Central & South Asia

The Falling Indian Rupee: Crisis or Contagion?

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September 19, 2018 16:24 EDT

American economic policies are causing the rupee to fall, but India’s fast-approaching elections might make its economic situation worse.

On August 26, the Indian rupee started falling. On September 11, it fell to a record low with $1 worth Rs72.7. This led to a plunge in stock markets, caused economic discomfort and sparked an emotive political reaction.

The reason for jitters in the country are understandable. In 1991, India faced a balance of payments crisis. It had to go with a begging bowl to the International Monetary Fund for a bailout, for which it had to pledge its gold reserves. India has never forgotten that humiliation, and it cast Chandra Shekhar, the socialist prime minister at the time, into oblivion.

Elections are due in 2019 and the depreciation of the rupee has led to a polarized debate that is heavy on rhetoric but low on facts. The interpretation of the depreciation varies dramatically depending on the political leanings of the commentator. Supporters of Prime Minister Narendra Modi blame depreciation on the rise in the price of oil, while the opposition blames it on the government’s mismanagement. Rising petrol and diesel prices have become a political hot potato and social media is awash with instant reaction, little of which is informed.

The operative fact is simple. Since August 26, the Indian rupee has declined by 11% against the US dollar. This fall in the rupee has led to headlines such as “Asia’s worst performing currency” or the “Indian rupee crisis: Worst is not yet over.” This in turn has fueled panic in the country. Yet most journalists fail to take a deep breath and examine fundamental questions.

What happens when the rupee depreciates? For a country that imports its oil, does depreciation lead to widening current account deficit, inflation and lower growth? Is this a result of worsening global conditions or has economic mismanagement played a part? Most importantly, could the depreciation of the rupee lead a full-blown economic meltdown?


US President Donald Trump has unleashed a trade war that is likely to upend the post-Soviet underpinnings of the global economy. Since World War II, the US financed the export-led growth model of its allies. Since 1991, it allowed many emerging economies to grow dramatically by running huge trade deficits. The ensuing trade surplus in places like China, Vietnam and other countries in Southeast Asia boosted their prosperity. Now that model is under threat.

Trump’s trade war threatens the export-led growth model, weakens competitiveness of emerging economies and dampens their growth prospects. Naturally, most Asian currencies are weakening. Analysts are placing India in the same club, forgetting that the structure of its economy is dramatically different.

India’s biggest worry is not Trump’s trade war — it’s the rising oil prices. India is an energy hungry economy that imports 80% of its total crude oil consumption. It is currently the second largest consumer of Iranian crude after China. Thanks to Trump’s jettisoning of the nuclear deal with the Iranians, India will slash oil imports from Iran by nearly 50%. This means that India’s oil import bill will surge by nearly 25%.

The rising oil bill will make the Indian economy less competitive by boosting the cost of everything from agricultural production to transportation of all goods. In an election year, the government will be under pressure to cut fuel duties and bring down prices. It is little surprise that people are selling off the rupee and discounting it today for short and medium-term risks.

In the long term, India does not face the same risks as the rest of Asia. For the last five years, it has experienced tepid growth in exports. India’s exports of goods and services as a percentage of GDP touched an all-time high of 25% in 2013. Since then, it has been declining. In 2017, this ratio stood at a mediocre 18.8%. India has been unable to increase exports because its banking system is broken, policies like demonetization caused much upheaval, and the Asian tigers have outpaced the lumbering Indian elephant by leaps and bounds.

In simple terms, the downward pressure on the Indian rupee is not caused by long-term structural changes like other Asian economies. It is a simple result of demand and supply. More people are selling the rupee than buying it. The price of imports has shot up, but it has not been matched by a similar rise in value of exports. Therefore, there is greater demand for dollars as compared to rupees.

In any case, India has historically operated a negative current account due to its inward looking growth model. Even the economic liberalization of 1991 did not change this model. India has sustained this deficit because of foreign direct and portfolio investments that have long sought to benefit from the country’s long-term growth potential.

Now these capital flows have reversed. The US Federal Reserve has raised interest rates and Trump has instituted protectionist policies. Capital is flowing back into US markets to take advantage of the growth potential in many domestic industries. Besides, the currency crises in Argentina and Turkey have also turned market sentiment against emerging economies. Therefore, currencies of most emerging economies are suffering.

Hence, the primary cause of the decline in the value of the rupee is the fear triggered by the economic policies of the US. The trade policy reset, an increase in interest rates, and the cancellation of the nuclear deal with Iran have caused a monetary contagion that is wreaking havoc in emerging economies. Even though India is not an export-oriented economy, its dependence on foreign oil and populist pressure to lower fuel prices before elections put downward pressure on the rupee.


The depreciation of the rupee will make imports, including those of oil, more expensive. It may lead to an increase in prices. Yet it is unlikely to cause an economic downturn. Currently, India is on a low inflation and high-growth trajectory. The country grew at a remarkable 8.2% last quarter despite adverse global conditions. At the same time, inflation has stayed at 4.8%, a low figure both by India’s historic and emerging economy standards.

In any case, the relationship between the strength of a country’s currency and its economic health is highly ambiguous. In 1992, the British economy rebounded after it crashed out of the European Exchange Rate Mechanism and devalued the pound sterling. Lower exchange rates make exports cheaper and imports more expensive. If Indians curtail foreign travel or send less students to study in the US as a result of this depreciation while exporting more automobile parts and diamond rings, the depreciation of the rupee might just be what the doctor ordered.

Besides, most commentators forget that they are making a fundamental mistake when they compare India to other Asian economies. Most Asian economies maintain fixed exchange rates or allow their currencies to float within a tight band. Their currency management regimes are fundamentally different to India. Their economic structures are different too, as is their ability to make open market interventions.

The lesson that Asian tigers took away from the 1997 Asian Financial Crisis was to keep huge war chests of dollar reserves. These might help them prop up their currencies, but they also help prop up the dollar. Asian currencies might seem healthier than the rupee, but propping them up means subsidizing American consumers to buy Asian goods on the cheap. In a curious role reversal, the poor are subsidizing the rich.

Similarly, comparing the current fall in the value of the rupee with the 1991 balance of payments crisis is misguided. Then, the fall of the Soviet Union left India perilously exposed. Saddam Hussein’s invasion of Kuwait and the Gulf War pushed up the price of oil. Furthermore, a ragtag coalition immersed in infighting and illiterate in basic economics held the levers of power. India may not be run by economic geniuses, but its fiscal deficit is nowhere close to 1991 levels.

Rajiv Gandhi’s Indian National Congress government and the subsequent coalition governments consistently ran fiscal deficits more than 8% of GDP since 1985-86. In contrast, earlier governments had run deficits of 6% in the early 1980s and only 4% in the mid 1970s. When the twin shocks of the fall of the Soviet Union and the Gulf War hit India, the currency went into free fall and the economy teetered on the brink of collapse.

Today, India is a much more robust economy. Its very failure to become an exporting powerhouse gives it immunity against external shocks. Besides, the fiscal deficit currently stands at 3.5% and has remained less than 4% for past three years. Furthermore, two major regulatory and institutional reforms give India some leeway. The goods and services tax (GST) has finally achieved what the Europeans achieved many decades ago. It has belatedly turned India into not only a political but an economic union, boosting inter-state trade. The Insolvency and Bankruptcy Code of 2016 has allowed the government to crack down on those defaulting on big loans. Both these measures have enabled over 8% growth, which was achieved even as the rupee was constantly falling albeit not so dramatically.


Even though the depreciation does not bode long-term dangers to the Indian economy, its political fallout could be immense. Election fever is about to hit India. The opposition is likely to throw the kitchen sink at the Modi government, blaming it for the falling rupee and rising fuel prices. At that point, populist politics might trump sound economics. The government might decide to lower fuel duties, causing an increase in its fiscal deficit.

India’s current account deficit — the difference between its exports and imports — is likely to increase in the short run. Understandably, the government is concerned about this deficit and announced measures to rein it in. If internal growth and consumption remain robust, India can ride out the increase in its current account deficit. The growth potential in India can finance this deficit, especially if it remains fiscally responsible and reforms its infamously dysfunctional institutions.

However, political economy always trumps pure economics in real life. Rising oil prices will lead to inflation. Elections in India are proverbially determined by the price of onions. If this goes up and political unrest begins, the Modi government might start behaving like a cat on a hot tin roof. It is likely to lower fuel duties, increase fiscal deficits, worsen current account deficits, erode the macroeconomic gains India has made over the past four years, and worsen growth prospects for the future. This is precisely what the government must not do.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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