India Policy Watch #1: To Catch A Falling Rupee Insights on burning policy issues in India — RSJ The Indian rupee this week declined to an all-time low as it went beyond 80 per dollar. For reasons that aren’t always clear to me, this kind of thing makes a lot of news in India. I mean, it was 79.9 the week before. There isn’t a yawning gap between that and 80. Yet opinion pieces are written, cartoons sketched, and old tweets of macroeconomic theorists like Akshay Kumar, Juhi Chawla and Sri Sri (Sri?) Ravishankar are dug out to contrast their current reactions to this phenomenon with their past asides. The WhatsApp factory also rolls out their new models that suggest how a strong dollar is bad for the US economy and how this is some kind of a switch and bait move that we are making on them. Somewhere in many of our heads, the strength of the Indian rupee is no longer subject to the dynamics of the currency market. Like many things these days, it too is anchored to our self-respect. And since our national clarion call is desh nahin jhukne doonga (won’t let the country down), we then start working on the narrative that shows all of this in a warm, positive glow. All in a day in the life of India. Anyway, I thought it would be useful to take this moment to appreciate the winds that are buffeting it, the long-term view of what will actually strengthen the rupee and then zoom out a bit to appreciate what’s happening to the US economy and what it could mean for India. The Safety Of Dollar We will start with why has the rupee gone to 80 a dollar? The simple answer is the US dollar has been more in demand since the start of the Ukraine war than before. This is true for all currencies, not just the rupee, as the chart below shows. There are reasons for this. The 40-year high inflation print that the US is witnessing month over month has turned the Fed hawkish. It is likely to raise rates by another 75 bps in its meeting next week, and the consensus suggests the benchmark rates will be around 3.4 per cent by the end of the year. These rate hikes make storing money in dollars more attractive. This potent cocktail of uncertainty around the Ukraine war, the high oil and commodity prices that make emerging markets more vulnerable and the prospect of a global recession is starting to give global fund managers a massive hangover. Their most obvious response: flight to the safety of the US dollar. The dollar demand has gone up as foreign portfolio investors have checked out of domestic equities across the world. In India, we have had over ₹2.3 trillion of outflow from the equity market so far this year. Things would have been worse had it not been for the domestic investors (mutual funds and insurers) who invested about ₹1.4 trillion during this period. The price of oil—averaging over US$ 120 or so during this year—has made things worse because we import over 90 per cent of our requirements. The across-the-board rise in commodity prices has further increased our import bill. Almost simultaneously, the high rate of inflation, the rise in interest rates and a prospect of a recession have meant our exports are beginning to soften. The commentary from our software services giants suggests the demand pipeline isn’t what it used to be. This might also show up in other export-dominated sectors as the steep rise in interest rates starts to kill off growth in developed markets. This has meant the consensus forecast among analysts for the current account deficit has inched up to 3 per cent for the year-end. We will need more dollars to support that kind of deficit. That apart, our own inflation numbers have remained high, and we are running a negative real interest rate (the difference between interest rate and rate of inflation). This will continue to support riskier assets and reward consumption that will feed back into inflation. So, expect further interest rate hikes, and that will impact growth. All of this