India’s ‘80 Phobia’: Why a Falling Rupee Is Not the End of the World

With deft policy interventions, a tumbling rupee can very well be an opportunity in disguise.

“Agar ek Amriki dollar 80 rupaiya ka ho jata hai, toh itni hai toba kyon?”

(Why this beating of chests if one American dollar were to become equal to 80 rupees?)

With rustic curiosity, that’s what my grandmother would have asked if she were alive today. Because the crescendo of impending economic doom is springing from every nook and cranny, from politicians to stock punters to social media hacks to crypto millennials.

I don’t mean to alarm anybody, but if Rs 80 per dollar is your tipping point towards Armageddon, then you ain’t seen nothing yet. Foreign investors have already pulled out over $30 billion this calendar year, India ran a trade deficit of $70 billion in just the first quarter of the current financial year, our foreign reserves have fallen by $50 billion to under the ‘bragging point” of $600 billion, and 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.

Why China & Japan Kept their Currencies Low

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. Of course, a bunch of other factors worked in their stunning economic transformation, but an artificially depreciated renminbi and yen were huge contributors – incontrovertibly and unambiguously. In fact, both giants had to suffer the stigma of being called “currency manipulators” as the wounded Western block struggled to compete with their ever-strengthening economies.

So, why did China and Japan deliberately keep weak currencies? Because in the initial transition years, a cheap currency ‘protected’ their low-tech, uncompetitive economies, buying them the time needed to scale up to a modern, highly productive industrial base.

But here we are, using our supremely half-baked knowledge to rue a falling rupee, forgetting how China has shellacked us. Remember, just three decades back, our GDP was equal to China’s; heck, we even had a higher per capita income than them. But today, China confidently parades a $20 trillion economy, even as we find reasons to celebrate our hide-and-seek with a $3 trillion count.

Frankly, if national pride is what drives us, then we should be pushing for a rapidly growing per capita income, not for a ‘strong’ rupee.

Can anybody tell me two, just two, bad outcomes of a depreciating rupee? I can see a flurry of hands go up instantly, because one adverse impact is universal and undeniable. A falling rupee fuels imported inflation, period. Higher oil prices, fertiliser costs, capital goods investments, and what not – every import becomes costly and feeds into a price spiral. So, yes, unarguably, one terrible fallout of a weakening rupee is imported inflation.

Ok, now tell me about the second bad outcome? Pause. Silence. Many of the raised hands begin to falter and flag down. “Err, second bad impact … well, you see … 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. If anything, it has a tonne of positives, beginning with higher export income, improving asset prices, and greater domestic investment, among other goodies.

When the Tide Turns

Plus, if markets are efficient and governments do not panic or intrude belligerently, a self-correcting mechanism kicks in. How? Well, let me explain, beginning with your bete noire’, the falling rupee.

Ironically, as more and more rupees are needed to buy a dollar, slowly, the cycle reverses. Indian assets and investments, which were earlier dumped for being ‘pricey’, begin to look attractive. Here’s a simple example to prove that:

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. One, A’s share price fell. And two, 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.

As our simple example proves, the tide of selling and exiting shall inevitably reverse. 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.

A Series of Good Outcomes

So, policymakers hike interest rates to control inflation. This dampens consumption and investment demand. Prices stop rising.

But ironically, higher interest rates also attract more dollars. As we’ve seen above, larger dollar inflows bolster asset prices and investment. Incomes begin to grow faster. At an inflection point, rising incomes start to perk up demand.

With rising economic confidence, the interest rate cycle also begins to reverse, which swells demand for consumer durables, construction, housing, capital goods, and what not. The economy jumps back into growth mode.

Stock prices, which reversed because of the falling rupee, now get traction from a lower interest rate, giving a further push to capital formation in the economy. The wealth effect returns. Finally, if investments and import substitution have happened smartly, then the economy would have become more efficient and competitive.

Do Not Rue the Falling Rupee

So, you see, the value of the rupee, the inflation rate, asset prices, and consumption/investment demand, all ‘hang together’. A change in A triggers a change in B, which in turn re-triggers a change in A, allowing the self-corrective instinct of competitive markets to kick in (of course, through a period of considerable pain and distress).

So, please do not rue the falling rupee. Instead, you must rue if competitive markets are damaged, if investments are not productive, if the inflation scourge is killed too mercilessly, if taxes are raised too sharply, if 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.