The past few days have seen much brouhaha about the Rupee touching 70 to the USD. Did you ever see such a reaction to the Rupee touching 31 or 35 or 40 or even 60?
All that was perfectly okay to the Lutyens ecosystem, that has been a beneficiary of the largesse showered on them by previous Governments. However, the moment the USD touched 70, this lot, with little knowledge of Economics and lots of knowledge about systematic disinformation, went about their work and tried to create a big furore about this.
No doubt a number of gullible souls will swallow the rubbish that the lutyens rudalis gurgitate and regurgitate on their printed pages and dubious portals such as the quint, wire, print and what have you.
Hopefully, you would understand by the end of this article that there is no need to panic. That the value of the rupee vis a vis the dollar is not necessarily an indication of ‘economic strength’ regardless of what the paid media and press tell you.
To understand how the Dollar Rupee pricing takes place, let us take an admittedly hypothetical example. Let us take the example of a kilogram of refined wheat flour or maida. Let us assume that the price was Re 1 per kilogram in 1947. Assuming it was the same in the USA, or US $ 1 per kg, as the Rupee value was Re 1 per USD.
Now if you see the table below, you will see how the price of flour would behave assuming inflation of 8% in India and 2% in the USA
|Year||Cost in USD for 1 kg of flour||Cost in INR for 1 kg of flour||Value of USD to INR|
However forex markets do not always behave in such a simplistic manner. There are many factors at play. For instance, the value of the USD to the Rupee in 1948 was 3.36. How many worthies in India made a noise when the lutyens darling JLN or Jawahalal Nehru depreciated the Rupee by 236% in just one year!
I remember when the Rupee was devalued to Rs 7.50 from Rs 6 to the dollar in 1967. Rupee dollar parity was decided on the basis of RBI or the Government’s whim. There may have been reasons for pegging the USD to a certain value against INR, but that was something only the mandarins of the Finance Ministry or RBI knew. This happy state of affairs, for the Government continued till 1993 when we were faced with a big forex crisis and had to open our markets. Shri Narasimha Rao, one of the best PMs we had, decided to bite the bullet and do the right thing. He allowed the INR to float, viz. to seek its own value. This and an open marker policy brought a huge influx of foreign currency into India. Since India was still in the fledgling stages of opening the economy, a free float was a better option than opening the currency to making the Rupee freely traded in the International markets. As the foreign currency kept coming in there was a danger of the Rupee strengthening greatly, making exports unviable. Remember that at the time we needed to shore up our forex reserves to ensure against any medium term or long term shocks.
In a situation where we have huge amounts of foreign money coming in, a free entry into the market can trigger off a catastrophic strengthening of the Rupee. Here is another conundrum. If the foreign currency is absorbed by the RBI, there is a problem of huge Rupee inflows into the market. Let us say that RBI decides to buy and absorb the dollars from the market. There has to be a corresponding outflow of rupees from the RBI. But this would lead to inflationary pressures building up. How does this happen. Increase in domestic currency in the banking system would lead to more money supply and there would be too much money chasing too few goods. The RBI gets over this by selling Government securities in its possession. The excess money supply gets absorbed due to the sale of securities by the RBI. Money supply stays put and all is well.
There are other factors such as inability to stop imports. The ever expanding reach of mobiles to even the poorest sections of society means imports of parts for assembly of mobiles in India or import of the mobile phones which means heavier outgo of foreign exchange. This government has managed to ensure that the inflows keep coming and the outgo is manageable. There always are risks and one of the biggest risks is FII or money being brought in by Foreign Institutional Investors. These are volatile kind of inflows that could disappear in a trice if there is adverse perception on the part of these investors. Much of the FII funds are coming from what are called Participatory Notes, introduced by a gentleman, and I use the term advisedly, called Palaniappan Chidambaram. It is a good avenue for the use of black money that has found its way abroad. What the owners of such illicit cash discovered is that the money kept in tax havens such as Swiss banks is a wasting asset. On the one hand there is no return on the money lodged in tax havens and on the other there is interest to be paid for keeping such funds. Our esteemed Finance Minister f yore decided that there was a way to ensure funneling such funds into the stock markets. Money coming in from Mauritius could be used to get good returns from Indian stocks. This could be done by not questioning the source of such funds. Typically such funds are routed through companies such as Morgan Stanley or Goldman Sachs who take money from investors and are permitted to invest such money in the stock markets. The investors get a piece of paper called a Participatory Note that tells them the amount invested. The best part is that no investor has to register with the Securities and Exchange Board of India, the stock market regulator. So the regulator has no clue of who is investing money in the markets. The front of reputed companies is used for the purpose. No KYC, no money laundering charge as these companies keep the list confidential. Suits the lowlifes and the crooks perfectly! This has not been attended to by the Modi Government. There should have been a ban on P Notes. However, with Jaitley as FM, there is little chance of that happening. After all it was this genius who screwed u the implementation of demonetisation, firstly by not ensuring adequate availability of Rs 100 notes and secondly by introducing new 500 rupee notes and a bigger denomination of Rs 2000. I suppose this man is there for a reason but damned if I can figure out why!
In any case, these are a few risks that exist. However, a cursory glance the position of FII shows that the inflows and outflows are almost matched and mostly purchases exceed sales. The final figure till 2018 August indicates that the net inflow is a mere 5000 crores. The forex reserves as per statistics available indicate that India has a forex reserve of $ 407 billion. That is more than adequate to take care of any run on the Rupee.
Of late the USD has been strengthening against all currencies. Forex markets are speculative in nature and once a trend has been established it gets followed by all speculators. Unless one is able to anticipate a change in the direction of movement the herd mentality prevails. Hence, the Rupee has to weaken to ensure that our exports are not affected adversely.
The Dollar strengthens when inflows to dollar assets increases vis a vis other currencies, e.g. the Euro or the GBP or the Japanese Yen for instance. China plays a large role in the forex markets and does not allow its currency to strengthen. India has to at least ensure too that its exporters are not hit too badly and has to therefore depreciate the Rupee gradually. The impact of this depreciation is not too bad. For instance in the prices of diesel and petrol, the impact could be about a Rupee or two on the basic price. To provide some relief to consumers of petrol and diesel, the taxes on these items should be reduced by State governments and a little bit by the Centre.
Overall, there is no need to press the panic button when there is a mild depreciation of the Rupee. When I was working in the Gulf in 2013, the Rupee went down to Rs 68 to the USD. This was an engineered feat and some speculators on the inside made a huge pile of money as it strengthened by three rupees almost immediately.
This country has lived through several devaluations of the Rupee in the past. Come to think of it, the rupee was at around Rs 63 against the USD in 2014. In four years it has gone to 72. Not too much considering the depreciation of other currencies vis a vis the USD.
Okay, also consider that for around 67 years we have had a Rupee depreciation of 6300% against the USD or an average of 94% p.a. So a depreciation of around 5% p.a , without pressure on commodity prices, is quite manageable!
Please understand that for almost the entire 67 years, the congress had been managing, or mismanaging, the economy. In fact in the five years of BJP rule between 1999 and 2004, the economy showed a robustness not shown for a long time. Kindly read my blog post on this.
Just ignore the Rudalis!