Rupee crash of 2013 – India’s downfall or a Global shift? Do we have a Solution?
August 19, 2013 Leave a comment
With the Sensex crashing, politicians pointing fingers, some in the media calling it the end of the India growth story and discussion about recession in India, it is easy to miss the real details. Following is my assessment of what is going on and what we should do about it. I’m not an economist and would be glad to be corrected.
Three key observations:
1) Sudden Fall in Rupee is not just about India but part of a global phenomenon, caused by speculation about US Fed actions and its potential impacts.
2) India does have serious challenges to be solved and there will likely be short term decline. But the fundamental long-term potential for growth & poverty alleviation remains true and the next 6-12 months might be the best time to invest in India.
3) One solution to India’s present problem is deep in Indian psyche – Faith.
4) Don’t trust everything shared on Facebook or “popular” news websites.
1. Fall in Rupee vs USD – Global Phenomenon
As the chart below shows, currencies of most major emerging economies have fallen against the USD in the last year – Brazilian Real, South African Rand, Australian Dollar, Russian Ruble and Indian Rupee. Indonesian Rupaiya has also fallen sharply. For different reasons, Japanese Yen has fallen sharply against the dollar as well. Chinese Yuan cannot be compared as it is tied to the US dollar at a fixed exchange rate (that their Govt decides). You can look closely at this chart on Yahoo Finance here.
There are lots of explanations & debates around why this is happening. We have to understand what happened since 2008 to understand the current events:
When the 2008 Global Recession triggered by US Financial/Real-Estate crash started, US Federal Reserve Bank started “printing” massive amount of Dollars (a few Trillion) to pump money into US banks, automotive companies, etc to avoid large scale unemployment and economic meltdown. This was based on economic principles of John Maynard Keynes from his study of the devastating Great Depression of 1930’s. Note: Recession is broadly defined as 3 consequent quarters (3 month terms) of negative GDP growth. This easy-money policies have actually worked well for the US and starting from 2011 unemployment has started decreasing, companies are starting to make historic profits and stock markets are reaching their historic peaks.
As the 2008 recession spread worldwide, many European countries ran into severe recession with concerns about bankruptcy – including Greece, Spain, Ireland. European Union came together and pumped more money (less than US) into these countries to keep these economies from crashing. At the same time, EU countries & UK have been careful about Govt expenses and have kept money supply under control. One result being the Euro economies haven’t come back as strong as US economy.
Meanwhile, most developing countries including China, India, Brazil, South Africa, Russia and also Australia continued growing (at a slower pace) and did not slip into a recession like the US or Europe. India’s GDP even grew 10% in 2010. Since the US interest rates were extremely low, US/Developed economies were growing at very low rates (1-2%) and there was massive extra cash (“printed” by US Fed as well as profits generated by companies), some of that money was diverted into these growing economies in search of higher return on investment. Even small countries like Colombia, Chile became hot investment destinations as the return on capital (capital created in US) was higher. Stock markets in India, Brazil & South Africa have all benefitted from this money.
US economy and in general the global economy is doing fine after 5 years of easy money pumped at the rate of $80 billion per month by the US Federal Reserve Bank. Now, they have indicated they will slow down in “bond buying” – one of the methods of pumping money, global stock markets are suddenly panicking that there won’t be anymore easy money.
Hence speculator feel that money will be taken out of emerging markets and taken back to US for better returns. This is the fundamental reason the Rupee, Rupiah, Real, Rand and the Ruble are all crashing.
What will happen
Reality is – no one knows. But one thing is clear – the sudden devaluation of emerging market currencies (including the Rupee) is a knee jerk reaction. These countries and the billions of citizens are not wholly dependent on US Fed money. They are on a fundamental growth trajectory that will continue for many years.
India has very real challenges – energy, infrastructure, education & employment of large youth population, divisive politics. In fact, India’s fundamental dependence on crucial foreign energy sources (oil, gas) is a primary reason for the large import bill and large current account deficit (CAD). This large import vs export deficit is the immediate reason why Rupee is being devalued. The concern is that once US Fed money supply reduces, less money will be invested into India and it will not be able to pay for the large amount of oil-related imports. The deeper worry of investors is that this problem might cause India to borrow more money at higher interest rates using lower valued Rupees, causing a downward spiral and lead to recession/depression in India. Given the uncertainties, Indian economy might indeed see a sharp decline until the early 2014 elections.
The answer for India is to build confidence and rapidly control current account deficit (which is easier said than done) by doing all of the following:
– Increase exports to get more foreign exchange. Encourage Technology, Agricultural & other industrial exports. India needs to produce more products and deliver more services that are in high demand in the global market. We may even want to explore “exporting” entertainment by making truly global movies/music/art and taking on Hollywood. This can also be a good way of generating good-will with other growing nations.
– Decrease import bill. One way could be by directly paying in Rupees and not in Dollars. Now all oil is paid for in US dollars which means India cannot “print” them as needed. Presently only Iran accepts Rupees for Oil. Alternatively, India could use more indigenous energy sources (clean coal, natural gas), nuclear energy or renewable energy (Solar, Wind & others). Another way is also to reduce or stop gold imports by encouraging sales/exchange of the massive amount of Gold within India.
– Build confidence about India amongst rest of the world that India is a growing country and that they should invest in India. With elections around the corner, there is uncertainty – India needs to give a clear mandate & the leaders need to step up to the challenge.
There has never been a better time to invest in India:
– Rupee is at its cheapest today. With a young country with the most working age population, rupee will certainly increase in value in a longer 5-10 year horizon.
– Interest Rates in India are extremely high (8-9%) compared to global standards.
– Indian Govt, Corporate Bonds provide massive returns 10-15%. Indian stocks have very attractive P/E ratios.
First, Indians have to firmly believe that they can build a stronger India and start investing in the country – not in unproductive things like Gold & Land but in productive Assets & Companies. Interestingly, it all comes to faith & belief.
The World Economy runs more on Emotions than on Dollars!!