MUMBAI – India may face its worst financial crisis in decades if it fails to stem a slide in the rupee, leaving the central bank with a difficult choice over how to make best use of its limited reserves to maintain the confidence of foreign investors.
If the central bank is too timid, it risks adding fuel to the ire of portfolio investors, which India relies on heavily to cover its imports tab.
Aggressive intervention would leave the central bank open to criticism that it is wasting precious money on problems that are beyond India’s control anyhow, noteably Europe’s debt crisis.
Unlike most of its Asian peers, India has recently been running large current account and fiscal deficits. That means it must attract sufficient foreign money — namely US dollars — to close the gap, and a weaker home currency makes that costlier.
This is a perennial problem for India. The current situation is so worrisome because India is grappling with big internal and external economic threats simultaneously. Growth is slowing. Inflation remains high. Political paralysis has stymied domestic reforms.
The Reserve Bank of India, the last line of defence against a currency meltdown, has cautiously begun to support the rupee, but its firepower may be more limited than its $300 billion in reserves would suggest.
Beyond India’s borders, Europe is the biggest worry. As its banks deleverage, investment money has flooded out of India’s markets. If Europe’s debt troubles deteriorate, India could be hit with a balance of payments crisis as severe as the one that forced a sharp devaluation in 1991.
The rupee, which has dropped 16% in the past four months, got a reprieve last week after the world’s big six central banks banded together to try to ease dollar funding strains, helping it to snap a four-week losing trend.