The sensational rupee
In 1895 Oscar Wilde inserted the following line into his play The Importance of being Earnest
Cecily, you will read your Political Economy in my absence. The chapter on the Fall of the Rupee you may omit. It is somewhat too sensational.
The recent fall of the rupee, as the remaining major Asian currencies remain stable, has been equally sensational. A typical analysis comes from Scotia Bank:
Renewed Spain-centered European financial stress, decisive and multifaceted central bank intervention, global portfolio diversification waves, alleviated supply-side crude oil market pressures and improved US growth dynamics are the key factors shaping investor sentiment in global currency markets.
INR is by far the least attractive major Asian currency, explaining its notable underperformance in April. The RBI cut rates by more than expected in April, but the pace of much needed easing going forward will be constrained by persistently high inflation. Growth momentum remains unfavourable (despite being reasonably high in absolute terms), while S&P recently downgraded the outlook for the country’s BBB- sovereign rating to negative in light of fiscal risks. The gaping current account deficit is a risk to INR during periods of financial market instability, while INR appreciation depends heavily on benign global macro-financial conditions.
The last factor is due to the internal market being highly under-developed, a condition that is bound to persist unless the buying power of the lowest 50% of the population improves substantially. Fiscal risks are largely the deficit created by large scale subsidies of various kinds. No government will dare to remove these until the poor are less poor. Till then, the Rupee will have to depend on external conditions to turn more benign.
One month on, an article in ET talks about possible reasons for the decline of the rupee:
To begin with, the oft-repeated myth is that the recent disturbances in the rupee value is mostly because of the euro turmoil. As Table 1 shows, there are two reasons to believe that the euro crisis is not driving the free fall in rupee value.
First is the absolute level of claims of European banks on South Asian economies, including India. Second is the decline in liabilities of the European banks on such economies in 2011. Both these factors should result in weakening of the domestic currency. As far as the first point is concerned, even though countries like Malaysia, Korea and Thailand had significant bank exposures, the pace of currency depreciation was much lower than India. For example, Malaysian banks’ exposure was at 20.3% of GDP but its currency depreciated only by 7% during August 2011-June 20, 2012. On the other hand, Indian banks’ exposure was at 7.2% of GDP but the rupee depreciated by as much as 27% during the same period. Secondly, the extent of deleveraging is higher for countries like Thailand and Philippines as compared to India during 2011, yet, the extent of currency deprecation is much smaller for these countries compared to India. Clearly, the euro crisis is not the reason for rupee decline.
The second myth that various analysts point out is that the Indian currency is the worst performing. This is not entirely correct. For example, in May 2012, rupee declined by 6%, but the decline was still less than the slide of currencies of Brazil, South Africa and Russia against the dollar.
We believe that movements in India’s balance of payments (BoP) have been the primary reason for decline in rupee value in recent times (refer Exposition 1). In particular, BoP has been in deficit mode in FY12, with an ever increasing trade deficit (at 10% of GDP). The deterioration in BoP had also been aggravated by a concomitant decline in capital flows, reflecting perhaps a loss of investor confidence. Clearly, the decline in rupee value is attributable to structural factors that may be specific to India!Advertisements