What drives the Rupee down ?

Indian rupee collection

Indian rupee collection (Photo credit: Wikipedia)

Global factors, local forces or animal spirits – what drives the Rupee down ?

As the Indian rupee nose-dived this past week, and stock markets were enveloped in gloom, pundits struggled to decode the answers to this question.

One thing however was painfully clear : the consequence of the lower rupee would be higher prices for all of us.

–       we would pay more for fuel, fertilisers and every item that had imported parts

–       we would pay more for our loans, as the Reserve Bank of India raised interest rates, in an effort to keep FII money from flowing out

How did the Indian economy, hailed as a roaring tiger just a few years ago, reach this sorry state ?  What triggered the fall  and what  sustains the rupee’s downward momentum ?

The first global trigger was the suggestion by Ben Bernanke on June 19, 2013, that the central bank of the USA was prepared to begin phasing out it’s Quantitative Easing (QE) Program.  As a result bond yields in the USA rose, and markets across the world fell, as Foreign Institutional Investors (FIIs), pulled money out of equities and emerging markets to invest in US treasuries.

Economies such as India, which had developed dependencies on FII inflows to fund their Current Account Deficits, faced immediate and painful adjustments.

A second trigger came earlier this week, as fears of military action against Syria escalated.  As the price of Brent crude spiked, markets assumed that rising oil prices would undermine growth – especially for countries highly dependent on oil imports.

However these factors affected many emerging markets. Why have the currencies of Mexico, South Korea and many eastern European nations held up so well, while the currencies of countries like Turkey, South Africa and India have plummeted ?

The answer is that FII’s are differentiating between countries.  They are looking at the fundamental factors driving each local economy and choosing where they wish to place their bets.

Countries that rely most on short-term foreign money to fund trade deficits have been the hardest hit. India has a Current Account Deficit (CAD) of  5.1 % of GDP (Turkey  is at 5.9%, S Africa  at 6.3%)

But even this does not fully why FII’s are pulling more money out of India, hence causing the Indian rupee to weaken more than other currencies ?

The answer lies with the elusive animal spirits.

There is a change in guard at the Reserve Bank of India. Markets will observe carefully to see if the new governor, Dr Raghuram Rajan, will take as strong a stance as his predecessor Dr D Subbarao, on inflation, monetary policy and the autonomy of the central bank.

More importantly it is clear to Investors that the Indian political establishment will cater to vote bank politics rather than focus on economics in an election year.

To quote the Wall Street Journal, dt Aug 29, 2013 :  “If India’s fiscally irresponsible “antihunger “ bill passes the Upper House, while needed structural reforms languish, don’t be surprised if pessimism over the country’s future deepens.”

What is the way out of this situation ?

The markets, like all of us, are looking to see decisive actions by the Government, that will help restore confidence in the Indian economy. Three simple steps will not only stem the fall of the rupee but also set the Indian economy back on the path of growth :

1)   Rein in Government Spending and bring the fiscal deficit under control

2)   Take quick measures to address the Current account deficit

3)   Start seriously undertaking pro-growth reforms

As Terrence Checki of the New York Federal Reserve stated “Fundamentals are Fundamental”. Three simple words that our Policy makers and politicians would do well to heed.


32 thoughts on “What drives the Rupee down ?

    • Many thanks Anand. Thanks also for sharing your thought provoking Dahi handi blog. The parallels with the Indian economy are true and tragic. Last year we lost a member of our guard staff in the Dahi Handi ritual – a young upright man with 3 children, who was quadriplegic for 3 months before passing away.

  1. mam your analysis was very good and it explains what are the things to be done immediately so as to overcome this critical situation

  2. Frankly it’s not all doom and gloom, the cheap money era brought in hot money to high yielding currencies and India benefitted largely the last few years. The reversals usually see an overshoot and will settle down. The cheap currency will make real assets attractive in India, bring in investments, make India exports much more competitive and with deregulation of fuel pricing, things will look a lot better FY15 one should hope!

  3. Madam U need in details more the 3 simple steps, they appear as very common statement that every 1st student of economics mite know, u need to explain in details as to what these steps should be.

  4. Hello Ms.Sanyal,

    Would want GOI to do the following urgently:

    – Sort out mining issues in Goa/Karnataka which will help in increasing iron ore exports also reduce iron ore imports
    – Sort our issues with Coal India which will help in reducing coal imports , will save USD, help in reducing cost of power
    – Increase Petrol/Diesel prices so as to reduce Petrol/Diesel demand and help reducing oil subsidies
    – Provide an investment avenue instead of Gold – Tax free FD interest upto 25K , Reduction in ST Gains, Reduce STT, Tax free IPO gains, clarity between Business income & CG income
    – Sort out environmental issues of all projects stuck
    – Increase limit of 1.5L interest deduction for investing in own home

    Above are some steps which may help in increasing investments, increasing exports, reducing imports, spur real estate demand, help in investments in Stocks/FD etc.

    Kindly comment.



  5. Thank you for posting such wonderful post on recent currency depreciation.However this could be high time for govt to seriously thinking about reducing CAD.

  6. As an Economics grad, I feel we need to favor pro-growth stance as you rightly pointed out and keep investing massively in infrastructure. Moreover, we need to make permit for businesses more friendly and spearhead reforms. Unfortunately, the DTAA with Mauritius is not helping us as we have given the small island a free hand and it keeps exploiting the treaty. Thus, we are losing. Nevertheless, I have stopped pursuing Economics which has stopped making sense coz of its capitalist nature, the reason for the collapse of Economies.

  7. Dear Meeraji,

    Once again a very pertinent issue, explained lucidly by you.

    As a senior treasury professional with a large Corporate house in Mumbai, the subject of depreciating rupee does resonate with me albeit being Net exporters we are in the money! However as any other individual, we too feel the ramnification of this on our day to day life – Inflation, Negative perception of the India growth story, Plunge in the stock market index , rising twin deficits, economic slowdown etc etc.

    I feel the approach by our Govt / RBI to address Monetary solutions to Structural problems is not going to do the trick. Also results out of day to day RBI intervention are not going to last long.

    My simple take on this (simple pointwise solutions similar to the mail shared on Mumbai’s traffic woes !) are :-

    1. Immediate Address to the wrongful perception by FIIs on the India story. – India still has a lot of potential and the growth fundamentals remain intact. For eg the concerns on the FSB are overstretched. a) It needs States to implement. b) Already Rs. 75,000 crs are budgeted towards food subsidy (a fig which can easily go to 85K – 90K). So the incremental effect, if it ever happens, is marginal. Likewise ill conceived revenue generation ideas like retrospective taxation in Vodafone case, which is regressive in nature should be struck down. GST should be implemented.

    2. Coal imports – Another major component of CAD. If we have 100 years of coal reserves and yet import from Indonesia and others, time to quickly implement reforms and let mining resume.(Plus start and complete work on Power plants). let us be surplus as far as energy goes. Quite clearly foreign countries / companies and NGOs fronting for them have vested interests in stalling reforms here and should be nipped in the bud.

    3 Oil Imports – Countries like Iran accepts payments in Rupees. We should step up imports from such countries rather than playing sweethearts to the US, which anyhow has maintained double standards with us vis-à-vis its policy on terror threats to us from our neighbour.

    4 Forex Reserves – We have Fx surplus of appx USD 270 billion. Even after netting off the USD 170 bio of short term debt repayments, we still have USD 100 mio to cushion against the dollar volatility.


    Shashank Chandra

  8. Nice article. You explained clearly why rupee is falling and what should be done. Don’t you think corruption, indecision, and inability boost investor confidence also played some role? Mexico contracted only o.2% because they put stitch in time to their system to save nine required later.

    • Abhijit you are absolutely correct – all of these factors drive market sentiment. Mexico is a really good example which shows that decisive and competent leadership makes a tangible difference not just to growth itself, but also to how Investors perceive the country’s future prospects.

  9. The fact that countries using short term finances to fund current account deficit are the ones affected is an eye opener for me. Thanks for highlighting this. The current crisis is very well explained in layman terms in this article .

  10. Dear Ma’m

    I had curiously searching for the reasons that led to rupee fall. With unclear and illogical assertions being made to cut the petrol usage and cutting down the use of brands made outside India, I wondered how could they affect Indian rupee.

    Now, i know the REASONS

    JY 2012 yatri

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