Tuesday, August 18, 2015

Is there no end to Rupee’s fall?

Despite lots of tailwind to Indian economy such as lower oil prices, Rupee’s fall continues. Is there no end to Rupee’s fall?

The short answer is it depends on RBI and the Govt. of India.

I will attempt the long answer too.

1.    Thanks to the rout in commodity prices. India’s imports are falling. But at the same time India’s exports too are falling. So the trade deficit is not coming down keeping the same pressure on Rupee. In the last one year, trade deficit ranged from $6B a month to $16B. On average it would be around $10B of trade deficit a month. It would mean approx. 5-8% of devaluation is assured every year for the Indian currency. When the imports were high in the past, pressure on Rupee was even higher. See the chart. From 45 a dollar in 2009, Rupee is devalued to 65 in 2015. That is a 45% fall in six years.
USD to Rupee exchange rate. Source:Investng.com
2.    ‘Winner takes it all’ in the global currency market. In 2009, it took 1.5 USD to buy a Euro, now it takes 1.1 to buy the same. And the latest victim is China. Its exports are falling so its currency cannot remain strong. It joined the emerging nation’s currencies in the fall despite trillions of dollars in forex reserves. RBI, are you taking note?

3.    During the last year, RBI added around $70B to forex reserves. Much of the incoming dollars ended up with RBI. Had they remained in the circulation, it would have taken some pressure off from Rupee. No, RBI wants to build a war chest. What war? When China’s currency fell with a $2 trillion dollar reserves, what kind of war RBI wants to fight with $350B reserves? Strength in economy brings strength to currency and not the reserves. While bringing strength in the economy is Govt.’s job, RBI tries to make up for the poor performance of Govt. by adding to reserves.

4.    What is the purpose of forex reserves? Primarily, we need to cover for trade deficit. $350B is enough to cover next 35 months of trade deficit. Then why keep adding to it than looking for ways to balance the trade? We need to cover our foreign loan payments too. And RBI wants to make Rupee fully convertible so it wants to take reserves. While they have a purpose in buying the dollars, when our currency is already under pressure, it is like ripping the consumers of this nation from the benefits of lower commodity prices. Had our currency traded at 50 a dollar, Petrol prices would have been below Rs.50 a liter and Gold would be below Rs.20,000 for 10 grams. That is the price we would have paid in the international market had we managed the currency better. It would have helped the balance of trade situation too.

5.    Let us come to capital outflow. When an economy is stronger, why the capital flows will reverse? If you cannot assure that why bring in FDI? Higher dollar reserves help only one country, USA.

6.    Will weaker currency aid exports? If so, why India’s exports are falling? All of the demand is not price dependent. That is the basics of trade. For export oriented countries, a weaker currency may help in boosting income but for India with its imports higher than exports, weaker consumer beats the consumer. Losses are outweighed in comparison to the benefits the exporter is getting.

If RBI does not stop buying dollars, Rupee’s weakness will continue. It needs to stop covering up for Govt.’s mistakes. If there is a huge fall in Rupee, let Govt. take the final blame and responsibility. If you cannot make them accountable, they would never change their spending patterns.

When the major economies are fighting deflation, India a developing country still has 4%+ inflation. And it might be clear to you now who is manufacturing this inflation? It is our central bank hand in gloves with the Govt. of India. Buying dollars and printing Rupee does not help if underlying economy does not improve. China has proved it. But we want to follow China and repeat the mistake. In future, if Rupee takes 100 bugs to buy a dollar, you know who let it happen.

While Rajan has done a good job of bringing inflation from 10% levels to 4-5% levels, it is still not an extraordinary job when Japan and Europe have 0-1% inflation, US and China have 1-2% inflation. When it comes to currency, there is only one winner ruling the world, it is US Dollar. And it is surely behind Rajan's control. But when it comes forex reserves, he has full control and he prefers to buy them like we common people buy gold as reserve and stare at our misfortunes.

1 comment:

  1. India is consuming market..US is producing market.
    Unlike "US"...India is entirely dependent..whereas US is interdependent.
    "US" is profit oriented market.
    Best example is 90% profit in smartphone industry taken by APPLE.."winner takes all".
    As you said,, higher inflation is the big reason.