange rate float. Its war chest of reserves, which has lately fluctuated around $600 billion, remains large enough to keep an external crisis at bay. RBI’s priority at this juncture, however, is inflation control. If it lengthens its horizon for external stability and opts to treat the current oil spike as transient, it could strategically choose to prop up the rupee in aid of internal price stability. Selling dollars would reduce domestic liquidity and also ease swelling oil bills. Given the tight spot we’re in and shifting views on currency floats, a brief span of special support is unlikely to attract US censure. This can only work as a calculated bet on a major export surge at the other end of this ‘bridge’, though. And we can count on such a boost only if the Centre is confident that its use of public funds for manufacturing incentives will shortly pay back in foreign earnings as we join global supply chains. Since world trade is expected to lose pace this year, we would need to speed up deals and grab every opportunity. Let’s keep the option of a rupee bridge open.