Rupee depreciation and inflation on the cards

Currency depreciation and general price increase is threatening the macroeconomic stability of the country. The rise in electricity and wheat price, and the weakening rupee is exerting pressure on the price levels. The decision taken by the central bank to hold the interest rate is further strengthening the belief that inflation would rise. At present, however, a major concern for the economy is weakening of the rupee. The interbank offer rate for dollar stood at Rs89.33 on 8th Dec 2011, this is 3.8 percent higher than the level it had on 30 Nov 2011. Markets fear that large trade deficit and foreign debt payments, and stagnant foreign investment would further deteriorate the exchange rate. The decrease in commodity prices, especially cotton, due to the weakening global economy has slowed down exports. This means that exports would not likely reach the record levels they achieved in the previous year as this slowdown is expected to prevail in the 1HCY12. On the other hand, the expansionary fiscal policy and the rising energy needs have inflated the import bill. Hence the deficit would widen and further financing would be needed to fill the gap. This consequently could result in further currency depreciation. Also adding pressure on the rupee is the decreasing foreign investment and eroding foreign currency reserves. The reserves stood at around $16.8 billion on 25th Nov 2011, this is a $1.4 billion decrease from the $18.2 billion level in June 2011. The hefty payments due to IMF in 2012 would further decrease the reserves. The problem however is governments mismanagement of expenditures and revenues and its poor debt management. The problem originates from the convenience that government has in borrowing from the state bank and the schedule banks. Therefore, if fiscal policy remains the driver of the monetary policy, the economy would further sink, as fiscal management is yet seen wanting. In such a situation, it is hard to expect any improvement in the rupee, trade deficit, budget deficit and inflation.