Falling Rupee is Not the End of the World, Here's Why

Please do not rue the falling rupee. You must rue if competitive markets are damaged, investments aren't productive.

Why you should not panic about falling rupee.

(Illustration: Aroop Mishra)

Video Producer: Shohini Bose
Video Editor: Prajjwal Kumar
Camera: Athar Rather

And, it’s hit 80 to the dollar. Officially, the Indian rupee is on octogenarian. But why so much hai tauba (chest beating)? Why should all of us be panicking?

And how did we get here? The tipping point was Russia’s invasion of Ukraine that disrupted the supply lines of global commodities, triggering unprecedented inflation.

The war’s economic fallout has been devastating:

1. Foreign investors have already pulled out over $30 billion from Indian stock markets in this calendar year

2. India has run up a trade deficit of $70 billion in just the first quarter of the current financial year

3. Our foreign reserves have fallen by $50 billion to under the ‘bragging point” of $600 billion

4. Nearly $270 billion of external debt is coming up for redemption within nine months. Now go figure which side of 80 will the rupee dance against the dollar?

Nothing Negative About the Falling Rupee...

But I find this ‘80 phobia’ highly amusing. I wonder how many people understand that Japan and China – both miracle economies over the last half century – deliberately kept their currencies low to win export markets for their manufactured goods?

A cheap currency ‘protected’ their low tech, uncompetitive economies, buying them the time needed to scale up to a modern, highly productive industrial base.

Can anybody tell me two, just two, bad outcomes of a depreciating rupee? One is clear – a falling rupee fuels imported inflation, period. Higher oil prices, fertiliser costs, capital goods investments, and what not – every import becomes costlier and feeds into a price spiral.

Ok, now tell me about the second bad outcome? “Err, I guess a falling rupee dents my national pride?

Hey, c’mon. Is that even an economic argument, or simply a foolish, political, maudlin statement?

Because the hard truth is that except for importing inflation, there is nothing – repeat nothing – negative about a falling rupee. Plus, if markets are efficient, and governments do not panic or intrude belligerently, a self-correcting mechanism kicks in. How? Well, here’s a simple example:

Here's Why

Imagine that six months back, a foreign investor sold Share A for Rs 75, and took one dollar back home. This had two impact points:

1. A’s share price fell.

2. The rupee also fell.

Now other foreign investors, fearing a falling rupee and share price (ie, a double whammy on the value of their portfolio), also begin selling.

Imagine that this selling spree has taken A’s share price down from Rs 75 to Rs 60, while Rs 80 are now needed to buy a dollar, which was earlier available for Rs 75.

Think what’s going through the head of our first foreign investor, who had sold Share A for Rs 75, and taken a dollar back home. He is beginning to salivate. Because now:

• He can buy Share A for about 75 cents

• making a neat profit of 25 cents for every dollar

• earning a whopping 25% return on his transaction.

Across the economy, as asset prices fall, and the rupee also falls, foreign sellers turn buyers. Now asset prices begin to harden, the rupee stops falling, domestic investment goes up, import substitution occurs, GDP grows faster, government revenues swell…

But Inflation Continues to Be An Overriding Risk

So, policy makers hike interest rates to control inflation. This dampens consumption and investment demand. Prices stop rising. But ironically, higher interest rates also attract more dollars, and that, as we’ve seen, bolsters stock prices and investment. The wealth effect returns. At some inflection point, rising incomes start to perk up household demand. The economy jumps back into growth mode.

So, please do not rue the falling rupee. Instead, you must rue if:

• competitive markets are damaged

• investments are not productive

• the inflation scourge is killed too strongly by mercilessly upping interest rates

• taxes are raised too sharply

• governments panic and clamp down, trying to ‘control’ and ‘stamp out’ momentarily negative variables with a hard hand.

But if policy interventions are deft, delivered with a light touch, slowly allowing each distorted price to correct and find its true, competitive level, then a falling rupee could be the beginning of a blessed turnaround, not the end of the world.