Explaining the Rupee's fall - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 28 April 2012
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Explaining the Rupee's fall A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
A lot of people are concerned about the value of the rupee. Governments, companies, institutions, and individuals are all concerned about why the rupee is falling. Some people are blaming deteriorating economic conditions, worsening investor sentiment, corruption, uncertain regulatory prospects, etc.

Of course, all the factors described above are important when it comes to the overall economic outlook. But, it we are interested in analyzing why the rupee has fallen, it is actually much simpler than that. Over the last two years, (from April 2010 to April 2012), the rupee has fallen by around 18% against the dollar. (USDINR has gone from around 44.5 to around 52.5)

18% looks like a large fall. If the stock market fell 18% over two years, we would be concerned. If GDP fell by 18% over two years, it would be a crisis. But for the rupee, 18% is actually not a significant fall. In fact, a fall of this magnitude is roughly where the rupee should be. Let's see why.

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Over the last two years, US inflation has average at about 2% per year. In contrast, Indian inflation has averaged at about 10% per year. What this means is that each year, the dollar loses around 2% of its value due to rising prices, and the rupee loses around 10% of its value due to rising prices.

Thus, over a 2-year period, the dollar is worth 4% less, and the rupee is worth 20% less. Another way to say this is that the dollar has gained 16% against the rupee over the last two years, simply due to inflation. Now, if the rupee has fallen by 18% against the dollar over the last years, we can see why this is the case.

The fact is that almost all of the rupee's fall against the dollar can be explained by the difference in inflation rates. If we look the performance of the rupee against the dollar in real terms (i.e. adjusting for inflation), it has actually fallen by only 2%, not 18%.

Now, if we analyze the movements of the dollar and the rupee over short and medium term timeframes, we do see a lot of volatility. Various economic events move the currency in different directions over short-term periods. But once we take a long-term view, the only factor that is relevant to explaining the rupee's fall is inflation.

As long as India's inflation rate is significantly higher than the US inflation rate, we can expect that the rupee will fall against the dollar over time. And this is not necessarily a problem. High inflation is problem that has many negative consequences, and this is what we should be most concerned with.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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16 Responses to "Explaining the Rupee's fall"

vinod

Jul 26, 2012

I disagree with Mr. Dossani, his analysis is absolutely wrong. The rupee slide with US dollars is purely based on lessor inflows of forex, whether because of more imports than the exports that is trade deficit, coupled with lessor amount of FDI, and FII inflows. Ours is an economy depending more and more on imports today, because our Politician do not have foresight, they did open the import of almost every product without thinking about the fate of India's own Industry. Our outflow of forex alone on Crude, Gold and Automobile components is far higher than it should be. In early 1970's the slogan " Export or Perish " is still the need of the Nation. Unless the trade deficit is made NIL by increasing Exports or by decreasing Imports, we will not survive and the rupee would keep falling. I still remember the good old days of late 1970's when the USD was about Rs. 8.00. Will can not live long on borrowed Forex, be it FDI or FII. May God bless our Politician with wisdom and they foresee that exports are of utmost importance than any thing else to have the rupee gain to its real value. The value of USD to INR in the year 2000 and 2010 clearly shows that INFLATION has to do nothing with the declinging value of Rupee as Mr. Dossani has said in his write up.

Like (1)

Amit

Jun 25, 2012

Poor article. India's rupee has been falling due to a poor Balance of Payments (BoP) situation. If I have my numbers correct, then India's BoP is now 4% of GDP. That is even higher than the 1991 crisis days. When India has to pay more in dollars (i.e. when the demand of dollars is high), the value of rupee will automatically fall! Simple economics!! Solution? Get oil from Iran and pay in Indian rupees. That will help the BoP a great deal. And announce structural reforms in India!!

Like (2)

M R Kamath

May 6, 2012

Inflation simply means you can't buy today what you bought a year back with same number of Rupees or Dollars..
but this is not fit all... some articles particularly electronics & manufactured goods may be bought with less number of Rupees...some like gold or land may be more expensive than average inflation...the article explains one obvious reason which can not be denied.

Like (2)

DEEPAK MUSCAT

May 4, 2012

Theory out of old text books of Economics -not relavant any more...

Uncontrolled printing of rupee notes by RBI and deficit financing by Govt. are some of the causes that the World banking systems do not like.

Further India is an importing economy. Crude oil import will be a bigger hole soon . Very difficult days ahead...


Like (2)

kalabairava

May 1, 2012

Liquidity is not directly related to Inflation in real economic theory. It is Keynesian loophole which offers the central bank an opportunity to use liquidity as a lever. Inflation is only when you have a buyer and seller willing to exchange money for goods and vice versa. Excess Liquidity is a state when there is no exchange but the market is flooded with currency. If it were real money it would imply wealth. Since this is fiat money, it implies junk and deforestation.

Like (2)

Vinod Sajnani

Apr 30, 2012

In the year 2000 USD-INR conversion was around 45-46 and again in 2010 we had the same conversion ratio. Does it mean that the inflation in India and in US was at par. Which is not true. The article is partial and must cover other elements that weaken the rupee. If I buy the theory that only inflation weaken the rupee then I would advice readers to invest all rupees in buying dollars as India will never be able to control the inflation.

Like (3)

Kunal

Apr 30, 2012

The article is quite well articulated and explained however, I would like to know why has the rupee fallen so drastically in past few months although the inflation (WPI) in past few months has averaged around 6-7%. Is this adjusting for previous high inflation figures.

Like (3)

Sandeep

Apr 29, 2012

Great article....

Like (3)

AMOL CHIDRAWAR

Apr 29, 2012

how could u correlate the falling of prices of rupees wrt doller with inflation of US & INDIA

Like (1)

S Dutta

Apr 29, 2012

It is well known that US has actually given up the gold standard since a few decades and currency is printed without gold backing. Is there any real significance of the inflation in a currency which is not backed by gold? The other reason why the USD is afloat are primarily the trading that is being done by various countries like China in USD and OPEC countries. In fact considering the financial imbalance of the US economy, the USD looks to be in crisis. The explanation by comparing inflation rates applies to countries adopting gold standard only.

Like (2)
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