Cancel the Holiday to the US! The Rupee is Tanking!

We need 80 Rs to equal 1 dollar. Ouch.

Recently, on a show on India’s economic progress @75 telecast on NDTV, Ruchir Sharma (Author, Breakout Nations) mentioned a  staggering statistic that the Indian Rupee has depreciated by 75 Rs in 75 years. The Rupee has been in news lately and has crossed the psychological mark of 80 before retracing back close to 79.

                                                                                USD – INR Movement 

The dollar is standing tall, while all asset prices are falling. Why?

The United States is the largest and the strongest economy in the world, if and when there is nervousness in financial markets, (there is plenty right now, with Ukraine – Russia & now Taiwan – China tensions), the world rushes to invest in the safety of the US dollar-denominated assets.

Interest rates were lowered to near zero by the US Fed (banking boss, aka the Governor) to combat the economic aftereffects of the pandemic. The world somewhat got through with it and now has to face the demon of roaring inflation.

Inflation is at a 40-year high of 9% in the US, so the US Fed is raising interest rates to fight it. They were the fastest in lowering rates and likewise in raising rates. The other countries haven’t caught up in raising that quickly, even though inflation is raging everywhere.

It follows therefore that return or yields or interest rates in US bonds are increasing, resulting in an inflow into investment in US bonds, especially government bonds. Right now, US treasury bonds are an unbeatable combination of safety & reasonably high return.

Also, the US is the world’s largest economy and houses the most innovative and adaptable companies worldwide. It leads to investment flows into their stock market when other geographies are looking iffy.

Nah.. it is still not clear why is the US $ going up & INR is going down.

Currency is like any other commodity, demand and supply determine the price.

If interest rates are going up in the US, large investors who have invested in India on account of higher interest rates here, start to believe that the difference between the rates in the two countries is narrowing. It is better to sell the riskier Indian bonds and stocks, take back the dollars they invested in the US and invest there.

This increases the demand for US$ so it becomes more expensive.

OK.Ok. Got it.

There is a demand for US dollars because people are selling other currencies (and or assets denominated) so the US dollar is rising.

India is a net importer, meaning the goods and services we sell to other countries are lower than what we import. To understand where we stand, we need to look at our balance of payments. Bop is a ledger of all the monetary transactions in and out of our country.

The BoP has two categories, called accounts — current and capital — to slot different types of transactions. The current account is further divided into the trade account (for export and import of goods) and the invisibles account (for export and import of services). If an Indian buys an American car, dollars will flow out of BoP, and it will be accounted for in the trade account within the current account. If an American invests in Indian stock markets, dollars will come into the BoP table and it will be accounted for under FPI within the capital account. To understand BoP further, click here.

Our Central Bank has been smart and has created a large war chest of dollars when there were a lot of dollar inflows into India. Right now the reserve stands close to 570 billion $ but can start to dwindle quickly if we are not prudent. To know more about India’s reserve click here.

Foreign institutional investors have been relentlessly selling Indian Stocks and Bonds leading to a fall in the Rupee. They have pulled out close to 2.56 lakh trillion Rs from our country since Oct 2021. To manage the demand for the dollar, the RBI has used up close to 10% of its reserves by intervening in the currency markets. The Central bank (Our RBI) intervenes by stepping in to sell dollars if there is too heavy a demand and the value of the Rupee starts tanking too fast.

What does the falling Indian Rupee mean?               

It is not all bad. First of all, the Rupee is falling lesser than the currency of many comparable emerging market countries. We remain competitive in our exports of software, tea, pharma, and textiles and at least keep up with the rest of the world in terms of pricing.  India as a tourist destination may become more attractive to foreigners.

On the flip side, a strong dollar gives means our import cost is high. The biggest effect is on the Oil & Gas sector. We import 85% of the oil and half of the gas we consume.  Our petrol price has risen which impacts everything and anything, inflation goes up which is currently at 6%.

Our central bank will have to also raise rates to manage inflation, when rates go up, demand is destroyed which helps to control inflation. Additionally, they have to raise rates so the interest differential between the countries does not widen and dollars does not move out of the country. Hence, borrowing costs will go up, growth will be slower. A recession may start in the US and spread all over the world.

Nonetheless, I believe that it is going to be hard to contain the fall of the Rupee, as our policymakers will try to contain inflation and hold on to our foreign currency reserves. They may just intervene and make sure that the movement in Rupee is not too violent.

So grin & bear it.

You may have to postpone or shell out much more for that much-awaited overseas vacation just yet.