And the rupee wept on

Greece is in turmoil. Europe is in the throes of a double-dip recession exacerbated by a sovereign debt crisis. The future of the euro is in doubt. There have been political consequences of the economic meltdown: at least 11 regime changes have taken place in the 27 countries of the European Union over the last few years. The Indian rupee has plummeted to a new low against the US dollar. Is there a connection? Yes, there is, even if the link is somewhat tenuous. However, we would be fooling no one but ourselves if we attribute the fall in the value of the Indian currency primarily to an unfavourable and volatile external economic environment.
On May 17, finance minister Pranab Mukherjee blamed the slide in stock market indices and the external value of the rupee to the euro crisis and the state of the international economy. Greece has upset the apple cart, he said, adding: “What was decided by the electors of Greece in defeating a particular political party raised the questions of uncertainty of resolving the euro zone crisis… The entire Asian market today has taken a hit... This is the complex situation in which we are living and we cannot ignore that.”
The finance minister said the government would be resorting to a fresh set of austerity measures but quickly added that he was not pressing the panic button. “I am going to issue some sort of austerity measures... whether people like it or not... to convey a signal that we are responding to the situation,” he said.
What are these unspecified austerity measures Mr Mukherjee was talking about? Was he referring to an impending increase in the prices of petrol, diesel and perhaps cooking gas as well? He has already claimed in his Budget speech that the Union government would be containing subsidies to two per cent of the country’s gross domestic product (GDP) during the current financial year. If this target is indeed to be achieved, a sharp hike in the prices of petroleum products is imminent. If that indeed happens — and few will be surprised if it does — it will take place when international prices of crude oil have eased a bit. India has, however, not been able to take advantage of this softening of crude oil prices because of the depreciation of the rupee.
In fact, the principal reason why the value of the Indian currency has come down sharply in relation to the US dollar is the huge 56 per cent hike in the country’s trade deficit (the difference between the value of imports and exports) in 2011-12 over the previous year. This is because of the fact that while imports have risen by nearly a third, the rate of growth of exports in 2011-12 has halved from the 41 per cent growth achieved in the previous fiscal year (2010-11).
The jump in the trade deficit has contributed largely to the rise in India’s current account deficit in the balance of payments (the gap between inflows and outflows of foreign exchange), which currently stands in excess of four per cent of the country’s GDP. Such high deficits are not sustainable and will entail strong corrective action.
The external value of the rupee has come down on account of other factors. Foreign institutional investors have been shying away from stock exchanges in recent weeks. The Reserve Bank of India has been reluctant to draw down reserves and pump dollars into the market to prop up the value of the rupee. The central bank says it intervenes only to check sharp fluctuations and not to artificially prop up the value of the rupee in the face of secular trends in exchange rates on account of external as well as internal considerations.
When the rupee depreciates, it is meant to provide a boost to exporters because the relative value of their goods and services come down. This, in turn, should help close the trade deficit. But this is not happening. Why? Imports are not coming down because one-third of India’s total imports currently comprises crude oil and 80 per cent of the country’s requirements of crude oil are imported. Moreover, markets for India’s exports are not growing; on the contrary, these have shrunk in the West on account of the Great Recession, which is continuing. China’s growth rate too has slowed down.
In other words, the economic crisis in Europe is having an impact on our country.
The impact goes beyond the fact that one of the many reasons why the rupee has depreciated against the American currency is simply because all currencies in the world have depreciated against the US dollar on account of investible funds as well as speculative money flowing out of the euro to the dollar. But, as emphasised earlier, this is only one part of the story. The weakness of the Indian currency is also a manifestation of the paralysis in our government, the deceleration of growth impulses in our economy, the persistence of demand-driven inflation and the fall in the growth rate of industrial production.
In this chaotic world we live in, are there any lessons for India to learn from Europe? The European Union was formed to create a single market, even if only 17 out of the 27 member states are at present part of the euro zone. Greece may soon opt out of the zone, but the bigger point to note is that economic unity can only be partially imposed on a politically diverse confederation of nation-states.
India’s experience has been different. This country may be more politically united than ever before but its economy remains disintegrated. And this is probably why the government of the day is finding it so difficult to implement what many believe would be the most important economic reform measure, one that could reduce corruption and create a unified market for the Indian Union, namely, the implementation of a common goods and services tax for all of the country’s 28 states and seven Union territories.

The writer is an educator and commentator