The Rise & Fall of the Rupee - Risk,Reasons,Potential

Rupee for the Economy 

Or 

Economy for the Rupee ?

The antics of Indian rupee is very exciting as it keeps swimming from a dive deep down to bumping back with a splash. It projects an image that of a nasty lover who throws up surprises for her partners (Indian stock market) as well as sets them in frenzy. While the rupee plays a catalyst to ignite some energy in the Indian economy constantly embroiled by other factors gaining fair share of attention, it still puts up a dramaqueen act. 

We Indians feel good about a strong rupee and somehow we equate the feeling to national superiority. But equating national prestige with a strong rupee is wide of the mark considering the proper analysis of the real economics. What matters is that India's exports are competitive, and current account deficit under control. If this co-exists with a strong rupee, fine. But if this requires a weaker rupee, that's fine too. However for the economy to be stable, the rupee has to perform and what better way than easing the pressure off the CAD.

It is not a hidden fact that foreign capital has seen an unprecedented inflow in the Indian market contributing to keeping the CAD under control but what remains a reality is that a large percent of the Indian free floating stocks are controlled by foreign investors. Moreover in financial year of 2013 the CAD was financed by short term inflows and portfolio investments by foreign investors. The problem which lies ahead is that these foreign investment are short term and may leave if they get even a little doubt about the potential risk in the market or out of political discourse. 

The real obstacle on the Indian economy is that it still struggling to overcome distribution system and supply-side constraints on growth. Even if the evaluation is done on the basis of the Quantitative Easing methods that can act favourable, the stark reality is that two key indicators are likely to govern the duration and extent of quantitative easing (QE) measures – the official unemployment rate and the annualised rate of growth of consumer/retail prices. Although Foreign capital inflows continue to be dominated by short-term portfolio investments into India and this situation is unlikely to rebalance in the immediate term. Foreign direct investment (FDI) and, therefore, long-term investment will only begin to recover when the economy's key macro economic parameters are stabilised. In particular, the government will need to show meaningful progress in addressing the twin deficits, so as to reduce the sovereign and long-term investment risk that is currently inherent in the Indian economy. For India as of now the data indicate the economy is struggling to overcome distribution system and supply-side constraints on growth.

Today, corporates are just holding back their investments in project .A lot of cash is waiting to come into India as China is no longer a preferred destination for capital, given its internal problems. But Japan is the next stop for investors before India eyeing even the portfolios of foreign investors. Overall, global investors are now seeking investments that will deliver enhanced yields and this is supporting a major migration of funds from sovereign government bonds into equities and lower-rated (higher yielding) corporate bonds. 

History has repeatedly shown India's vulnerability to sudden stops of forex inflows. Such sudden stops can be triggered by global events even if there is no disaster in India itself. The best remedy is continuously rising productivity, making exports more competitive and imports less competitive, ending any significant current account deficit. The current account deficit will shrink but will be mainly because of the conditions on import.

Either ways what needs to be improved is the trust in the Indian rupee which is exposed to external shocks as investors divorce it for the much attractive Dollar. Take the case when US Fed announced tapering off quantitative easing while the Indian Rupee was at an all time high back in May-June 2013. As soon as investors got a hint they fled for the safety of the Dollar leaving its short term interest in the Indian rupee in a lurch.

Hence the financial planners of the country should aim at improving domestic productivity and lessen its import. It may not help the Rupee climb the highest peak but it will surely insulate the economy and the Rupaiya’s Nosedive Saga.