Is it a good idea to use the forex reserves to prop up the rupee?
It’s a bad idea for two reasons. First, India’s reserves are not too large. The resources available to global speculators are vastly larger than those available to the RBI. We should understand and respect the capabilities of the global financial system.
Second, reserves are not net wealth that we can use as we please. They are the assets that balance the liability that is the Indian rupee, that is issued by the RBI. Selling one dollar means sucking Rs 64 out of the economy. Selling $10 billion means sucking Rs 0.64 trillion out of the economy.
RBI will then need to do ‘sterilisation’ – buying bonds to put this money back into the economy – and that has its own complexities.
What measures can be taken immediately?
I would suggest reversing everything that has been done in order to defend the rupee in recent months.
The long-term strategy consists of two parts. First, we should engage in fiscal prudence, so as to boost domestic savings and thus narrow the current account deficit. Second, we should build sound frameworks for capital flows.
Can we really leave the rupee to market pricing?
We don’t have a choice but to live with market pricing. Nifty and the rupee are a thermometer. They are reporting that the patient has a fever. We should stop trying to hit out at the messenger. Instead, we should focus on the fever. We should undertake economic reforms so as to make the patient better.
This requires reducing subsidies, reducing the fiscal deficit, enacting new laws that reform the government, and achieve better performance on core public goods such as the judiciary and law and order.
We need to go much faster on building infrastructure. India is one of the worst emerging markets in the World Bank’s `Doing Business’ indicators. It is truly painful to build and run a business in India. We must change that.