Is a strong Indian rupee hurting?

The Indian rupee continues to be strong touching at 64.03 to a dollar as on December 24. The rupee’s appreciation is the net effect of embarrassment of riches! There is a problem of plenty as FII investors started pumping money in the Indian stock market obviously smelling gains in the growing economy. Foreign exchange reserves have already crossed $400 billion

Mind it; the reserves were less than $1 billion in 1991 They all suddenly wake up to the reality about the heavy downpour of foreign capital coming to India because of the changed economic and political scenario.

Foreign portfolio investments are pouring in. Net FPI in the debt segment has been more than three-and-a-half times that in equities in 2017 so far: Rs 34,352 crore in equities and Rs 1,29,863 crore in the debt market. The total inflow this calendar year has been four times the net inflow in 2015 and 2016 combined.

Journey of the Rupee vs Dollar

In 1947 the value of 1 Dollar was equal to 1 Rupee. In 1975 the value became 8.39 Rupees, rising to Rs10.10 in 1983, Rs 16.90 in 1990 surging to 32.37 after devaluation, before reaching an all-time high of 68.76 on November 24, 2016.

Now the rupee is strengthening day by day. However, foreign governments and financial agencies are watching all this from the standpoint of free trade and the movement of goods. There are suggestions that the currency is undervalued.

When the rupee is so strong, who are the beneficiaries of this strength? Here is the list of a few direct gainers.

The government is the first gainer as it helps in controlling inflation and fiscal deficit. Such a position sends a strong message to people and decision makers all across the world about the health of the economy. Corporates and institutions having large external borrowings gain directly from a strong rupee.

Indian businessmen and manufacturers who have large imported inputs would also gain from a strong rupee. The stock market gains from the rupee’s strength. It keeps foreign funds coming in, mostly into debt these days, and the additional liquidity keeps stock prices high.

Liquidity also helps rein in interest rates. Consumers gain from the relatively cheaper prices of foreign-made phones, TV sets and so on, enabled by a strong rupee. Consumers are always eager to increase consumption, while foreign investors can borrow cheaply from abroad. Yields in Indian bond market are still 7 per cent whereas many countries still offer capital from 5 per cent onwards which does get invested when the rupee is strong.

At the same time a strong rupee can have adverse consequences:

1. A strong rupee can hurt Indian exports. Indian exports have been falling because of lack of competitiveness. IT Companies, Commodity & Garment exporters are hit very hard. In fact the leading IT companies are suffering from profitability issues despite an increase in market share, restrictions due to immigration policies, and the gloomy economic situation in those countries.

2. A strong rupee also hurts overall growth and job creation. New entrants to the workforce cannot find jobs easily.

Options before the Reserve Bank of India (RBI)

The root of the FPI attraction to India is its relatively high interest rate in a world of cheap money and the policy of keeping the rupee strong. If the rate of interest comes down, a lot of FPI invested in short-term debt would leave, and weaken the currency as well. The RBI worries this would lead to inflation.

The RBI must cut rates, curb FPI in short term debt and let the rupee slide. This will redistribute income from the elite to the subaltern, and spur net exports, job creation and overall growth.

It is not as i the government has not woken up in the past to correct the currency when needed. The rupee was devalued officially, while exchange rates were adjusted against a basket of currencies. In 1966, the rupee was devalued by a massive 57.4 per cent vs. the dollar on June 6, 1966 to correct disequilibrium in external payments and also to give exports greater strength. In 1991, the rupee was devalued in two stages resulting in a cumulative devaluation of 18 per cent.

Conclusion

Inflation is a function of overall economic management by the government. One key issue that many of the key Emerging Market Economies are facing is the issue of excess forex flows, both because of a current account surplus in most cases, and additional capital flows.

India has been managing this complexity relatively successfully within the context of high economic growth, high credit growth, a reasonable degree of price stability and most importantly maintenance of financial stability.

Since there are several factors within and outside the control of financial pundits and the policy makers, the rupee has to adjust in view of the volatile fluctuations of the currencies/ the trade scenarios. The near-term outlook remains bullish for the rupee.