Answer Writing Practice for UPSC IAS Mains Exam: Paper - IV (General Studies – III) - 17 September 2018


Answer Writing Practice for UPSC IAS Mains Exam


UPSC Syllabus:

  • Paper-IV: General Studies -III (Technology, Economic Development, Bio-diversity, Environment, Security and Disaster Management)

Q. “There are several effective instruments available to the government to help the rupee find an equilibrium”. Analyze in the context of sharply declining rupee against the dollar. (250 words)

Model Answer:

Approach:

  • Why in news?
  • Introduction
  • Instruments available
  • Conclusion

Why in news?

The rupee is currently the worst-performing currency in Asia. The value of rupee has fallen precipitously against the dollar, and is now hovering around the 72 level. It was just under 64 at the beginning of the year losing about 12% of its value since then.

Introduction

The depreciating rupee is also a symptom of persistently higher domestic inflation in India over many decades. For example, in line with vastly different inflation rates in India and the U.S., the rupee has lost about 60% of its value in the last 10 years against the dollar.

Instruments available

ad hocsteps

The government has announced a set of five measures lately aimed at supporting the rupee. They are – 

  • To curb the import of non-essential goods and encourage the export of domestic goods,which will help in addressing the country’s burgeoning current account deficit that hit a five-year high in July.
  • To attract more foreign portfolio investors (FPI) into the corporate debt market, the government will review (ease) a couple of restrictions on their investments.
  • Government is to encourage Indian borrowers (Indian Corporates) to issue rupee-denominated ‘masala bonds’ to facilitate the inflow of dollars and de-risk the economy from fluctuations in the exchange rate. For instance, the government has exempted all such bond issues until March 31, 2019, from withholding taxMasala bonds are rupee-denominated instruments issued abroad by Indian borrowers.
  • The government will review the mandatory hedging condition for infrastructure loans borrowed under the external commercial borrowing (ECB) route. Presently there is no compulsion on borrowers to hedge these loans.
  • In order to curb dollar demand, manufacturing companies borrowing up to $50 million through external commercial borrowing (ECB) will be able to do so only for a one-year term as against the three-year term allowed earlier.

Sustainable solution to the problem

India should find sustainable domestic sources of energy to address the over-reliance on oil imports. The rise in the price of oil has traditionally exerted tremendous stress on the current account deficit and the currency, as is happening now.

The government needs to think of a long-term plan to boost exports, preferably through steps that remove policy barriers that are impeding the growth of export-oriented sectors, in order to find a sustainable solution to the problem of the weakening rupee.

  • Other corrective options
  • Both the Central and State governments earn huge revenues from excise duties and value-added tax (VAT) on petrol and diesel. Now that the rupee cost of crude has shot through the roof, the Centre should certainly lower duties. Rates of VAT should also be lowered by State governments.
  • The RBI can consider offloading large amounts of dollars. This would increase the supply of dollars and so check the appreciation of the dollar, but at the cost of decreased liquidity. Clearly, this weapon has to be used with caution. Of course, the RBI does intervene in the foreign exchange market from time to time to manage a soft landing for the rupee, and this has to continue.
  • The Central bank now has an explicit inflation target of 4%, a level that is almost certain to be breached if the rupee remains at its current level. This is very likely to induce the Monetary Policy Committee (MPC) of the RBI to raise interest rates again in order to dampen inflationary tendencies. But, the MPC must moderate any rate increase. Any sharp increase has an obvious downside risk to it — any increase in interest rates can have an adverse effect on growth. Any ‘big’ negative change in profitability of companies may make foreign portfolio investors pull out of Indian stocks and actually exacerbate the rupee’s woes.

Conclusion

Hopefully, the storm will pass over and the rupee will soon find an equilibrium but returning to anything below 70 to the dollar is unlikely. This should not be cause for much concern because the economy will adjust to the lower value of the rupee. What must be avoided is any sharp fluctuation in the exchange rate — in either direction.

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