Impact of a rate cut on the exchange rate
Problems before the Indian economy
- A gloomy world economic scenario
- Over-leveraged corporate balance sheets
- An extremely weak rural demand.
How could rate cut depreciate the exchange rate?
- Ninety-five per cent of India’s investment comes from domestic sources. Further, a significant portion of foreign direct investment (FDI) into India is believed to be domestic capital round-tripping via tax havens like Mauritius.
- Hence, even a doubling of FDI may not suffice to bring about the stimulus needed.
- The government is limited in its ability to inject a fiscal stimulus because of the threat of inflation.
- In this situation, foreign markets offer a thin sliver of hope for Indian business.
- Hence, the efficacy of the rate cut should be seen not in terms of its impact on domestic investment but on foreign demand, through the channel of its impact on the exchange rate.
- Lower foreign demand for Indian assets following the rate cut would be the channel through which the rate cut would depreciate the currency.
Is Rupee overvalued?
RBI governor Raghuram Rajan has argued that if the growth of India’s productivity is factored in, the rupee ceases to be overvalued.
Impact of rate cut on Foreign Investment and Foreign Markets :-
|Foreign Investment||Foreign Markets|
The argument that the rupee is already sufficiently weak in real terms, and does not require further depreciation may not hold water. The rupee should be left to depreciate further, as it will boost up our exports.