Adverse effects of continual depreciation of the rupee

Friday, 21 December 2018 00:00 - - {{hitsCtrl.values.hits}}

By R.M.B Senanayake

The government seems to be quite satisfied to let the external value of the Rupee to slide downwards continuously. But there are the adverse effects of exchange rate depreciation on our Terms of Trade which cannot continue to be ignored. When the Rupee is depreciated in terms of the U.S dollar it means we have to sell a greater volume (or quantity) of exports to obtain the same foreign exchange value. It means we have to export more in volume to earn the same value in foreign exchange. It is a burden we are imposing on ourselves. Therefore, it is better to avoid exchange rate depreciation. But exchange rate depreciation becomes necessary when we continue to run balance of payments deficits in the current account which have to be met by a fall in foreign reserves (it wouldn’t matter if the current account deficit is covered by an inflow of foreign capital to the capital account which adds to the foreign reserve and thus avoids a reduction of the foreign reserve). So some countries impose direct controls on imports rather than resort to exchange rate depreciation. But this distorts the free market economy and leads to other problems where supply and demand mismatch such as black markets and smuggling.

The only sustainable way to avoid a reduction of foreign reserves is to balance the current account of our balance of payments which has been in deficit for the last forty years or so.

Let us ask our governments to refrain from running budget deficits which is the primary cause of current account deficits in our balance of payments. If not for them the people and the government would be forced to fund their expenditure from earnings of tax revenue in the case of the government. The exceptional case for budget deficits under Keynesian economics does not apply in developing countries where there is no sudden fall in aggregate demand in a depression as in developed countries. Keynesian Economics does not apply in the case of under-development.