Rupee’s fall to 83: What does it say about India’s fundamentals?

With the rupee falling to a new low of 83 per US dollar on Wednesday – a fall of 12% in the calendar year of 2022 – the cold comfort that it has held up better than other currencies no longer holds.

On October 14, two days before Finance Minister Nirmala Sitharaman delivered her famous statement in Washington DC, “I would look at it not (as) the rupee sliding but as dollar strengthening incessantly”, the IMF had published a detailed report on the relative performance of currencies. Its very first sentence read: “The dollar is at its highest level since 2000, having appreciated 22 percent against the yen, 13 percent against the Euro and 6 percent against emerging market currencies since the start of this year.”

Yes, the USD strengthened but this was the least against emerging market and developing economies (EMDEs) – a club to which India belongs. The rupee fell more than the average of EMDEs – by 9%, as of October 4, against the average of 6%. Not just that, two peers, Brazil and Mexico, saw their currencies appreciate against the USD.

Why did that happen with EMDEs? The IMF analysis (Gita Gopinath as lead author) attributed it to two factors: (i) they were “ahead in the global monetary tightening cycle – perhaps in part out of concern about their dollar exchange rate” and (ii) “positive terms-of-trade shock”, that is, more exports than imports.

There is little to gain from the battering other currencies received. The war, the energy crisis that it has sparked and unusually high inflation have pushed Europe towards a recession. The US already has witnessed two quarters of technical recession and more are expected. China is yet to overcome its Covid crisis. India would do better to look at its peers’ performance.

Why is the USD strengthening?

The IMF said it was because of the US’s economic fundamentals: (a) rapidly rising US interest rates and (b) more favorable terms-of-trade caused by the energy crisis in Europe following the war. Although the US share in world merchandise exports has declined from 12% to 8% since 2000, the dollar’s share in world exports has held around 40%.

The IMF’s answers partly explain what could have prevented the Rupee’s fall so rapidly: (i) timely adjusting interest rates to stay ahead of the inflation curve, not behind, as the out-of-MPC cycle hike in May 2022 demonstrated and (ii) positive terms-of-trade, that is, boosting exports and raising its global share in trade – from mere 1.57% in global exports and 2.1% in global imports (in 2020).

What Rupee fall tells about India’s fundamentals?

It is plain common sense that the value of a currency depreciates because of both internal and external factors. Since little can be done about external factors, the key is to focus on internal factors or macroeconomic fundamentals. Stronger the economic fundamentals, the better is the ability to withstand a crisis-like situation at present. These fundamentals refer to growth (and post-pandemic recovery), fiscal deficit, trade and current account deficits, forex reserve, external debt, investments inflows/outflows etc.

Has India done a good job on these fronts?

This year’s Budget documents show that the Centre’s fiscal deficit remains far higher than the FRMB limit, 3% of the GDP – at 4.6% in FY20, 9.2% in FY21, 6.9% in FY22 (RE) and 6.4% in FY23 (BE). This is a long-term trend and reflects bad fiscal management. In the past 8 years of this government, between FY15 and FY22, the average fiscal deficit is 4.9%.  

The trade and current account deficits are progressively worsening. RBI reports show both widened in Q1 of FY23, compared to Q4 of FY22 – with trade deficit touching 8.1% of the GDP and CAD 2.8% (very close to the comfort level of 3%). This has happened mainly because merchandise exports are failing to match imports. Further, the growth in both merchandise exports and imports moderated in July and August (last month for which data is available) and the total trade deficit (merchandise and services together) went up to (-) $86.9 billion – a sign that global demand is sliding and the recession is setting in. Both deficits (trade and CAD) are expected to worsen further – putting more pressure on the rupee value.

But this is not something new. Data shows, the total trade deficit has been growing in the past eight fiscals – from -1.48% of GDP in FY15 to -4.8% in FY22. Exports have fallen from the peak of 25% or more of the GDP during FY12-FY14 to 22% in FY22.

India is a marginal player in world trade – unlike the US – to provide it any cushion during crisis. It has further hurt trade prospects by walking out of mega multilateral trade agreements, RECP in 2019 and IPEF in 2022 – the two contribute 70% to global GDP and control more than 50% of global trade in goods and services.

Sound forex reserve is very critical. It was the forex reserve crisis that forced India to seek the IMF’s bailout in 1991 and nearly averted a repeat in 2013, when India was declared one of the “fragile five”. As on September 23, 2022, the forex reserve stood at $537.5 billion – down by $69 billion from $606.5 billion on April 1, 2022. The RBI says 67% of the decline in forex during the current fiscal is “due to valuation changes arising from an appreciating US dollar and higher US bond yields”. The rest must account for selling USD to check the rupee fall. An analysis of IMF data showed, India spent more than others who saw their currencies depreciate more than India’s, except the UK and Japan; their forex reserve saw smaller decline compared to India.

The forex reserve, however, is not a cause of alarm at this point but needs careful handling.

Sound investment growth is a sign of robust and growing economy. India has been witnessing a reverse trend for quite some time. Overall (public and private) capital investment (GFCF) has come down from the peak of 23.7% in FY05 to 15.8% in FY22. Private sector’s (listed companies) investment in fixed assets (capital investment) fell to six years’ low of 2.3% in FY22, despite 63.5% growth in earnings. Now, Q2 of FY23 is likely to mark the end of unprecedented rise in corporate profits for eight consecutive quarters as net profits of Nifty50 at Rs 1.38 lakh crore is less than Rs 1.46 lakh crore in the corresponding previous quarter of FY22 – a recent analysis has shown.

Why don’t corporates invest despite unprecedent profits? Why their investments have fallen so drastically even before the US raised its interest and rupee fell? Why bank credit growths are driven by personal loans for years, and not by industry? A SBI research paper said whatever credit is going to industry is to meet its need for “working capital”. Can we then say that India’s economic fundamentals are robust?

When it comes to foreign investment, the story soured much before the current crisis. Foreign portfolio investors (FPI/FII) fled India in a big way in FY22 – net pullout was $18.5 billion from equities. Up to October 20, 2022, they further pulled out an additional $8.6 billion. This a reversal of trend since FY16 when they last pulled out (net). Growth in FDI inflows, which are long-term commitments and can’t be pulled out on whims, have slowed down – from 20% in FY20 to 10% in FY21 and 3% in FY22.

These are again not due to the current strengthening of the USD but the tightening of the US interest rates has seemingly impacted the NRI deposits – down to $134.68 billion as of August 2022, from $141.52 billion a year ago.

The only other area (apart from forex reserve) where India is comfortably placed is in external debt – pegged at 1.9% of the GDP for FY21 and FY22.

All the above facts then point at one direction – India’s growth story has weakened over time and the K-shaped recovery, instead of the much talked about V-shaped one, has hurt.

Does living in denial help?

The most troubling aspect of the narrative over the rupee’s fall, or even the prolonged economic slowdown, job crisis, high inflation, rising poverty and hunger, is the  reluctance to admit or prepare remedial measures with adequate consultations and planning. For example, the RBI and Finance Ministry (MERs) regularly publish reports analysing the state of economy. Not one of these reports talk of any problem except “imported inflation” to explain away everything.

Unlike the impression that is sought to being given now, the 2013 crisis – when the rupee fell by nearly 20% to touch 68.85 per USD in four months, CAD rose to 4.8% of the GDP, WPI inflation touched 7.4% and fiscal deficit 4.9% of the GDP, India was not alone. It was among the “fragile five” and the list included Brazil, Indonesia, South Africa and Turkey. India did get out of it quickly.

The 2013 crisis, as the then RBI Governor Duvvuri Subbarao recently wrote, was sparked by the chairman of the Federal Reserve Ben Barnanke’s statement about “tapering” (withdrawing) the quantitative easing (QE) programme. Bernanke received the Nobel in economics this year for groundbreaking research in banks and financial crisis.

A reading of the RBI document analysing the 2013 crisis – “Major Episodes of Volatility in the Indian Foreign Exchange Market in the Last Two Decades (1993-2013): Central Bank’s Response” – shows how matter of fact the approach was. The report bluntly says that (a) the rupee “was one of the worst performers (among emerging market economies) during the period from the second half of May 2013 to August 2013” and that (b) “the rupee was generally depreciating in line with economic fundamentals even prior to Chairman Bernanke’s testimony (tapering of QE) on May 23, 2013”.

What to do now?

Having weathered the 2013 crisis within months, the RBI and FinMin know what to do now as both the situations are similar. These measures are spelt out in various reports, including the one mentioned above. Besides, they also have institutional memory (like muscle memory) which produces instantaneous reflexive reactions. But for that to happen, they must enjoy autonomy and independence from political leadership.

Here is what the IMF’s paper suggested for all the economies whose currencies are hammered.

It said the appropriate response would be to (i) “allow the exchange rate to adjust, while using monetary policy to keep inflation close to its target”. Higher price of imported goods would lead to reduced import, which in turn would reduce the buildup of external debt. It sought (ii) fiscal policy to be used to support the most vulnerable, without jeopardizing inflation goals (iii) additional steps should be taken to address several downside risks like, greater turmoil in financial markets, including a sudden loss of appetite for emerging market assets that prompts large capital outflows, as investors retreat to safe assets and (iv) prudent use of forex buffer, among others.

These are useful tips for India.

The next important thing to remember is that global recession is coming and India would not be spared. A Fortune India report recently quoted a global survey to say that “47% CEOs in India weighing job cuts over next 6 months” and that “about 33% CEOs in India and 39% CEOs globally have already implemented a hiring freeze”. That should worry the policymakers.