Is it time to peg the rupee to the US dollar? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Is it time to peg the rupee to the US dollar? 

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In this issue:
» India scores well on export competitiveness
» Is the 2008 crisis worse than the Great Depression?
» Foreign bond issuances have been rising
» The big blow from SC on coal blocks
» ...and more!


00:00
 
India's volatile rupee caused quite a headache not just to the erstwhile UPA government but also to the RBI. So steep was the depreciation of the rupee that the import bill shot up and the current account deficit widened. Since then, some half hearted attempts were made to shore up the currency; placing a curb on gold imports being one of them. This did help to some extent but the fact remains that these are just short term fixes and what India needs is something that is more meaningful and long term in nature.

In this regard, an interesting article in the Forbes, talks about how India needs to make drastic changes in the area of monetary policy. The author of the article rightly points out that to become a true global economic power, one needs to have a stable currency. Indeed, Britain became a major power when it pegged its pound to gold in the 1700s. Japan and Germany were able to overcome the aftermath of the second World by also pegging their respective currencies to gold. Interestingly, China has also become a force to reckon with because of pegging the Yuan to the US dollar.

So as per the article in Forbes, the solution for India is to peg the rupee to a hard currency such as the dollar and the Euro. The point is that a floating currency causes too much volatility and inconsistency and it is important to have a fixed rate that is definite. Ultimately, the idea is to shift to pegging the currency to gold.

We wonder if this solution will really work. China is a classic case in point. True, that the dragon nation pegged the Yuan to the US dollar. This was one of the factors that fuelled exports and turned it into the world's manufacturing powerhouse. But in a global economy, there are bound to be dissidents. Firstly, China faced increased pressure from Asian countries, as the latter began to lose their export competitiveness since their currencies appreciated. But the major dissident was the US which turned up the heat on China to let the Yuan float and appreciate against the dollar. So for India to peg the rupee to the US dollar seems easier said than done.

Secondly, the US dollar itself has received considerable flak in recent times on account of the relentless money printing spree that the Fed has embarked on. Indeed, there was a time when the US dollar was pegged to gold but this practice was then dismantled in the Nixon era thereby eroding the value of the dollar. All said and done, a peg if any needs to be against a solid asset such as gold but whether we will revert to the 'gold standard era remains to be seen.

So we ask, should India copy China and peg its currency to the dollar? Or should different countries have their own currency policies that suit their respective economies? We don't know. What we do know is that India needs to run a current account surplus and not a deficit and needs to quickly move on this. And it also needs to work on improving the country's exports growth. And none of this can be achieved through short term fixes.

Do you think that pegging the rupee to the dollar is the answer to making the rupee stable? Let us know in the Equitymaster Club or share your comments below.

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02:11
 
While investor appetite for Indian equities is on a rise, desire to lap up bond issuances from India Inc isn't left far behind either. Taking the advantage of the current situation, corporates are queuing up to raise money via debt markets from abroad. As per a global rating agency, Moody's, foreign currency bond issuances are likely to peak this year. For the first seven months of 2014 itself, India Inc has already raised US$ 15.9 bn. Compare this to the US$16.4 bn raised in the previous year. Oil & gas, metals and telecom are the sectors which have witnessed most fund raising.

While the current conditions are suitable to raise funds, we believe Indian companies should not go overboard in raising money from foreign markets. Though the cost of debt is low abroad, it entails foreign currency risk. And in the past, we have seen profits of many companies swinging wildly due to sharp depreciation in rupee. True, that in the globalization era, most companies choose to hedge their exposure to forex risks. However, the ones which do not are at a grave risk of sharp currency movements. Investors should tread with caution while investing in such companies.

02:46  Chart of the day
 
One of the key highlights in the Narendra Modi's Independence Day speech was to invite the world to set up manufacturing units in India. His reasoning was that the country has the skill and talent to become a global manufacturing hub. What further strengthens his point is the costs advantage that India offers. As per a study done by the Boston Consultancy Group, India continues to remain a competitive player in the export market. Comparing costs of various countries - currently and a decade ago - and comparing them to the costs of manufacturing in the US, the study indicates that India's competitiveness has remained intact in the decade gone by. A key factor for the same is the 35% decline in the rupee against the US dollar over this time frame. Further, within the costs, it the labour charges that makes the key difference when compared to other emerging markets.

Well, this point may very well be taken by the government as it supports the goal of India becoming a manufacturing hub. However, the fact of the matter is that along with this, other factors such as improvements in the labour laws, regulatory hurdles and infrastructure will need to be worked upon as well to achieve this goal.

India remains competitive in exports


03:47
 
Coal has never been the 'black gold' for India! The country has amongst the biggest coal reserves in the world. However, politics, corruption and inefficiencies have ensured that the mineral drains India's wealth. Shortage of coal has been the biggest stumbling block for India's power sector ambitions. Most of the ultra mega power projects have remained uncommissioned or in losses over past 5 years! And Coal India has shown little attempt to improve its mining efficiency and supplies. It was expected that at least the captive coal mines will help ease the challenges in procuring coal. However, the latest Supreme Court verdict on coal block auctions has come as a big blow.

The verdict itself is a testimony to the fact that the government cannot squander the country's precious natural resources at its own will. Plus there needs to be sufficient transparency and not crony capitalism in these matters. However, for the time being, the Supreme Court judgment alone does not solve any problem. Unless the government steps on the gas to reallocate the coal blocks and penalize those who fetched undue benefits, India's power sector is doomed to stay in darkness.

04:15
 
Was the great financial collapse of the year 2008 worse than The Great Depression? Well, the man who was perhaps the closest to the unfolding crisis has given his verdict. And he believes it indeed was worse than The Great Depression. The man is none other than the US Fed Chairman of the time, Ben Bernanke. "September and October of 2008 was the worst financial crisis in global history, including the Great Depression" . This was the specific statement that Bernanke made back in November 2009 but which surfaced only recently.

What's interesting to note is that the results weren't nearly as disastrous? Thanks to a gigantic and timely intervention by the policymakers, what looked like something worse than The Great Depression eventually ended up becoming The Great Recession? So, are we finally over the hump now? We don't think so. The Fed's actions have only kicked the can down the road according to us. And none of the problems that led to the crisis in the first place have gone away for good. Consequently, we won't be surprised if one of Bernanke's successors makes a statement about another crisis as big as The Great Depression that he had to oversee.

04:45
 
The Indian stock markets pared early gains but continued to trade above the dotted line in the post noon trading session. At the time of writing, the BSE-Sensex was trading up by 46 points (0.2%). Majority of the sectoral indices were trading weak with realty and power stocks being the biggest losers. Oil & gas stocks were the top gainers today. Most of the Asian markets were trading in the red with Hong Kong and China posting major losses. Even European markets have opened the day on a negative note.

04:56  Today's investing mantra
"Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well." - Warren Buffett

Editor's note: There will be no issue of The 5 Minute WrapUp on 29th August 2014.
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11 Responses to "Is it time to peg the rupee to the US dollar?"

Niraj Sukare

Mar 10, 2017

INR should be pegged to doller.

Like 

Joshua Kurien C

Oct 9, 2014

India should not peg its currency to the US Dollar. The world will find an alternate reserve currency. Changes will take place in the global financial arena where the USD will not be favorite. Let us keep our options open

Like (1)

Sashi

Aug 29, 2014

At a time when countries are trying to diversify away from the dollar and in fact, dealing with the problem of fiat currencies, it would be extremely short sighted for India to have a peg to the USD (or Euro) today. The move to have direct dealings with other major trading partners in currencies other than the USD (Rupee, Rouble, Yuan, Real, etc) is better. Ultimately pegging to something of value (like Gold) makes the most sense, but would also impose restrictions on free spending by governments which may not be so politically possible.

In the end, it does not have an easy solution, but I think the RBI has managed the situation very well by having swaps and other measures to deal with short term problems.

By tying to the USD, you also can import problems linked to the USD as well, which may not be in our control.

Like (1)

Esmail Colombowala

Aug 29, 2014

Indian Rupees should be pegged to "Fixed Parity with Dollars" instead of pegged to "Basket of currencies" to resolve Current Account deficit to surplus & avoid currency Volatility. Take an example of Gulf Countries pegged their Currencies to "Fixed Parity with Dollars". Esmail Colombowala

Like (1)

parimal shah

Aug 29, 2014

Two points.
1.Pegging INR to US dollar will be a disaster. How can one call US$ sturdy when debt of US is much higher (many times higher) than the GDP. The so called 'sturdy' is from its status as international currency - its real value has severely declined since the QEI. If at all INR has to become more sturdy it must be pegged to GOLD and there is no point in imitating China. The day US$ loses its international currency status (not very far - may be a decade or two) US$ will be the worst currency in the world.
2.Quoting Ben Bernanke's (QEI) policy as timely intervention is the greatest mistruth of the century. Had US the economy and the market left alone and not influenced, the natural market forces would have removed the chafe from the grain. The QE policy has added more chafe - and that too, officially. It was (and is) the silliest (and misplaced) way to make an economic recovery. Japan has blindly followed that path whereas Japan's own history (after WW-II) should have taught that country a lesson to rely more on production and less on money printing spree.
God save the world, and the markets.
-Parimal

Like (1)

VINOD KUMAT

Aug 29, 2014

Looking at the Indian psyche of Investing in the Yellow Metal (GOLD) for its own sake and the quantum of Gold held by India (RBI/Banks)/ Indians / Temples and HNIs together, and of course the Universality of Gold as a Treasury Investment across the World, pegging Rupee to Gold holdings as a fraction of the total World Gold( not to the US$ value of Gold!)would be a much better option as it would provide a paradigm shift in the Value of Indian Currency!

Like (1)

Rasikbhai Gandhi

Aug 28, 2014

Due to present rate of USD about 61/- our exports of essential agro commodities have increased but our imports of Agro commodities have become very costly. Due to both of these reason general index of inflation of edible index has gone up.

Like (1)

Rajendhiran S R

Aug 28, 2014

Dear Madam/ Sir, I hope our Country is not short of Economist/ Financial Analyst. Why don't we suggest and provoke to think the reasonale behind the unreasonable fluctuation against the US Dollor? What is preventing us from following the Chinese route or practised else where? (Let us not reinvent the WHEEL; just copy the system best works else where?) or try out for a particular period, if not reverse the system (I can understand the great difficulty involved in this?)
Last but not least, let the Equitymaster Club, reminded the RBI, Central Government and Authorities concerned on a very regular basis (Always Govt. system takes its own time to react, hence continuous reminder is inevitable - this is hard earned experience of mine)to adopt a NOVEL ideas to test and adopt on a regular intervals.
Let us all try to do some thing for our great NATION!
S R Rajendhiran, Chennai.

Like (1)

Balakrishnan R

Aug 28, 2014

In order to have stable currency, it may be better to peg it to gold. But, present conditions, it would be difficult. Hence, we may try to peg it to CHF (Swiss Frank), which may not vary much. Or we must try to peg it to India's most export or importing country's currency.

Like (1)

Ganapathy Sastri

Aug 28, 2014

Implicit in the assumption that INR should be pegged to USD is that USD will be a strong or stable currency. There is ABSOLUTELY NO BASIS for this belief. If anything, one is comparing one weak currency with a weaker currency. Despite significant devaluation of INR since 2008, the country faces a MASSIVE TRADE DEFICIT year after year and rivalled only by USA. If govt wants to maintain stable, it should first start LIVING WITHIN ITS MEANS and not resort to the massive deficit financing that had been the hall mark of the government during the last six years. The last six years also saw a MASSIVE INFLATION of over 15% CAGR. This has eroded competitiveness of Indian industries including IT companies. Salary levels in IT companies are ten times of what they were twenty years ago. Given these factors, govt should let the INR find its own level whereby trade deficit turns into trade surplus. It is no use comparing ourselves to China and USA. China has been having huge trade surpluses and USA can keep printing a currency that the world keeps accepting. Neither the country nor the government can keep living beyond their means for long. It is time we change and hope for ache din.

Like (1)
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