Rupee busters: Don't intervene in currency market, but in specific sectors.

As the rupee slides against the dollar, the Reserve Bank of India (RBI) will be tempted to protect its value by selling greenbacks. It should resist this temptation. Sure, the fall of the rupee dents sectors which are net importers. Three sectors are particularly vulnerable: oil, gold and capital goods. In each case, there are specific things which can be done to ease the pain.

India imports nearly 80% of its oil. Higher import prices, caused by a weak rupee, cannot now be passed on to consumers because the government controls the prices of most major fuels, including diesel. So, the higher-price burden is borne partially by the government and partially by India's oil marketing companies, which again are largely state-owned.

The government can rid itself of this burden by finally freeing up diesel prices and allowing it to float according to the movements of crude and exchange rates. Higher diesel prices will initially bite big users like the railways, trucking and farm pumpsets, but it will also force these sectors to economise. Artificiallycheap diesel has stunted the development and adoption of fuel-efficient technologies. It also leaves little incentive for the adoption of alternative fuels. Free pricing could nudge the economy in these directions.

Last year, India imported record amounts of gold, largely as a hedge against inflation. Imports are lower this year, but they continue to be a substantial drain on our foreign exchange reserves. To offset this, the government should restore commissions which were earlier paid to distributors of financial products like mutual funds. This could trigger a recovery in financial assets and a drop in gold demand. The government should also launch sovereign bonds indexed to inflation to create a market for risk-free inflation hedges.

Capital goods imports are necessary for the expansion of India's creaky infrastructure. To offset the impact of the weak rupee, the government should scrap the 5% import duty on capital goods and the 7.5% rate on power equipment till the rupee strengthens decisively. These measures, implemented fast, should offset the impact of depreciation without using the hammer of dollar sales.

Source : economictimes.indiatimes.com