Daniel Altman

If India’s Really Booming, Why Is the Rupee Crashing?

Meet the banker who could save the country's faltering currency.


How the mighty have fallen! Look where the supposedly world-beating BRIC countries are today: Brazil is mired in protests, China’s growth is slowing, Russia is addicted to self-destructive spy games, and India’s currency is at an all-time low. Of the four, India has the brightest prospects for growth ahead, so why has the rupee taken such a dip?

Even though China is growing faster right now, India has many more years of rapid expansion ahead simply because it hasn’t urbanized or adopted new technologies to the same extent. You’d think foreign investors would be desperate to get in on the ground floor of this long-term boom, but naturally they’re more fickle — and less patient — than that. And since the value of the rupee in global markets depends on their demand as well as its supply, you have to consider both to understand what’s happening.

On the demand side, the key is to think about why people might want to exchange other currencies for rupees. Buying anything from India — goods, services, financial assets — can require rupees. When demand for any of these things rises, so does demand for rupees. Of course, when the rupee gains value, anything bought with rupees becomes more expensive for foreigners, so demand may equilibrate on its own.

That hasn’t happened yet for Indian assets. In April 2011, the International Monetary Fund forecast that India’s economy would grow by a total of 37 percent from 2013 through 2016. The fund’s latest prediction, updated last month from the April 2013 figures, is for growth of just 28 percent in the same four-year period. It goes without saying that less potential for growth means less interest from foreign investors.

At the same time as India’s growth forecasts were falling, other markets were becoming more attractive. A few years ago, investors frustrated with the slow recoveries in established markets might have taken a risk in India. Now, with a backdrop of somewhat greater stability, investors are returning to the advanced economies to hunt for bargains and ride the cresting wave. Not surprisingly, credit is tougher to come by in India; the yield on its government bonds has hit a five-year high.

The jump in bond yields may also have to do with expectations for inflation, which is another concern in India. As prices climb, the value of the rupee in real terms falls, and investors won’t give up as much of their own currencies to buy it. Consumer prices rose by only 3.8 percent in 2004, but the rate quickened in every subsequent year through 2010, when it hit 12 percent, one of the highest rates in the world.

With inflation still at 9.3 percent last year and possibly higher in 2013, the new governor of the Reserve Bank of India (RBI), Raghuram Rajan, has his work cut out for him. His job is to decide the supply of rupees, and by slowing the printing presses he could stem inflation. Yet by curtailing access to credit even further, he could also cool the economy, and not at a good time. India’s leaders are already starting to worry about next year’s elections, and the RBI is much less protected from their meddling than the Federal Reserve or the European Central Bank.

That said, there is certainly room for improvement on the supply side. Between July 2011 and July 2013, the Indian money supply increased by about 29 percent. During the same period, the value of India’s gross domestic product in rupees probably increased by about 27 percent. In other words, the RBI let the money supply expand by more than the amount necessary to cover inflation and economic growth; the extra rupees dumped into the economy were just more fuel for the inflationary fire. The bank may have made the money available to help foreigners purchase Indian assets, but by cheapening the rupee it may actually have driven them away.

In the longer term, the rupee should be able to tolerate moderate inflation without losing more of its value. The productivity of Indian workers is indeed increasing as the country urbanizes and adopts new technologies. Wages will rise, and so will prices. With a higher price level, anyone selling a unit of Indian stuff will receive more rupees for it. Barring a big change in the exchange rate, more rupees will buy more foreign currency, and more foreign currency will buy more foreign stuff. None of this would necessarily preclude equilibrium in the supply and demand for rupees.

So what’s the endgame here? As long as the RBI doesn’t start printing rupees like there’s no tomorrow — and with Rajan in charge they almost certainly won’t — the currency’s freefall will be temporary. At some point, Indian assets, goods, and services will seem cheap, and buyers will return.

But for that to happen, the currency markets must be left to their own devices. The pre-Rajan RBI has moved in the opposite direction by limiting Indians’ ability to sell rupees, which investors will interpret as a last-ditch effort to maintain the currency’s value at an artificially high level. In Argentina, similar measures recently led to a black market in pesos and further undermined confidence in the country’s economic policies. For Rajan, reversing course will be job one.

 Twitter: @altmandaniel

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