What Is Happening To The Rupee?
What US treasury secretary John Connally said in 1971 to his D-10 counterparts is valid even today, “The Dollar is our currency, but it is your problem.”, this resonates well even today. This morning the Rupee touched an all-time low of 82.7 against the US Dollar. Last year at this time the value of the Rupee was 75 Rupee to Dollar. India's Forex reserves were close to USD 600 billion in March 2022, which declined to 537.5 Billion USD. The falling rupee has become an issue of national concern, and usually, it is seen as a government failure. However, there is more to the story.
What is happening to the Rupee?
Since March 1993, Rupee is a free-floating currency, whose demand depends on market forces. Foreign investments increase the demand of the Rupee while increasing exports lead to an increase in the supply of the Dollar. Both these factors appreciate the value of the Rupee while rising imports and foreign investors exiting from the market decrease its value. This implies there are factors beyond the scope of the central government.
The Rupee depreciation is mainly due to external factors. Inflation globally has increased by 8 to 9 percent. The major reasons behind this inflation are supply-side disruptions and economic stimulus payments. These packages were launched globally for post covid recovery all over the world. For example, in the USA it was a 5 trillion USD package. This is despite production not recovering completely. It has become a classic case of too much money chasing too few goods, that is, inflation.
Further, climate change induced droughts and cyclones have hampered food production. This has pushed up food price inflation. Adding fuel to the fire is Russia Ukraine war, which has pushed up gas prices and has resulted in wheat shortages globally. If some experts are to be believed, the global economy is heading toward recession.
If this situation persists, it means there is less money to be invested in India. In addition to cash backing away from the economy, skepticism form global investors leads to them becoming investment averse. In this scenario, investors prefer US treasury bonds and gold as they are less risky. In common parlance, we call it a ‘Safe Haven Mindset'. If dollars are withdrawn from the market, they become scarce and their value goes up.
Crude oil becoming expensive has a direct impact on inflation because it pushes up the cost of transportation. Also, inflation pushes up export prices, making them uncompetitive. Exporters also delay exports so that they can gain more by exporting later. This happens while imports are increasing. The entire scenario leads to a further decline in Rupee, which leads to a vicious cycle.
Another lesser-seen impact is the negative effect it has had on India's forex reserve. The reserves are not just in Dollars, but in Pounds, Euros, and Yen as well. If the Dollar goes up, all the other currencies will go down in value. A recent RBI statement noted the same by saying, about two third of valuation loss is due to the Dollar markup.
The silver lining
While a lot is said about the negative impact of the falling Rupee, enough is not said about its positive effect. For one, India's exports become more competitive due to the depreciation in the Rupee. This is because the price of the same product in Dollars costs a lot less now. Secondly, Rupee depreciation also serves as an incentive for foreign tourists to visit India. They get more Rupees for the same amount of dollars, making travel cheaper. Thirdly, some investors view India as a cheap investment market, they can easily invest in fresh Indian assets. Also, those units that have been loaned out to companies abroad. This usually happens with Indian companies that give loans to their overseas subsidiary. The repayment of this loan is done in Dollars and the Indian company will get more Rupees for the same.
Exports becoming competitive will have a positive impact on India's defense sector, for example, Argentina and Malaysia are considering purchasing Tejas fighter aircraft from India. Due to depreciation, the sale of these assets will become cheaper, which will give India a geopolitical advantage. In a way, it is also promoting the government's ‘Make In India' initiative and might serve as a good opportunity for Indian manufacturers.
