Is hiking import duty the best way to save a falling rupee?

Publish Date: September 27, 2018

The government has hiked import duty on 19 major commodities to support a falling rupee and deteriorating current account deficit.

Items such as refrigerators, air-conditioners and small washing machines will get expensive. Traveling may get costlier too as the government has made it more expensive to buy jet fuel, known as Aviation Turbine Fuel (ATF).

But will these measures help? We do not think so, except maybe for a couple of sessions.

Related read: Why the rupee has weakened in recent weeks?

Right now, the need of the hour is to generate higher savings. But, let’s first understand how weak savings can put a country’s current account under pressure.

Usually, when foreign capital inflows is robust, the country’s capital account is in the surplus. This situation spurs domestic spending. But high domestic spending can be a double-edged sword. That’s because if government spending/expenditure is more than the country’s income, its current account shows signs of strain. This is when there is a deficit in the country’s current account.

To put it simply, India needs to shore up its savings to solve its current account issues and consequently, strengthen the rupee.

Related read: What high current account deficit means to investors

So, how do we increase the country’s savings?

1) Selling foreign exchange assets can be a start. Selling them would bolster the rupee. That’s because demand for the rupee would go up.

2) Encourage capital flow from overseas and keep the government’s share of spending in check. That would result in a surplus in current account. India needs to explore policies that will encourage foreign direct investment (FDI) inflows. Reforms in labour and land are crucial. Privatisation of public sector units (PSUs) will be well received too. At the same time, ongoing reforms in taxation and formalisation of economy should continue. These are the crucial missing puzzle pieces to India’s growth story. Once they are in place, the Indian economy would attract significant inflow from overseas markets. This will be beneficial for the rupee in the long run.

Therefore, obsessing about current account deficit and attacking trade may be a misguided policy. Having said that, we are not arguing for free trade. We will be tackling this paradox in our future reports.

Let’s turn our attention to the recent US Fed rate hike. The US Federal Reserve stuck to its script and hiked rates by 25 basis points to 2.00-2.25%. It has signaled that there will be further rate hikes in future. While the next rate revision is expected to be announced in December, three more hikes are likely to take place in 2019.

The US Fed exuded confidence and caution in equal measures. Confidence because US businesses and the dollar are on an upswing and cautious because it doesn’t want to impede the growth story by raising rates too quickly or being too slow in raising rates and over-heating the economy.

We expect the rupee to open 72.60 against the greenback and and then trade with a positive bias. Support is around 72.50 and 72.00 levels on spot. Resistance is around 73.00 and 73.50 on spot. Tactical uptrend is intact as long as it is above 71.50 on spot.

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