A Strong Economy vs. A Weak Exchange Rate: What Happened to India?

Indian Rupee declines in 2018

Recently, the Indian rupee resumed its downward trend, with the rupee at a record low of 74.56 per US dollar on October 7, 2018. The rupee has been falling since the beginning of the year and has now depreciated by nearly 15%, making it the worst performing currency in the Asian market. For the future trend of the rupee, it is expected to remain near the record low in the next year, and the possibility of a rebound is unlikely.

It is worth noting that the performance of India’s economic growth is opposite that of its currency. India’s economy has been strong all year. In fact, India is once again the world’s fastest growing economy. In the second quarter, India’s GDP growth rate soared to 8.2%.

Why didn’t the strong economy boost the currency?

It is an economic reality that the currency exchange rate does not necessarily correlate to economic growth. Rather, it depends on the country’s balance of payments, inflation rate and monetary and fiscal policy regulation, among other factors. Based on comprehensive market analysis, the main reasons for the depreciation of the rupee include the rise in the price of crude oil, the increase of the trade deficit, the increase in capital outflow and the failure of government interventions.

Why does the rise in oil prices affect the exchange rate of the rupee?

Technically, it’s a vicious cycle. As the rupee has plummeted against the US dollar, the dollar-denominated oil price has become more expensive. The rise in oil prices has led to an increase in import costs, stimulating higher inflation and expanding India’s already large current account deficit, further exacerbating economic losses and putting further downward pressure on the rupee.

According to data released by Nomura Holdings, for every $10 increase in oil prices, the proportion of India’s current account balance in the GDP will fall by 0.4 percentage, and the inflation rate will be pushed up by 30-40 basis points. More than 80% of India’s oil is imported.

In recent years, Indias trade deficit has continued to increase

India’s trade deficit in fiscal year 2017-18 reached US$156.83 billion, the highest level since fiscal year 2012-13, and its proportion of GDP increased from 0.6% in the previous fiscal year to 1.9%. According to the latest data from the Indian Ministry of Commerce, India’s trade deficit in July was 18 billion U.S. dollars, the largest single-month deficit in the past five years.

More than other factors, a long period of large trade deficits will weigh on a currency.

Capital outflow

The Fed’s rate hike has prompted global investors to retreat from emerging markets, exacerbating the pace of the rupee’s depreciation. According to local media reports, India lost more than $2 billion in foreign investment in April alone, the highest level in 16 months.

Government bailout has not been effective

The continued decline of the rupee fully demonstrates that the Indian government’s efforts to save the currency have been in vain. The Indian government, led by prime minister Modi, has made a number of moves. The government announced an increase in import tariffs on 19 “non-essential commodities”. It also reduced institutional exposure, curbed capital outflows, and eased the requirement for banks to issue overseas bonds. The Reserve Bank of India has also used foreign exchange reserves twice since June to curb currency volatility.

However, the market did not respond positively to this series of interventions by the Indian government. During the fall, the rupee continued its downward pattern. Then, on October 5, the Reserve Bank of India said it would keep its benchmark interest rate unchanged at 6.5%. It was quite contrary to market expectations, and as a result the rupee fell below the 74 mark in the short term.

Expectations

According to a survey conducted from October 5th to 9th that interviewed more than 50 foreign exchange strategists, the rupee was expected to remain at the current level through the end of the year, about 74 rupees against the US dollar. For longer term expectations, the strategists predict it would slightly strengthen to around 73 rupees a year later. The weakest expectation in the survey was 78.0, while the strongest expectation was 67.97.

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