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MC Exclusive | India’s slightly undervalued currency is its strength: Salvatore Babones

The RBI’s strategy of a slightly undervalued currency is providing India with macroeconomic stability. George Soros has attacked countries with overvalued currencies, the development economist and professor said.

February 21, 2023 / 04:18 PM IST
Representative image

Representative image

In October 2022, when the rupee breached the Rs 83 to the dollar mark, finance minister Nirmala Sitharaman told Parliament that it wasn’t the rupee that had depreciated but the dollar that had appreciated. The comment invited the ire of the Opposition that had been attributing the fall to “incompetence and wrong policies of the government”.

A falling rupee in an election year makes for bad optics for the government.  A weaker currency, some economists say, reflects the state of the economy.  The rupee fell 11 percent in 2022 and was the worst-performing Asian currency.  According to the Reserve Bank of India’s (RBI) Financial Stability Report, the rupee recovered in mid-October 2022 from the bouts of volatility experienced in the earlier part of the year. In 2023, the rupee has been in the range of 80.88-82.94, with the RBI playing a critical role in managing volatility, according to analysts.

Salvatore Babones, associate professor, University of Sydney, and a development economist, contends that what’s working for the Indian economy amid all the global turmoil is the RBI’s handling of the currency.

“What’s important to do is what RBI is doing—having a slightly undervalued currency. Not a heavily undervalued currency but a slightly undervalued currency. It discourages imports and encourages macroeconomic stability because India is able to maintain large forex reserves in case of problems.

“Having such large forex reserves is in itself an indication that the rupee is slightly undervalued. Countries that have slightly undervalued currencies have big reserves. Countries that have overvalued currencies face the axe by the likes of George Soros,” he told in an exclusive interview.

Soros is a US-based investor, billionaire and philanthropist who is known to take audacious bets against countries. He is attributed to have triggered the Asian financial crisis in 1997, which was a series of currency devaluations.

India’s forex reserves at $566.95 billion in February saw the sharpest slump in over 11 months. But Babones said that the recent drop in India’s forex reserves is only when denominated in dollars.

“In recent years most countries have diversified their foreign currency holdings. So they are holding euros, yen. If you are holding more euros but your reserves are denominated in dollars, a fall in the value of euros is reflected in your currency reserves as expressed in dollars. The RBI hasn’t released any statistics on it. But I am pretty certain that most of the fall in forex reserves is not actually a literal drop in reserves, instead it is a drop in the value of the euro, yen and pound because the US dollar has risen against these currencies,” explained Babones.

Why is a weaker rupee good?

“When the pound was overvalued, when the Southeast Asian currencies were overvalued, Soros attacked them and pricked the bubble. Overvalued currencies are generally preferred by the rich. The rupee has been chronically undervalued, which encourages manufacturing in India but makes imports more expensive. The currency mechanism doesn’t pick winners or losers,” said Babones.

Commenting on the government’s strategy of following a policy of import substitution—raising import tariffs to discourage imports—he said: “The reason import substitution doesn’t work is because it tends to become corrupt. When the government picks winners and losers, they tend to pick their friends. I am not saying that the government is doing that. But when you discourage imports and encourage exports through a currency mechanism instead, you are letting the market decide who is going to export, who will import.”

India over the past two years has raised import duties on a range of products from gold to headphones to smart meters to steel. Several economists have argued that protectionism of this kind doesn’t usually yield the desired results of building domestic capacities. In Budget 2023-24, the government increased customs duty on as many as 32 items to give domestic manufacturing a boost. Babones argued that a currency mechanism is a more effective way to encourage competitiveness.

“Throughout its entire development period from 1980 to 2010, China had a seriously undervalued currency throughout the period of rapid growth. Most countries that have developed rapidly have taken this approach whether consciously or unconsciously,” he told Moneycontrol.

You can watch the full interview here:

Shweta Punj
first published: Feb 21, 2023 04:18 pm