At the beginning of April, $1 (£0.77) was worth 65.1 rupees. On 11 September, $1 bought 72.7 rupees – a record low for the Indian currency. In a little over six months, the rupee has slumped more than 11%.
Why is the rupee falling? One big factor is oil. India imports more than 80% of the oil it consumes. That dependency – coupled with higher oil prices – has seen the country’s oil import bill shoot up this year. The oil import bill for the first three months of the financial year was $28.9bn, up from $18.8bn last year.
A higher oil import bill basically translates into a greater demand for dollars by the oil marketing companies, which bring oil into India.
Money takes flight
Along with the oil marketing companies, a greater demand for dollars has come from foreign investors who are pulling out of India.
Over the years, foreign investors have poured a lot of money into India’s stock and debt markets. This was largely fuelled by all the easy money floating around the Western world in the aftermath of the financial crisis that broke out in 2008.
Foreign investors borrowed money at low interest rates and parked that cash in India and other emerging markets. Now with interest rates likely to go up in the United States and other parts of the Western world, there has been a dash to take money out of India, particularly the debt market.
As well as rising interest rates, the general global bearishness regarding emerging markets after crises in Argentina and Turkey has intensified India’s currency woes.
In the three months to June, these investors withdrew $8.1bn from India. During the same period last year, they had brought $12.5bn into India. When these investors sell their Indian holdings, they get rupees. They sell these rupees for dollars, and thus push up the demand for the dollar.
Typically, this demand for dollars is met through dollars that come into India via the services sector – primarily information technology companies that bill in dollars. But services receipts during the period have gone up only 2.1% to $18.7bn.
Foreign direct investment coming into the country, and remittances from Indians working abroad, also bring in dollars.
To cut a long story short – the dollars coming into India haven’t been enough to meet the demand for dollars leaving India – and this has led to the rupee falling in value against the dollar. A clear case of supply not meeting demand.
The Reserve Bank of India (RBI), has tried to stem the tide by selling dollars and buying rupees. The foreign exchange reserves of the RBI stood at $400bn as of August. They were at $424bn just four months earlier.
The larger point here being that even with the RBI intervening, the rupee fell against the dollar. The one lesson that the world learnt from Asia’s 1997 financial crisis was that it is a very bad idea for a country’s central bank to get obsessed with the value of its currency against the dollar and try to defend it at any cost.
There are only so many dollars that a country’s central bank has, and they need to be used wisely. At $400bn, India has enough foreign exchange reserves but they need to be used judiciously.
In fact, when the rupee last fell sharply against the dollar in 2013, the RBI tried to stem its fall by intervening in the foreign exchange market. Everything from raising interest rates to talks about a bond issue for non-resident Indians, was interpreted by the market as a panic reaction. This put the rupee under further pressure against the dollar.
But there will be great pressure on the RBI from the government to keep defending the rupee, at all costs.
Pain at the pump
Prime Minister Narendra Modi, in the run-up to the 2014 general elections, used the falling rupee to discredit the government. He is facing the kind of taunts he made back then, from the opposition parties right now.
Further, any dip in the value of the rupee leads to an increase in petrol and diesel prices, which is a very sensitive issue for India’s large middle class. As well as this, industrialists who have borrowed in dollars to take advantage of low interest rates, without having hedged their borrowing, have already started making noise.
Given this, there will be tremendous pressure on India’s central bank to prevent the fall in the value of the rupee against the dollar. The industrialists will lobby for it as well. At best, the RBI should intervene to smooth the rupee’s fall and let it find its level.
Also, RBI Governor Urjit Patel can do what former RBI governor YV Reddy did in 1997 during the Asian financial crisis. Mr Reddy, who was a deputy governor of RBI back then, talked up the value of the rupee.
Mr Patel can do the same. India’s economic fundamentals are looking up. Economic growth for the three months to June stood at 8.2%. Some of it was because of base effect, but even considering growth over a two year period, it is close to 7% per year – very healthy by global standards. On top of this, quarterly results for the three months to June have been the best in two years.
The problem is Mr Patel, unlike his predecessors, does not like to talk.
It’s high time he broke his silence.