It’s a good time for a vacation in the United States. It’s also a good time to invest in Indian equities. This is because the Indian rupee is enjoying a rare, almost uninterrupted streak of appreciation against the US dollar. Consider this: On December 30, you needed about Rs 68 to buy a dollar. Today, you need only Rs 65. That doesn’t sound much in absolute terms, but it is a 5% appreciation. Indeed, the rise has been starker over the past two months.
As the Business Standard noted in its editorial, “The rupee was coming off a seven-week period of weekly appreciation, its longest such run since 2010, and in which period its increase in value against the dollar (4.3 per cent) was Asia’s best performance. The rupee also put in its best first-quarter performance since 1975.”
Piggybacking on foreign inflows
What has driven this stunning performance of the rupee versus the dollar? The biggest factor is the rise in portfolio inflows from foreign investors. When foreigners want to purchase Indian equity shares and bonds they create demand for the rupee. The BJP’s victory in the Uttar Pradesh Assembly election in March improved the perception about the Indian economy’s prospects among foreign investors. They pumped in $12 billion to buy equity shares and bonds in India, driving the Nifty and the rupee up. In the period from the BJP’s victory in Uttar Pradesh in mid-March to April 17, the Nifty rose 2% while the rupee went up 3%. For a foreign investor, that amounts to a gain of more than 5%, a significant return.
Bad news for exports?
While a strengthening rupee is good news generally, there is one area it could impact negatively: exports. A product that sold at $100 would have fetched an Indian exporter Rs 6,800 at the end of 2016. Today, it would go for just Rs 6,500. Ignoring the role of hedging, the exporter has two choices: accept the lower revenue as a loss or increase his selling price to retain the rupee revenues. But if the exporter increases the selling price, he could be undercut by a competitor from another country whose currency has not seen similar appreciation as India’s.
Thus, an unbridled rise in the rupee can hurt India’s exports. And exports are a key component of the Indian economy – from product exports such as petroleum, gems and jewelry, and agricultural produce to “invisible exports” such as software. These are labour-intensive industries that contribute significantly to the economy. Moreover, as the Economic Survey for 2017 stated, the economy to fulfill the country’s dream of 8%-10% GDP growth, exports need to grow at 15%-20%. A rising rupee could prove to be a speed breaker. No wonder then that a strong rupee usually prompts the Reserve Bank of India to intervene: it supplies more currency to depreciate the rupee to an acceptable level. This action, though, is missing this time.
Indeed, the government appears to be taking a different approach than pegging the future of India’s exports on the rupee-dollar equation. It wants to address structural problems that hobble India’s exports.
Asked if this was a fundamental rethink by the government, Nirmala Sitharaman, the minister for commerce and industry, was quoted by Mint as saying, “Yes, that’s right. That is something that the government has been looking into. That is one of the reasons why sometimes it may appear as though we don’t put so much emphasis on exchange rate anxieties. We may have to look at it in a larger macroeconomic perspective but the attention of policy planners, the state governments should go towards (improving) logistics, (trade) facilitation.”
Impact on inflation
There is another, more domestic, angle to a stronger rupee – it lowers inflation. India’s big imports include oil, gold and jewelry, and electronics. As the rupee strengthens, import prices fall and drive down inflation. In its latest Monetary Policy Report released early this month, the RBI stated that “in contrast [to a depreciating rupee], the combination of a benign global macroeconomic and financial environment, the expected acceleration in domestic growth and the policy initiatives to attract FDI flows can lead to an appreciation of the domestic currency, with a soothing impact on domestic inflation. A five per cent appreciation of the Indian rupee, relative to the baseline assumption, could soften inflation by 10-15 bps in 2017-18.” This beneficial impact on inflation could be behind the RBI’s decision to let the rupee appreciate in the near-term.
What lies ahead?
Over a long period of time, the rupee, like the Nifty, tends to follow the path of the economy. As long as the economy does well, the rupee remains stable. A jolt to the economy makes the currency suffer.
As of now, the outlook for the economy appears to be positive. The assumption is that the recently rolled-out Goods and Services Tax, much like demonetisation, could cause short-term disruption but will eventually bring economic gains by reducing India’s complicated indirect tax system. The worst of the demonetisation-related fears appear to be behind us and, perhaps, the tax bounties could be reaped in the future. Oil prices are also broadly under control and this year’s Union budget painted a reasonably positive picture for the new fiscal year.
Unfortunately, there is no respite when it comes to bad loans in the banking system and the industrial slowdown. Somehow, investors are ignoring or underplaying their importance. Whether this causes an economic crisis in the future remains to be seen. Otherwise, it appears the rupee has found a sweet spot to stay in, at least for the near-term.