Currency: Where are we heading?

The INR had seen a wide range of low of 44 against the USD in July 2011 and a high 68 against the USD in August 2013. Currently, it has cooled off a bit and is quoted at Rs. 60. What could have caused such a huge move? A widening fiscal deficit and balance of payments seem to be the answer.

 

The Ministry of Finance cited the above reasons and took immediate steps to curb imports of items such as gold and other electronic devices, which seem to be favorites of Indians. Almost all of them who travel abroad buy gold and electronic devices on way back home. In our previous article on gold, we had discussed on howone has to pay for imported items such as gold or electronic items such as phones and TVs in US Dollars. This thrusts pressure on the economy because all the dollars are going out to buy gold. However, one could very well argue that many dollars go out for other purposes as well. Most of the gold goes in to bank lockers or in form of ornaments. Hence, economists say that money invested in gold is in real terms blocked. If that money rolls in the system, it could do much better for the economy.

 

The curbs that were imposed by Ministry of Finance proved to be useful and the situation came under control. The rupee strengthened almost 15% in six months. Currently, these measures are looking great. However, it looks a temporary fix more than a permanent solution. Well, I guess we are here to discuss the outlook of our currency and not to suggest the government on what can be done on such topics. Here is why we can venture into it. I would like to give a small example.

 

We are net-net importers, with our imports always greater than our exports. Hence, the dollars that we get, are less than what we have to give. Now, our maximum outflow of dollars is to buy Crude Oil. Therefore, a weak currency would mean that we would literally pay more to buy the same amount of a commodity, as common sense suggests.

 

There is a close relation between interest rates and inflation. If the RBI lowers interest rates, money supply increases in the markets, which increases spending behavior leading to a rise in inflation. In India, inflation is taken very seriously. Hence, a balancing act becomes the need of the hour for the government. All these being majority factors, there are many small ones too that need to be taken care off.

 

India has huge incoming dollars and other currencies in the form of remittances as well. According to the World Bank, India sees one of the highest remittances in the world. This is good for the Indians staying abroad who send money into the country. They get more rupees for the same amount of dollars they send. Hence, their spending capacity increases. This has been a real breather for the slowing down real estate sector, which saw good inflows due to this reason.

 

Hence, on a broader perspective, the expectations are that the rupee should be in the range of 55-65 in the times to come. Whenever it could touch a higher range, government would be swift to react and get the situation under control. We hope the same continues and lower levels are maintained. It is good for the economy.

 

Written By: Sumeet Jain, CMT

Currency Research Desk

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

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