Tag Archives: Indian economy

Currency Woes

In 2008, while a global financial crisis was devastating advanced economies like the United States and Europe, creating levels of unemployment and instability not seen since the Great Depression, emerging markets like India incurred only modest negative impacts- and sometimes even prospered in spite of it. In fact, in 2009 alone, while the United States contracted by 2.6%, India’s growth rate increased from 7.4% in 2009 to 10.4% by 2010.

However, since then, the proposition that India has weathered the financial storm is becoming increasingly implausible. Signs of financial distress are taking shape in a debased rupee, which reached a 10-year high of 57.06 against the US dollar on June 22. Troublesome current account deficits have made foreign investors wary of India’s financial health, causing them to pull their capital out of India’s markets. Government policies like retroactive taxation on foreign investors have also discouraged investment, further weakening the rupee. Yet, for all that a weak currency implies, suggestions that a devalued rupee is categorically undesirable for India’s growth are incorrect. In fact, a weak currency provides a number of opportunities that India can use to bolster its domestic industries in ways it could not do otherwise.

The most direct advantage of a weak rupee is that it makes India’s exports more competitive in overseas markets. This happens because a weak rupee means that India’s goods are cheaper relative to foreign goods, making them more attractive. Higher demand for India’s products stimulates exports and reduces imports, which increases India’s overall output. While foreign goods are more expensive, the increase in manufacturing puts people to work at home and supports competitive domestic industries. If India invests its money wisely, a devalued currency can also reduce the real value of its debt, lessening the burden of future payments with higher growth rates.

Indeed, it is not always clear whether a strong currency is good for an economy. The desirability of any movement in exchange rate depends on why that movement occurred. If a country’s businesses are lucrative and there are innovative entrepreneurs entering the market, the demand for the currency will increase as investors try to purchase that country’s assets, thereby strengthening the currency. On the other hand, if a country is running persistent budget deficits, causing interest rates and inflation to rise, the demand for that currency will also increase because investors will seek higher returns on their bonds, again causing a stronger currency. Yet, there is a palpable difference between the two cases. In the first, high growth potential underlies the strong currency; in the second, it is worrisome budget deficits. So it is not always the case that a strong currency indicates a strong economy. But what does that mean for India?

It means that there is no unambiguous answer to what the ideal value of the rupee should be. What matters instead is how the government adjusts its policies in response to the movements in its currency. Government policy, like retroactive taxation, should certainly not discourage foreign investment, but that is still a narrow confinement in analysis. If policy makers and central bankers realize that a weak currency does not mean a weak country, then they can use this window of opportunity to support domestic producers. With strong growth, investment in India will return as the rupee becomes more attractive, and India will, hopefully, return on its path to prosperity.