As told in my previous article, in a flexible exchange rate system, exchange rate is determined by the forces of demand and supply of foreign exchange. When demand for foreign exchange rises, its supply remaining constant, then the domestic currency depreciates and vice versa. Similarly when supply of foreign exchange rises, its demand remaining constant, the domestic currency appreciates and vice versa. Thus, for rupee to appreciate in relation to US Dollar, either (or both) of the two things must take place. Either demand for US Dollar must decrease or supply of US Dollar must increase with the currency dealers in India.
If we observe both of these options carefully then we find that although these options may look different initially, but they point towards the same thing, that India must attract foreign investment and
look to sustain it. And to accomplish this, Indian economy must present a strong fundamental outlook, which is not the case with it presently.
Improving the fundamentals of the Indian economy from current levels is no small task. It would require a firm stance on part of the Government to alter its policy from populist to reformist. Here are some steps that, if taken by the government, can help in bringing Indian economy back on track and thereby attracting foreign investment and arresting rupee downfall.
• Expedite FDI reforms in sectors like telecom, banking, insurance etc.
Raising FDI limits in various sectors would go a long way in reviving the investment sentiment, which is imperative for growth of any economy. In fact, in its report to the Finance Minister, a panel headed by Mr. Arvind Mayaram, Secretary, Department of Economic Affairs, has proposed hiking FDI cap in sectors wherever it is currently 26% to 49%, wherever it is 51% to 74% and wherever it is 74% to 100%. The benefits that such a step would have are that it will raise the productivity of sectors concerned, bolster government revenues, create employment opportunities, raise the skill level of employees and many more. All this bodes well for the Indian economy.
• Reduce Current Account Deficit
The government should be working towards reducing current account deficit, which shows the excess of imports over exports, to a sustainable level. Greater current account deficit causes rupee to depreciate as gap between imports and exports, or outflow and inflow of foreign currency, widens. Although government has taken some steps to address the problem of high CAD like tightening of screws on gold import by raising import duty on gold, but it does not seem to be enough. CAD for June quarter remained at 3.6% of the GDP, way higher than the desired level of 2.5% of GDP.
• Need for administrative reforms
You cannot expect ripe fruits from a rotten tree. Similarly, if the government machinery is itself flawed and ailed by red tapism, bureaucratic hurdles and corruption, you cannot expect smooth and speedy roll out of reforms. The main problem of Indian economy isn’t planning but execution of plans. Unless the government does not work to improve its own system, Indian Economy would find it difficult to get out from the shambles of mediocrity. Some of the suggested administrative reforms are putting a limit on the maximum time that different departments take to grant project clearances, doing away with unnecessary licenses and promoting transparency in administration of investment related policies.
Although there may be more ways in which government could act to improve the fundamentals, but
in my opinion, these are the most important of them all, which address the basic problems of Indian
Economy. I honestly feel that if the Government of India implements the above discussed things and back it up with further reforms then not only can it succeed in arresting rupee downfall but also can go a long way in creating greater demographic dividend for people the country.
By- Abhilash Jain
Views presented in the articles are those of the author and not of ED.