The Indian Rupee has seen better days. With respect to the dollar, the Indian unit of currency fell to an all-time low of 68.83 on Wednesday. This marks the all-time lowest level that the rupee has reached against the dollar.
Rewind back to May 22nd of this year, when the Fed first signaled that it would pursue QE tapering. As soon as the Fed indicated that it had increased faith in the US Economy, and that recovery within the United States was proceeding at a healthy rate, international markets suffered. The $85 Billion being pumped into the US market through the Fed’s bond purchases meant that money was literally being flooded into emerging markets across the world. Take away the crutch that the Fed had provided, and BAM! You get international chaos. Currencies have plummeted and it’s now increasingly costly for these emerging markets to borrow. India is not alone with this problem, and we can look at Indonesia as a prime example. Like India, Indonesia also has a significant commodity market, and following the Fed’s QE tapering hints, the Indonesian Rupiah has also plummeted.
Both countries are running huge current-account and trade deficits, but India is certainly importing at a much larger magnitude than Indonesia. How big you might ask? India is actually importing almost 50% more than it is exporting. The following tables show the Indonesian and Indian standing respectively:
India is one of the largest net importers in the world with an over 700 Billion Rupee ($10 Billion) trade deficit or 4.8% current account deficit. In addition, when considering countries that have a GDP equivalent to at least 1 trillion US Dollars, India is actually running the largest current account deficit of all included nations (the United States is running a 3% CAD in comparison). Although Indonesia is also running a current account deficit and has substantial debt, the country does not have the same Debt-to-GDP red flag that India does.
Australia comes in just behind India in terms of current account deficit with 4.6%, and a comparable GDP; $1.5 trillion to India’s $1.8 trillion. The big difference being India’s population is over 50 times the size of Australia’s. The similarities are reflected in a chart of the Aussie Dollar, but while the Aussie has fallen some 16% compared to the US Dollar since May, the Ruppee has fallen nearly twice that at 30%.
Similar to other emerging nations, India’s initial economic boom was fueled by a large influx of capital inflows. These capital inflows ride on the hopes that the discovery of new high-potential markets offers very favorable return potential, but India did not really fulfill its end of the bargain. Instead of using its capital inflows to improve infrastructure, standard of living, and other constituents of national health, India has simply increased its level of imports on primarily non-essential goods like precious metals while exports have lagged. As developed countries have signaled promising signs of recovery, the pressure on emerging markets has escalated significantly. According to BBC, international investors have withdrawn over $12 Billion in investment from India since June alone, which only places even more pressure on the country.
The crude oil situation in India is a prime example of the nation’s dependence on other countries. India imports about 80% of its crude oil from other countries, and in New Delhi, this is subsidized so that consumers aren’t paying through their noses for it. So when the rupee drops by an equivalent of 1 dollar, you can imagine what this does to the subsidy bill. Abheek Bhattacharya discusses this problem in a recent article from the Wall Street Journal. In the article, Bhattacharya cites Nomura executive, Anil Sharma, who says that “every one rupee drop against the dollar adds an extra 81 billion rupees ($1.26 billion) to the subsidy bill. Seeing as how the rupee has dropped almost 15 dollars since May, that means that’s an almost 20 billion rupee burden for New Delhi.
However, the depreciation of the Indian rupee is not all bad news, even within the Indian subcontinent. Although India is burdened by such a hefty export/import imbalance, the nation is very good at exporting one commodity: labor. We all know that there has been an influx of Indian workers within the United States in recent years, and this strategy is clearly paying off for some of India’s biggest foreign-based companies. Dhanya Thoppil wrote an excellent article in the Wall Street Journal (Aug. 21st) about this topic. As Mrs. Thoppil notes, for major outsourcing firms, the fall of the rupee is nothing short of a blessing, as all foreign revenue is amplified when it is converted back to rupees. For example, Tata Consultancy, the largest outsourcing company in India, generates more than 90% of its revenue from outside India, and this means that the firm is lifted rather than hampered by the currency’s fall. Additionally, major companies can count on the devaluation of the rupee to offset any recent increases in wages, as a weaker currency lessens the burden of having to shell out more cash for operational purposes.
Despite the many advantages of a weaker currency for major outsourcing firms, there are still formidable obstacles created by the rupee’s tumble. For example, management in India will have difficulty creating stable contracts. If I am a big-time Indian IT Company owner, and I secure a 5-year contract with a foreign client today at a specific rate, and then the rupee gets stronger in upcoming years, this creates some problems. This is because buyers of Indian outsourcing services will want to renegotiate large contracts to reflect changes in exchange rates. Even if the rates for the contract are locked in upon initial signing, buyers of the services will likely try to extract some sort of extra value from the IT companies in any short-term projects that emerge within the contract period, and any future negotiations within the contract period will allow the buyer more leverage and discretion. My client’s discretion can ultimately chip away at the profitability that I had envisioned in the first place.
In my personal opinion, India can only improve from within. For starters, India needs to start paying away its massive debt. India’s reliance on imports, especially in the energy sector is very problematic, and the Indian government needs to search for alternatives domestically. India needs to simultaneously cut down its levels of non-essential imports, but also be wary of what this will do to international supply/demand. As India is the largest buyer of gold in the world, if it drastically cuts down on it’s imports of the precious metal, this could adversely affect the gold market on a large scale. Furthermore, with India’s high inflation making it more expensive for domestic manufacturing to take place, this is largely limiting the export boom that should follow a currency’s depreciation. As long as inflation is at 10%, real interest rates (nominal interest rates adjusted for inflation) will take a hit, and the stunting of growth from excessive inflation will outweigh any possible growth from keeping interest rates low. India should commit to one solution at a time rather than trying to study the economy without taking any action. The RBI’s incoming governor Raghuram Rajan has already voiced his intention to prioritize the stability of the nation’s currency over inflation and growth, whereas I believe that it is more prudent to control inflation than the rupee itself. As long as uneasiness over Fed tapering and war in Syria exist, emerging markets will see their currencies undergo some volatility, and this could make some of the RBI’s efforts counter-productive or ineffective if world news counteracts their intentions. However, if inflation can successfully be controlled, this will allow India to grow through manufacturing, even if the rupee does fall. Aside from that, the nation is brimming with corruption and “black” money. This is something that I do not see changing in the near future, as a reform to curtail corruption would ironically require a bribe to reach the country’s Supreme Court in the first place. India’s infrastructure needs a complete makeover, and major ports and roads need to be managed so that growth can begin from within. Unless India finds a way to enact major reforms in the near future, the rupee could test the 70 rupee per dollar level, and I don’t see any reason to go long with India at the moment.
Aug 28, 2013
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