Accept Dollars and Euros...

Every country needs foreign currency to pay for its imports, and, reduce the gap between exports and imports, called the CAD (Current-Account-Deficit).

An outflow of foreign exchange would mean a depreciating currency because the supply of foreign exchange to the economy has decreased. Low supply stronger currency.  Our ability to pay for imports will decrease, because we can buy less foreign currency since it is strong now. This will result in higher CAD and, therefore, this time we need to push exports so that we can earn more foreign exchange to reduce the CAD gap. But, if there is an inflow it means that the supply of foreign currency to the economy has gone up and the home currency will appreciate now because foreign currency will depreciate since its supply has increased. We know, high supply means a weak currency. This will lower the CAD. Our ability to pay for foreign currency and imports will increase. Countries really do not bother to reduce surplus, rather they are more bothered to reduce the deficit.

The confidence in an economy is an important determinant of foreign currency inflows and outflows. A healthy economy will attract more foreign currency and a weak one will repel others. Growth rates are an important indicator of economy’s health and confidence. A high growth rate with a high interest rate will attract more foreign capital and vice-versa. High foreign currency inflows reduce the CAD burden and low inflows aggravate it, if exports are not responding.

India’s CAD problem is due to high imports and low exports. A real and natural solution to reduce the $ 20 billion CAD is to give a push to exports, but, due to high interest rates nobody is taking initiative in that direction. Manufacturing in the export sector is very low and India is defending its position by exporting non-manufactured products, mainly. But, that is not enough to reduce the CAD. Moreover, FIIs and FDIs are not helping us out of this serious CAD problem, because they have become low in the recent years because of low growth rate. India needs an out-of-the-box solution to handle the CAD. We, basically, need to earn foreign exchange in order to bridge the gap between the imports and exports, i.e., the CAD.

We can earn foreign exchange without resorting to exports and FIIs…

Yes, we can earn foreign exchange without pushing for exports and FIIs, but, we will need FDI and, most importantly, in multi-brand retail. We have not opted for imports of goods and the investors in this space will have to source goods and services locally, from India. This is a clause. And to this, with others, we need to add one more clause that when we will supply we will only accept dollars or euros. In the short run we may not be getting too much foreign currency because foreign firms are pouring foreign currency, anyways, to the banks and money market. Yes, banks and money market, but, not in the real market… In the goods and services market!  And in the long run it will definitely help us. I do not think foreign firms will have any problem with this because they are also operating in the US and must be paying in dollars. So where is the big difference? Moreover this would help them because this will make the Indian currency strong in the long-run and they will earn more home currency for themselves.


This will help India in many ways;

(i) Build reserves: It will help us build reserves because that will eventually go through the banking system and in terms of bank deposits, too.

  

(ii) Strong domestic currency: Supply of the dollars to the economy will improve and the domestic currency will appreciate, other things remaining constant, and,

(iii) Automatic investment: There is a chance that dollar will appreciate because to buy oil we will need dollars. There is a decreasing returns coming out of oil. Demand for dollars is likely to go up with oil-demand and prices, and, with it income and investment in dollars.

And, may be many more benefits…