“This is the beginning of the big bang for India” quoted Masayoshi Son, CEO of SoftBank while talking about the current economic growth patterns in the country. Then why is it that the most promising Asian country also houses the worst performing Asian currency?
Before demystifying this apparent ‘paradox’, let’s dive into the basics of currency valuation. Like all goods, the value of a currency is determined by its demand and supply. Naturally, anything that alters the demand of a country’s currency also alters its value, where greater the demand, higher is its value. Factors like imports and exports, employment, interest rates, macroeconomic policies, variation in cash reserve ratio, and geopolitical conditions affect a currency’s value. An increase in demand for imported goods increases the demand for foreign currencies thereby lowering the local currency’s value. A country that sells more goods than it imports has a higher supply of foreign currency and a higher demand for its own currency. Hence, the local currency’s value strengthens.
Now that we have a basic idea of how currencies are valued, let us go through a brief history of what happened to our Indian rupee. Back when the Indian rupee was still pegged to the Pound, 1 Pound was equal to ₹13. Eventually, in 1966, the rupee was devalued and pegged down to 1 Dollar at ₹13. Since then it has only seen devaluation until the current ₹70.73=$1 USD (as of 23/11/18 FEDAI Data). Let’s take a ride to the 1950s when the government was facing an acute lack of funds. India borrowed extensively in the form of loans. The war with China (1962) and Pakistan (1965) coupled with the great drought in 1966 further worsened the situation. Political instability after the assassination of Indira Gandhi in 1984 reduced the confidence of foreign investors and after the economic crisis of 1991, the international community declared India a defaulter. Devaluation of the rupee was the only way out of these problems. Since then, corruption, ill management and failure of various economic schemes have only led to further depreciation.
The Indian rupee hit an all-time low this year at 74.39 per dollar on October 9 (RBI reference rates are used w.e.f. May 2012 FEDAI Data). And even though the rupee has steadily appreciated since due to softer crude prices and capital outflows, the obvious question arises here, with the Modi government boasting of exponential economic development, why is the rupee facing such steep falls?
India is one of the largest importers of crude oil. Naturally, rising crude oil prices have hit the Indian trade deficit hard. Import bills are higher than ever. This large trade deficit in India has led to greater demand for foreign currency. As per the law of demand, quantity purchased varies inversely with price. Thus, as the demand for dollar in the country increases, its price compared to rupee also increases causing depreciation in the Indian rupee.
Every economic shock has a direct impact on one person- the Aam Aadmi. Common people like farmers, housewives, vendors, and students like you and I face the brunt of these economic problems. The rupee depreciation is no exception. Falling rupee would mean that education abroad, especially in the United States would cost a bomb. Shelling out more money in terms of rupees for fuel causes public transport prices to rise. Increased transportation costs would increase the costs of basic commodities like fruits, vegetables, and groceries. In fact, any product in any store that requires transportation would become costlier.
Increase in fuel prices would make traveling more expensive. Even short-haul trips to Singapore, Dubai or Thailand would cost us more. So does that mean you can never fulfil your ZNMD and DDLJ dreams? Here’s where India’s rich geographical heritage can help. Why go to Switzerland and Spain when you have Kashmir and Goa! A depreciating currency presents an exciting opportunity for the domestic tourism industry.
Making the most of this opportunity should be our aim. Who all can benefit from the fall of the rupee? As the Indian currency falls, Indian goods become relatively cheaper making them more competitive in the global market. Thus, exports will increase. Indian manufacturers and traders will be the big winners. The government must hence promote Indian goods. In fact, some economists believe this is exactly why China’s currency is so undervalued. As the software and information technology is export-oriented and has a large share of dollar-denominated revenues, the falling rupee will bring fortune for this sector. Another sector that can benefit is the metal and machinery industry as the local price of metal depends on its import parity and greater amount of exports. Being one of the largest exporters of pharmaceutical products, India can expect an increase in revenue in this sector too.
If the government sells foreign exchange assets and buys its own currency, the demand for its own currency would increase and so will its value. Further, when RBI increases the repo rate, the rate at which the central bank lends to commercial banks, foreign investors are attracted by the higher bond yields and better returns when compared to other markets. If India gives a credible assurance of targeting a higher exchange rate, it might encourage speculators to invest in the country. Lower inflation levels will increase demands for Indian goods. Apart from this, political stability and steady economic growth will attract foreign investors and hence appreciate the currency.
Economics is the only subject where two people can present two contrasting ideas and earn Nobel Prizes for these ideas. Every condition has its pros and cons. But, we need to ensure that rupee depreciation doesn’t lead to grave repercussions. As continued capital flight and uncertainties pertaining the upcoming elections persist, the exchange rate can be expected to continue to hover around the 68-72 mark, a report by Tanvee Gupta Jain (Economist) and Rohit Arora (Strategist), UBS Securities India, said. While the government and RBI have major roles to play in this crisis, even we can contribute. A small step would be the minimisation of fuel usage and investment in goods and services produced in India. Acche din are not far if we strive for them.
– Shruti Mukherjee
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