Indian Economy – Prelude to Rupee Panic

The Indian Economyremains moribund with few signs of a growth turnaround. Forecasts for GDP growth over the next two years continue to be revised down while financial markets exhibit choppy behaviour. There has been some stabilization of inflation expectations (still high) but these will be hit by pass-through of the exchange rate likely to hover around Rs.60/$ near term. Neither this level nor the sharp correction recently should be surprising. Nonetheless, the fuller implications, including the dangers of a vicious cycle are not widely appreciated.  Beyond constraining the room for monetary policy (e.g. rate cut that business lobbies clamour for), the external debt of Indian firms is an increasing investor concern who are also concerned with dropping rates of return. The government’s fixation on attracting foreign capital may be tilting at windmills at this juncture; worse, agnosticism as regards type of inflows may add to our vulnerability to external shocks. Structural reforms confront a similar reality, either failing to gain traction, impact being attenuated due to exchange rate movements (e.g. fuel prices), or manifesting as expedient measures that lead to perverse incentives and bigger problems in the future.

Emerging Market Currencies Currency Units per US Dollar

01Apr13 28Jun13 (%) Change
Indian Rupee 54.28 60.19 10.9
Brazilian Real 2.019 2.1959 8.8
Russian Rouble 31.0093 32.7907 5.7
Chinese Yuan 6.1347 6.2298 1.6
South African Rand 9.2252 9.9319 7.7
Philippine’s Peso 40.71 43.21 6.1
Indonesian Rupiah 9612.45 9897.2 3.0
Turkish Lira 1.8091 1.9177 6.0
Mexican Peso 12.3178 13.0047 5.6
Source: Yahoo Finance

This is not to suggest that the authorities try to defend or prop up the rupee exchange rate; that would be futile and quite possibly, ruinous. The Reserve Bank’s stated position of intervening only episodically to curb excessive volatility is indeed appropriate. What then should industry do to manage its operations and finances effectively and predictably?

First, it should inform itself better. At a minimum, rather than focusing only on the $-Rupee valuation, a clear distinction is necessary between the Rupee’s performance against a suitable basket of other currencies and the cross-currency trends among them. The former is driven by domestic economic factors (inflation differentials, trade competitiveness/current account balance, capital flows, external debt) while the latter reflect developments in global financial markets where India is a bit player. A level of understanding deeper than chart patterns (“technical analysis”) is helpful in anticipating critical policy responses.

Second, industry managers need a firm grip on the impactof exchange rates specific to the IT/ITeS industry including impacts on profitability, FX losses and their accounting, foreign (including $-indexed) costs, as well as return on foreign liabilities. This should be supplemented with an appreciation (not detailed knowledge necessarily) of economy-wide implications including cost of imports, increased inflation as well as debt burden.

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