Is 65 the new 45?

A very famous joke doing rounds these days is that Rupee has grown from our very own Rahul Gandhi’s age to our Finance Minister’s age and if all goes this way it may reach Prime Minister’s age. But actually if this happens, it should not be appalling for us, considering the approach with which our country is moving ahead.  We would find many economic theories which would tell us that rupee is highly undervalued now. Our very own Mr. Chidambaram said that rupee has tumbled below 65 (It may have very well fallen below this by the time this article reaches you), it is undervalued and hence there is no need to be pessisimistic. Rupee has depreciated by 13% since April and around $12 billion FIIs have moved out of India. Theoretically, he may be absolutely right, but there is a doubt on how well this holds true if it is thought of practically.

First, what is meant by undervaluation of a rupee? It means if the economic theories tell us that 1 $ should be equal to 40 Rupees. But we have 1$ equal to 50 Rupees as exchange rate in the economy, this implies that rupee is undervalued. This means that fundamentally the rupee should have been higher, but it is temporarily lower.

The question to ponder over is that if it is currently undervalued, then what is making our currency go down even further? Why is it that irrespective of an undervalued currency, we are not having our export sector booming?? What has happened that a country that was having a robust growth story even during the world crisis is continuously facing depreciation of its currency? Or is it is that we are moving to our true currency value and 65 is going to become the new 45?

Now the questions are many but the answer is only ONE. There is no doubt that we have had long and strong growth story, but is also true that the fundamentals of the economy have been shaken entirely. There has been no front on which India is not facing any crisis. We have very high trade deficit( i.e. excess of import value of goods and services over export value), high current account deficit( means dollar that flow  in the country is that less than what is required to even pay for our demands, making it obvious that this would increase the value of dollar) on external front. If we talk internally, we have extremely low GDP, very high fiscal deficit (excess of government expenditure over government revenues), chronic inflation, and very low investment. To make the matter worse, there is lack of clarity on foreign investment policies and tax policies.

Now realizing this vicious circle, means all these factors are leading to depreciation of rupee which again back feeds and leads to widening of current a/c deficit, trade deficit, and high inflation and so on and making the matter worse. The government is trying is trying to do its bit, but it is too less to prevent the freefall of trust that is being put on our currency. What is making the effort of government almost futile is their wrong approach. It clearly is a case of politics over economics.

Government has come up with liberalization of FDI rules but the final decision of whether to allow a company to set up in a particular state is left on state government, hence keeping everyone happy. Second, rather than addressing the fundamental problem of lack of proper investment climate in the economy, the government is just trying to get in whatever funds available ( like FIIs which are very volatile) in the short run so as to cover this problem currently. Third, they want to contain fiscal deficit, but still want the populist food bill to be passed (more focus on 2014 elections).

Fourth, to manage current account deficit, they are trying to put controls on import of gold and some other items rather than trying to find alternative means of investment for people and not artificially forcing them not to buy some commodities. Fifth, time and again RBI has been blamed for keeping the interest rates high leading to less investment, less growth. In this the government has ignored that RBI was trying to curb inflation that was spreading like a plague. Also, RBI has always warned government about the mounting fiscal deficit problem which was stopping them from lowering the rate of interest. It may actual taper off investment by bringing in more uncertainty in minds of foreign investors. All these measures by the government have a problem of short sightedness!

It seems we were too happy about our growth story going strong. Growing at one of the highest rate even in the world crisis era, added to the overconfident attitude and we stopped looking at fundamentals in the economy. But we can’t forget that a building cannot be strong if the fundamentals start shaking! It is to be wondered till when can we just casually pass on the blame and being happy by the fact that fundamentally rupee is strong, it is just that currently it is undervalued. Because if keeping heading the way we currently are, we surely would find this new value of currency to be the true value!! And if this happens, we are in for big trouble. It was very rightly said by John Connally, the treasury secretary for President Nixon, “It’s our currency, but your problem.”

So here we go; falling in a trap and moving to new lows!!

-Aakanksha Arora