Originally Published 2018-08-20 05:10:06 Published on Aug 20, 2018
The rupee’s future

The rupee’s free fall to a historic low crossing Rs. 70 to a dollar recently is something to be worried about. No doubt, India is an important player in the global arena and global winds affect the value of the rupee. It was one of the fragile five — India, Turkey, South Africa, Indonesia and Brazil -- countries most vulnerable to the volatility of Foreign Institutional Investment (FII) flows. With Indian rupee plummeting nearly 10 per cent in 2018, India has not quite quit the group.

But no doubt, all the recent turmoil is due to President Trump’s trade war which in its latest turn has targeted Turkey over a diplomatic issue of President Recep Tayyip Erdogan detaining an American pastor.  But this time, Trump’s move can lead to global recession. All Emerging Markets have been impacted by Turkish lira’s steep fall on account of Trump’s sudden doubling of tariff rates on Turkish imports of steel and aluminum. Turkey’s economy was already weak in recent years (since the failed coup against President Erdogen in 2016) with high inflation, low export growth and high interest rates, and now the sudden rise in tariffs has led to an economic meltdown that could spread to other countries.

Already the Indonesian rupiah has fallen and so has the Chinese yuan and South African rand. Stock markets across the globe have plunged as the FIIs have pulled out of Emerging Markets and sought safer havens in developed countries. Many have gone back to the US whose economy is doing well and has re-bounced to a 3 per cent GDP growth rate with unemployment at a record low level of 3.9 per cent in July 2018.

Turkish Lira’s fall has also been due to FIIs pulling out too rapidly because in the past, they had piled money into Turkish assets lured by a stable economy and high returns. Investors have been driven by the fear of contagion and have pulled out of the Indian market also. Since the beginning of 2018, FIIs have been leaving India ( $7 billion since beginning of 2018) regularly to get back to US as its economy showed sure signs of recovery signaled by hikes in interest rates.

But India’s case is better than Turkey’s and the RBI has sufficient forex reserves of around $405 billion to deal with any major volatility in the stock markets. The RBI has been intervening regularly to support the rupee in the past months and $21.8 billion of India’s forex reserves has already been depleted by end March.

 Many have welcomed the fall of the Rupee because they claim the Rupee was overvalued by around 7.6 per cent in terms of the Real Effective Exchange Rate (REER) which is valued against 36 currencies, taking into account adjustment for differences in inflation in different countries.  The fall in the value of Rupee in terms of dollar is a correction that they seem to welcome. Among those who have supported the depreciation of the rupee are the Vice Chairman of Niti Ayog and the former RBI Governor Raghuram Rajan.

For India to weather this crisis smoothly, the fundamentals will have to be strong in an increasingly turbulent trade regime. There is no doubt that some exports like software and IT services from India will benefit from the rupee’s depreciation. But India imports much more than it exports and the current account deficit has been widening in the last few months and could reach $75 billion this fiscal. Most importantly, a lower rupee will hike the oil import bill. India also imports many electronic items and edible oils plus various inputs that go into export industries.

All imported consumer goods will cost more and so will holidays abroad. Students studying abroad will also be adversely affected by the fall of the rupee. But if India’s external debt is in check and inflation is in control, India is not facing any imminent danger because it will stem any big FII outflow.

The corporate India’s earnings have shown a rise of 7.9 per cent in the April to June quarter. If sustained by a rising consumer demand, it will contribute to the rise in corporate profits. Corporations, however, will be hit by rising servicing charges on the loans they have taken in the past. Turkey became vulnerable to a meltdown mainly because it has a high private sector debt and a lot of it is foreign exchange denominated. Commercial borrowings in India is 38 per cent of the external debt and around 49.5 per cent was dollar denominated in March 2018.

India should also be wary against fiscal slippage. This is because investors are watchful of such indicators and if they see any widening of the fiscal deficit, they are tempted to withdraw from such markets as it is indicative of rise in inflationary pressure. Already the July inflation is higher than the RBI’s medium term target of 4 per cent.

In the past, protectionism led to the Great Depression but President Trump does not seem to care. In addition, higher oil prices will aid in ushering a worldwide recession. It is important that India does not provoke Trump because his retaliation is now feared by all. India is in a vulnerable position as it has a current account surplus with the US and it has tried to impose additional tariffs worth $235 million on 29 American products. Negotiations are going on and hope there is a compromise.

China is paying the price of trying to retaliate against Trump by targeting American products worth $34 billion with higher tariffs. Its economic slowdown is now a matter of concern to President Xi Jinping in the face of its export stagnation. For the first time, it is facing a trade deficit.  China exports much more than it imports from the US. China’s yuan has depreciated by 0.34 per cent recently. In any case, unlike China, the US economy is not driven by its export sector and it is still the biggest economy in the world.

Unless the Indian economy guards itself against fiscal profligacy and inflation in the election year, the rupee may come under pressure repeatedly, creating problems in industrial growth and hence a lower GDP growth. The rupee has to perform well to attract FIIs for the health of the stock market. So far it has been the worst performer in Asia.

 This commentary originally appeared in The Tribune.

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David Rusnok

David Rusnok

David Rusnok Researcher Strengthening National Climate Policy Implementation (SNAPFI) project DIW Germany

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