Pegging nationalism to value of rupee, a tragic mistake

The country saw huge public uproar against the contionous depreciation of the rupee in recent days. The twitterati left no stone unturned in criticising the government on the depreciation.

Prime Minister Narendra Modi had sarcastically remarked in July 2013, that India’s Prime Minister is an economist, yet the economy is in such a bad condition. Very soon, the dollar rate will touch the age of then Finance Minister, P Chidambaram, who was 68 at that time, he had added. These comments have come to haunt him off late.

The Indian rupee was pegged at Rs 68.18 as against the dollar, as on February 3. This is a devaluation of 6.6 per cent since the beginning of August, last year, when it stood at Rs 63.96 as against the dollar, as per the data available on the Reserve Bank of India website. The rupee has not only depreciated as compared with the dollar, but also showed a depreciation pf 6.1 per cent against the euro, and 10.5 per cent against the yen, in the same period. This fall has been despite more than 65 per cent drop in crude oil prices in the same period, as per the data available with US Energy Information Administration (EIA).

India imports 80 per cent of the oil that it consumes. Oil is bought and sold internationally in dollars. When Indian oil marketing companies buy oil they pay in dollars. This pushes up the demand for dollars and drives down the value of the rupee against the dollar. On the contrast, the rupee is depreciating.

The last time the rupee went so low against the dollar was some time late August, in 2013. But back then, the oil prices were at a really high level. Further, inflation was also high back then. The consumer price inflation (CPI) in August 2013, stood at a whopping 9.52 per cent. In order to hedge against this high inflation, people had been buying gold, which India produces very little of its own. Gold, like oil, is bought and sold internationally in dollars.

Worldwide devaluation trend

One important fact to be noted is that the dollar has been appreciating against virtually all currencies. “The most important reason is that most of the countries have deliberately kept their currencies depreciated to increase exports, in the wake of declining domestic demand,” says Govind Rao, Member, Fourteenth Finance Commision. “In the beginning of the year, as many as 20 central banks have eased their monetary policies, and this includes Japan, the Eurozone and even China,” he adds.

In other words, there has been competitive devaluations in many countries to boost their exports in the wake of declining domestic and falling international demand.

It is also a fact that while the economies in most of the countries in Europe, and emerging markets including China have substantially weakened for various reasons, the US economy has recovered well and is expected to grow at three per cent this year. “India is the only large emerging market economy which is seen to be doing well. At the same time, continuous decline in exports for over 13 months is a cause for worry and is an important reason for the depreciation of the Indian rupee,” opines Rao.

 It is therefore, not surprising that the Indian rupee has depreciated in comparison with the dollar, though, the depreciation is relatively less. Rao is of the opinion that, as compared with other currencies, the Indian rupee is far too strong and it may be one of the causes of falling exports. “Perhaps, during the course of the year, with the US moving out of quantitative easing and increasing interest rates, there may be grater pressure on the Indian rupee and this might require further depreciation of the rupee,” he adds.

Quantitative easing—a problem

Rao brings in an important point here. He highlights the issue of quatitative easing. In the wake of the financial crisis, which started in September 2008, Western apex banks led by the Federal Reserve of the United States, cut their interest rates to close to zero per cent.

Ben Bernanke, the then Chairman of the Federal Reserve of the United States, was instrumental in this. The basic idea behind this was that at low interest rates people will borrow and spend more, and economic growth would return in the process. While that happened, what also happened was that financial institutions borrowed money at low interest rates and invested it in financial markets all over the world.

In 2013 also, if we look back, we in May 2013, just months before his term as the Chairman of the Fed was coming to an end, Bernanke hinted that the ‘quatitative easing’ policy being followed by the US central bank could come to an end. This meant that interest rates would go up in the months to come.

Fluttered, financial institutions started withdrawing their investments abroad. Between June and August 2013, foreign institutional investors sold stocks and bonds worth Rs 75,291 crore in the Indian stock market as well as debt market. They were paid in rupees, when they sold their investments in stocks as well as bonds. Due to conversion of this amount into the demand for the dollar went up. In the process the value of the rupee against the dollar crashed. If the hearsay is to be believed, the interest rate hike might happen now. Janet Yellen, the current Chairperson of the Federal Reserve, might raise interest rates. This means that the financial institutions, which have borrowed in the United States and have invested across the world, would have to pay a higher rate of interest on their borrowings. This may make their trades unviable.

Between November and December alone, foreign institutional investors have sold stocks and bonds worth Rs 15,035 crore in Indian markets, athough in 2015, total inflows to India increased by 22 per cent to o $34 billion, as compared with last year. Also, as the rupee loses value, the foreign institutional investors also lose the money. Let’s say an investment is worth Rs 100 crore. If one dollar is worth Rs 65, then this investment is worth $15.3 million. When dollar depreciated to say Rs 67, then this investment is worth only $14.9 million. In order to prevent this loss, bonds investors sell out of Indian stocks and bonds. So any indication of hike in interest rate in the US will have a domino effect, effecting the rupee also.

So, have foreign investments really helped us after all the brouhaha surrounding it? We should note that the volume of investment required is large and it has shown a declining trend from over 38 per cent of GDP in 2007-08 to about 29 per cent in 2014-15. We need foreign investments not only to create jobs but also to get modern technology. “We need to create conditions for labour intensive manufacturing to occupy the place of China, which has moved up in the value chain as the labour cost in the country has increased. Enhancing investment is the key to prosperity and we have to get the investments from wherever we can and this requires changes in the mind set and reform of policies and institutions,” said Rao.

The basic problem with most of us is that we peg our nationalism to each and every thing, including the rupee. Banking on this, Indian politicians have turned the value of the rupee against the dollar into a prestige issue. And amidst all this, we tend to forget that we live in a highly connected and sophisticated world. The appreciation of the rupee might have an adverse effect on foreign investments and exports. It is a time we stop making rupee a prestige issue, and let the market factors play their part in it.

Average monthly exchange rate of Rupee against major currencies

                      USD     GBP       EURO    YEN
Feb 2016*    67.90    97.48    73.93    56.32
Jan 2016    67.25    97.11    73.08    56.87
Dec 2015    66.60    99.94    72.46    54.68
Nov 2015    66.12    100.62    71.09    54.01
Oct 2015    65.06    99.76    73.06    54.19
Sept 2015    66.22    101.60    74.39    55.15
Aug 2015    65.07    101.49    72.51    52.87
Changed %    4.34    -3.95    1.96    6.53