With the Indian rupee touching 60, a new all time low, it is time one reflects upon the reasons for this mire. To put it in perspective, the rupee was 44.87 two years back and 55.95 a year back this month. The rupee has depreciated 8 percent in the last one month. While the higher growth rates in the country compared to the US have helped the rupee appreciate over time, the other factors such as high trade deficit, inflation, dependence on external funds for capital requirements, recent FII outflows have all contributed to this massive rupee depreciation.
India’s high trade deficit – 10.4 percent of the GDP 2012 has been one of the primary causes for the continued downward pressure on the rupee. Increasing gold and oil imports weigh in significantly here. Gold imports have risen almost 90 percent in May and 138 percent in April this year. Though our real effective exchange rate has been rising as it should owing to the higher growth rates compared to the US, in nominal exchange rate terms the currency has been significantly undervalued as Mr. Anatha Nageshwaran argues in his recent post in Live Mint column. The high inflation India has been witnessing since 2008 has eroded the comparatively higher growth rates lead appreciation effect.
This inflation effect on the currency has to be emphasised further. Inflation eats into the purchasing power of the rupee and erodes its value at home and abroad. There has been a lot of debate on the reasons for high inflationary scenario in India for the last couple of years. Most arguments tend towards supply side constraints and to a smaller extent to higher wage rates in the rural economy owing to generous rural employment schemes contributing to higher fiscal deficit. The inflationary expectations etched into people’s decision making have led to a large scale gold purchase as an inflation hedge, thus reducing domestic savings available for investments. This makes us vulnerable to finance capital needs from the outside, thus putting pressure on the rupee again.
The fiscal deficit of India has been on the rise too with current numbers hovering around 4.9 percent of the GDP. This has to be inevitably financed through tax receipts, disinvestments or in a worst case resort to monetary economics and postpone the pain to future generations. The latter comes with a bitter pill – inflation and to a smaller extent crowding out investments in the private sector that has muting effects on growth too. Neither of which is good news for the currency.
FIIs have been benevolent to the emerging economies so far, especially in the bond markets. Given the near zero interest rates in the US, there was no better place for them to invest. This is fast changing judging by the events following Bernanke’s exit plans announcement on May 22. Emerging markets have witnessed a major sell-off in bond markets since then. Further, India has only encouraged corporate foreign borrowings lately. Low interest rates in the west incentivised such continued borrowings.
There is certainly some of truth to the arguments that say the rupee slide especially in the last month is primarily due to external factors and is merely part of a global phenomenon. A couple of the reasons mentioned here, although, only ephemeral effects, are symptomatic of a larger malaise we need to fix in the country – like structural reforms to curb inflation, fiscal prudence, providing investment incentives to domestic savings and making our exports more competitive. The economic crises in the past have not been harmful exactly (1991 BOP crises lead opening of economic borders) for us and rather served as booster shots forcing our governments to take necessary and bold steps. So, arguably, this could be that event we have been looking for.
Pratham Jahoorkar is an entrepreneur in financial services industry and is based out of Mumbai.