For several decades, it was widely accepted that the rupee will keep depreciating—some said forever. Sure, there may be occasional periods of modest strength, but given the fundamental weakness of the Indian macro—high inflation, weak systems and processes, limited export strength—the rupee would simply have to decline over time. And, indeed, it did.
Over the last 15 years, the rupee has moved from a high of 39.25 to 83.25 (a few weeks ago), a drop of 120%. The path it followed was a series of seven downward steps of between 8 and 12 per dollar each, interspersed with corrections, some of which were quite substantial—the largest being around 10 to the dollar. Prior to 2008, too, rupee weakness was a matter of faith—it was about 5 to the dollar when I was born, 7.50 when I went to the US to study (in 1972), and fell steadily till the 1991 devaluation, when RBI brought it down in two-steps (totalling 19%) to about 23 to the dollar. It kept falling at a steady pace after that, losing about 100% of its value over the next 15 years—incidentally, about the same pace we have recently experienced.
Global investors would build in a 4-5% annual decline as part of their calculations. Indian exporters, for many years, would never hedge their receivables, till the arithmetic of the handsome (7-8% pa, at some point) forward premiums began to turn the tide. Indian importers also didn’t hedge, but prayed a lot.
Now, one of the fundamental truths of life is that nothing goes in one direction forever. Thus, from time to time, it is worth pondering whether the rupee’s long decline may have finally reached a turning point. We need to look at what made the rupee fundamentally weak over the years. Well, starting a long time ago, we were a monumentally inefficient economy as a result of which our exports were more or less zilch; on the other side, despite tariffs and import substitution, we needed to buy lots of critical stuff from abroad. Thus, we always had a large and growing current account deficit, which maintained pressure on the rupee. In the early days, when the domestic FX market was tightly constrained, RBI did its best to run a balancing act and controlled the rupee depreciation. After 1991, when the economy finally began to open up, exports started to grow but our demand for imports grew even faster and we remained on the slippery slope of a perennially weak current account. On the other hand, as capital flows opened up, volatility increased and there were periods where inflows would rise (largely dependent on global risk appetite), which enabled the rupee, too, to rise from time to time.
In parallel with this dance in the external sector were our domestic conundrums, primarily controlling inflation. For decades, inflation in India was 5-10% higher than in the developed markets, as a result of which the rupee had to keep falling just to stand still from a point of view of competitiveness.
Today, our current account is in flagrant disarray, and with global growth unlikely to turn around anytime soon. On the other hand, inflation is lower than in most of the large developed economies. Kudos (for once) to the government for managing the fiscal deficit through the Covid era, and double kudos to RBI for the decades-long efforts at getting the plumbing of our markets in better shape and, of course, for effective management of inflation.
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Critically, geopolitical events (the switch of supply chains from China, Russia’s invasion of Ukraine, which has affected India less than most other countries) are making India look even better than it actually is, not to underplay our reasonably successful efforts at strengthening our economy. Thus, global investors are increasingly seeing India as one of two (or at most three) bright spots to be in. This investor enthusiasm could also soon be multiplied if/when Indian bonds are included in global bond market indices.
Thus, with Indian inflation likely to remain at or below global levels at least for a few years and investment interest strong, it would seem that, despite the difficult current account situation, the rupee could be turning around for more than just a few months.
Of course, hope springs eternal. Back in 2003, when the rupee was around 45 to the dollar, I (again) saw the light and put out a report titled 38 to the dollar in 5 years? As things turned out, the rupee did appreciate for nearly 5 years, reaching 39.25 in 2008; I was ever so disappointed that it didn’t get to the 38 big figure—I’d have bought billboards on Marine Drive to advertise my supposed smarts. So, no cigar. And, of course, in due course, the rupee resumed its “fundamental” weakness. Could it be different this time?
The writer is CEO, Mecklai Financial