Indian rupee’s turmoil has echoes of 2013

Currency volatility is like history. No two episodes repeat, but some sure do rhyme. Which is why it’s useful to compare the pall of gloom hanging over the Indian rupee with the rout of 2013.

Back then, the Federal Reserve had signaled that it was going to taper its quantitative easing program and tighten monetary policy. Currently, the Fed is easing.

Also in 2013, India’s inflation and current account deficit were out of control. Foreign investors clubbed the most-populous nation with Indonesia, Brazil, Turkey and South Africa. Morgan Stanley called them the Fragile Five.

That bleak landscape has changed dramatically. Domestic inflation is practically nonexistent. And while exports swooned in October, pushing the trade gap to a record, few analysts are losing sleep over the country’s ability to finance its trade shortfall.

Yes, the 50 per cent tariff imposed by the US, the highest in Asia, is bad news for labor-intensive exports like textiles. But services trade should hold up. Although outsourcing firms in Bengaluru and Hyderabad are under attack from artificial intelligence and US immigration policies, multinationals are placing AI tools directly in the hands of India’s vast pool of young, technical talent, paying top dollar to create strategic intelligence hubs.

Why then is the rupee Asia’s worst-performing currency this year, down 5 per cent against a falling dollar, and why are analysts bearish about its prospects?

For one thing, the much-awaited trade deal is yet to get done. In the absence of more reasonable 15 per cent to 20 per cent tariffs that Washington has offered to rival producers in Southeast Asia, rupee depreciation may be helping to mitigate India’s loss of competitiveness. A measure of that — the rupee’s real effective exchange rate against trading partners — is down considerably from its 10-year average, though it took a bigger slide in 2013 to restore market equilibrium.

The other problem is the extreme despondence among overseas equity investors who have pulled out $17 billion this year. They don’t think corporate earnings are rising fast enough to justify lofty valuations. The backdrop to profitability is no longer the double-digit growth in nominal gross domestic product that could be taken for granted in the past. The most recent rate of GDP growth before adjusting for inflation was 8.7 per cent. All hopes of a liftoff are pinned on household spending, aided by lower consumption taxes. Investors, meanwhile, are obsessed with AI, where the local market has nothing to offer. Money managers aren’t even requesting to meet Indian firms at investment banks’ annual conferences.

This is where history offers a contrast and a connection. The seeds of the Fragile-Five debacle were sown by the Reserve Bank of India buckling under political pressure and cutting rates in 2012 amid soaring fiscal deficits and untamed inflation. The economy overheated because real interest rates were too low. Nowadays, they are too high. Effective borrowing costs of more than 6 percentage points — inflation of 0.25 per cent subtracted from the 10-year yield of 6.6 per cent — are a problem for firms. And they can’t expect any immediate respite. The RBI’s easing cycle is believed to be over.

As for what’s rhyming with the past, the answer is gold. In 2013, spooked by the loss of purchasing power of their home currency, Indians had switched to buying imported bullion in a big way, aggravating the trade deficit.

This time around, it’s the rally in gold prices that’s encouraging imports for investment and speculation. This week’s Fed rate cut has further whetted appetite. An exodus of foreign capital just as money leaves due to gold purchases is reminiscent of what happened 12 years ago. Besides, gold is no longer the only tradeable global asset available to the middle class to express its unhappiness with the rupee; there’s also crypto.

The RBI wasn’t too concerned when the rupee recently stumbled past 90 to the dollar. A cheaper currency is a shock absorber against US tariffs. But where’s the floor? If the deal with Washington gets pushed to spring — it was supposed to get done this fall — markets may test Governor Sanjay Malhotra on just that question.

Traders know that the rupee at 100 (it’s at 90.4 now) will be politically embarrassing. Prime Minister Narendra Modi rode to national power in 2014 by attacking the then-government for elevated fuel prices and a depreciated currency. Now the shoe is on the other foot, and bond investors are feeling the pinch. The central bank’s net dollar shorts in the forward market — $64 billion in October — has them worried about a deeper slump.

After all, were the RBI to buy incoming greenbacks to square off its position, the rupee might slip further and squeeze returns for overseas fixed-income funds. So far this month, foreigners have sold 70.99 billion rupees ($790 million) of index-eligible Indian bonds. Even with the yield on the benchmark government note at its highest in more than three months, they seem unwilling to bite. Lest the rupee comes back to bite them.

The RBI lost the plot in 2013 amid the Fed’s “Taper Tantrum.” Malhotra’s challenge in 2026 will be Trump’s tantrums. With the US president signaling one day that a deal with India is close and vowing to punish it the next for dumping rice, the new threat looks every bit as scary.