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Why the rupee will never strengthen - Views on News from Equitymaster
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  • Dec 1, 1998

    Why the rupee will never strengthen

    The Indian Rupee is doomed to be a weak currency. Not only because our economic policies are so confused and lopsided with nuclear tests given higher priority than onions, but also because the politicians and the bureaucrats are determined to keep the Indian currency down on its knees. And their determination to keep the Rupee weak has never been clearer than in the past one year.

    Initially, in July 1997 just after Thailand devalued its currency, the policy makers in India did not comprehend the panic that was about to set in for all emerging markets. With little thought, the policy makers continued to talk about capital account convertibility and the free trading of the Indian currency.

    The foreigners figured that India was either brave or stupid. In any case, it did not matter at that time as not much damage could be done to the Indian rupee since trading in the currency was limited. And there were easier pickings and profits to be made by whacking the other Asian currencies. But by October, 1997 when the South Korean won was battered, the alarm bells went off in the minds of our policy makers. And that is when the will to talk the Indian currency down gained momentum.

    Fearing that weakened Asian currencies would increase imports and hurt many of our local industries, coupled with fears that our exports would be less competitive, resulted in a government that watched the rupee slip from Rs 36 to the US dollar in June 1997 to Rs 39 by December 1997. Then, just as the Indian currency looked like it would stabilise at below Rs 40, the Indian government again opened its mouth and effectively said that a lower currency would be better. The currency quickly slipped to Rs 43. At a conference call with foreign investors in June 1998, the Finance Minister was quick to point out that the Indian rupee was only tracking the Japanese yen. He was right. The yen had fallen by 18% since the start of the year and so had the rupee. Not that I agree with the logic of tracking the yen, but since he is the finance minister and I am not, I will grant the logic.

    Now, between his conference call in June, 1998 and today the yen has gained about 15%. If the logic of tracking the Japanese yen was correct five months ago, hopefully it is still correct today. If that is so, why is the Indian rupee not at Rs 36? Why has the Indian rupee not gained against the US dollar like the Japanese yen and the other Asian currencies? Could it be that the same logic to oil prices for consumers applies to currencies: when global oil prices rise, charge the consumer higher, when they fall, keep quiet and continue to cheat the consumer!

    There was also the argument put forward that China had devalued its currency a few years ago and India was playing catch up to the Chinese action. Let's put that in perspective. Between 1992 and 1993, the yuan had declined by 33% and has stayed there for the past five years. There was a period in 1993 when the yuan had fallen by 80% to 10.5 yuan, but then the Chinese government probably realised that the currency was undervalued and brought the exchange rate down to 8.3 yuan. The argument that I can present to the "playing catch up with China" justification is that India, too, had devalued its currency from Rs 16 in June 1991 to Rs 31 by January 1993 - a knock of 90%.

    And look at how the China approach of keeping its currency steady in this crucial period won praise from the international community. President Clinton made a visit to China earlier this year in recognition of China's help in trying to stabilise the Asian economies. This action was also a slap in the face for Japan which was seen as part of the problem in Asia, and unwilling to help solve the Asian crisis. And India? We were busy with our nuclear tests.

    But our policy makers in New Delhi will continue to batter down the Indian rupee - because that is their mind set. That is how they have been moulded. They are living in a world in which they believe that a weak currency boosts exports, hurts imports, and nothing else matters. Look at our exports over the past ten years and see how wrong they are - India is a nation of low-priced, low-quality exporters who have no desire to improve the quality of their products and their service to end customers. The easiest way for exporters to maintain profitability was to beg the government and the central bank to weaken the rupee. This they gladly did as there is no "visible"cost.

    And then there were the industrialists who built cement, steel, and petrochemical plants and were scared that the more efficient foreign producers would flood the Indian market with less expensive goods. A weaker Indian currency saves their skin, too. As long as we try to protect our exporters and save the import-substitute producers, we will adopt a weak currency policy. At his next conference call, the Finance Minister will probably use the weakness of the currency in Timbuktu as a rationale for knocking the Indian rupee ever lower. When will economic sense prevail? When will the policy makers realise that preserving the value of the currency is important to attract capital flows and that it is time to cut the umbilical cord for the exporters and the producers of import-substitute products? Alas, probably never.



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