Rupee has hit a record low against the dollar and has left everyone in India worried. But what has triggered this fall? Why is the rupee falling? Till what level, will the Indian currency plummet? Is it a local problem or is there an internal crisis going on? What can the Indian regulators do to arrest this slide? This blog post is an attempt to explain what has caused this crisis and its aftereffects.
What triggered the Rupee Fall?
Turkey Lira crisis and the emerging markets contagion:
Turkey’s currency Lira has lost almost half of its value against the Dollar in last one year itself and this has caused turmoil not just in the Turkish economy but in other emerging markets as well.
Turkey is historically a country with low domestic savings rate and heavily depends on external loans in foreign currencies. With sharply increasing gross external loans and limited foreign exchange reserve, Turkey had already started showing signs of defaulting on these loans. This eroded the investor confidence in Turkey causing reduced inflow of foreign investment into the country. Already in a weak spot, Lira faced its greatest crisis thanks to Donald Trump!
US President Donald Trump, on August 10, doubled the import tariffs on Turkish steel and aluminum. This action was in response to Turkey’s rejection of US request to extradite an evangelical christian pastor called Andrew Brunson who is currently jailed in Turkey. Brunson faces terrorism charges and the Turkish President Erdogan blames the pastor of being involved in a coup attempt against the himself.
After this announcement, Lira weakened against dollar by more than 14% in a single day. Thanks to this confrontation with US, Turkey is now a risky choice for investment which has caused less inflow of Dollar causing the consistent fall in the value of Lira. Fall in currency value has also led to double digit inflation. The most logical response to fight this crisis is to increase the interest rates which Erdogan has resisted so far further pushing the country into uncertainty.
So, how did India and Rupee get caught in this cross fire? In fact, it’s not just India but almost all emerging economies are facing currency crisis i.e. the currencies are losing their value against Dollar. Indian Rupee has depreciated about 12% while Chinese Yuan has lost around 10% of its value this year. Among other emerging economies, Argentina’s currency has lost more than 50%, Brazil and South Africa currencies close to 20% and Indonesian Rupiah approximately 10% value against the USD. This currency crisis involving most of the emerging economies is being called as the emerging markets contagion.
But why are the emerging economies including India facing crisis?
Again Donald Trump. In pre-Trump era, US economy was growing at roughly 2% every year. The interest rates were also low because of which US was not an attractive destination for the investors. Investors would pick emerging economies (with comparatively much higher interest rates) for extending loans as investment in order to getting more returns.
However, after tax reforms, deregulation and focus on domestic manufacturing brought in by Trump after his election as the President, the US growth rate has revived to 3% and it reached 4.1% in the second quarter of the current economic year. This was around the same time when the Lira crisis was unfolding. Thanks to higher growth, the fed interest rate has been hiked in US which has made it one of the most attractive and very safe destination for investment.
Trump is also indulged in trade war with other emerging economies like China and India which is why foreign investors are withdrawing money from these markets and investing in US which is why Dollar is getting stronger and other currencies are getting weaker.
Is that the only reason for Rupee fall?
There is one more recent reason which has not only affected the value of Rupee but also caused slump in the share market which is an indicator of investor confidence. On 7th of September, RBI data showed India’s Current Account Deficit (CAD) declining to 2.4% of the GDP in Apr-Jun quarter. Current Account Deficit simply means a country is importing more values of goods and services than it’s exporting. This rise in the CAD is because of high crude oil prices and an already depreciated Rupee. This has further led to depreciation of rupee over last 2 days.
Can India do anything to arrest this slide?
Yes, the RBI has many instruments to control the value of the currency and the most useful way is to use the foreign exchange reserve. India has a foreign exchange reserve of approx $400 billion from which the RBI can sell dollars to reduce the stress on Rupee. But it also needs to maintain balance between how much dollar RBI should sell and when to intervene in order to ensure that the Rupee also finds its own value. That is also one reason RBI has so far shown restraint in stepping in to stop the fall. Another instrument which RBI and Monetary Policy Committee will use is to raise the interest rates which is very likely in current scenario. Despite all these measures, Rupee is expected to fall to a level of 74-75 against USD as per several agency reports.
Any imminent threat to the Indian economy?
Most likely No. Credit Rating Agency Moody’s has predicted no immediate risk to Indian economy because of the current crisis. Similarly Nomura has assessed the risks of exchange rate crises for 30 emerging market economies and noted that seven countries are at risk of exchange rate crises with scores over 100: Sri Lanka, South Africa, Argentina, Pakistan, Egypt, Turkey and Ukraine. India’s score on this scale is 25.
So All’s well?
No. And that’s again because of Donald Trump. US President, in a shocking move, pulled out of the Iran Nuclear deal and has also announced sanctions against Iran as well as any country involved in trading with Iran. India imports a lot of crude oil from Iran and once these sanctions kick in November, crude oil prices may rapidly increase thanks to less supply of oil in the market. India being the 3rd largest crude oil importer in the world will be directly hit by this increase in prices. India needs to be careful and prepared for this upcoming crisis.