India: Let the Rupee fall and enter the currency wars

By Sober Look

Almost exactly a year ago we discussed the issues faced by India, as the nation’s currency weakened to record lows (see post). We are now back to another round of rupee devaluation. In the last few days the USD/INR exchange rate exceeded the psychologically important level of 60 for the first time in history. Foreign investors are panicking, as capital leaves emerging markets.

Source: Investing.com

Why wouldn’t India’s central bank intervene? Here is one possibility. India’s current account has been under significant pressure in the past few years. Exports have not kept up with rising domestic demand and increasing labor costs have made it more difficult to compete in global markets.

Source: Tradingeconomics.com

One way to arrest this trend is by allowing the rupee to devalue. India certainly has sufficient foreign reserves to halt the rupee devaluation, but so far it is choosing to let it go.

Bloomberg: – The Reserve Bank of India sold dollars, two traders with knowledge of the matter said, asking not to be named as the information isn’t public. The bank sold “small amounts” to smooth volatility rather than protect a certain level, one of them said. The country’s foreign currency stockpile was $290.7 billion as of June 14, down from an all-time high of $321 billion in 2011, official data show.

It seems that the nation has decided to let the flight of capital out of the country devalue the currency, possibly to “improve” competitiveness. Inflation has not been a major problem thus far, so why not enter the currency war? Just follow Japan’s example …