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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Plus & Minus

Posted by Muthu on September 7, 2013

Every one is talking about rupee depreciation and how bad it is for economy. There are talks about good old years when 1 USD was equal to 1 rupee in 1947. There are also writings that rupee depreciation for last 6 decades means that our economy has gone from bad to worse.

Till 1993, the exchange rate of rupee was determined by RBI and only then it was allowed to be freely valued by world currency market. So the data we’ve till 1993 was administered exchange rate.

Till 1966, 1 USD was equal to Rs.4.79. The war of 1965 and worst economic situation resulted in RBI devaluing rupee to Rs.7.50; a whopping 57% depreciation in a short period of time.

In fact from 1926 to 1966, for 40 years, the British pound was pegged at constant rate of Rs.13.33 per pound.

In 1991, 1 USD was equal to Rs.17.90. The economy was in grave crisis then with foreign exchange reserves available for only one week of imports. The rupee was devalued to Rs.31.37; again a whopping depreciation of 75% in a short period of time.

Given such short term volatile depreciations, the current downfall of 20%+, as determined by market forces looks more manageable.

In the last 15 years, the exchange rate has been fairly stable in the range of Rs.40 to Rs.50 per USD. In 2007, when the exchange rate became Rs.39/- per USD, there was a hue and cry by exporters and media against RBI and government. RBI was forced to intervene to depreciate the rupee.

So both appreciation and deprecation of rupee have its own set of challenges and problems. What is expected is range bound stability. As much depreciation brings problems, it has advantages as well. Exports get more competitive as we can see it happening now in areas like textiles against China. As much as appreciation can reduce the cost of our oil imports, it can make our exports uncompetitive. Our demographic dividend in terms of wage arbitrage can be nullified if our currency appreciates strongly. Appreciation of rupee would reduce the value of gold we hold. Indian women doesn’t like fall in prices of gold:-)

We are not in a situation now which is similar to 1996 or 1991. Unlike 1991, we have around 300 billion dollars of foreign exchange now. Whenever there is volatility, traders tend to make money by taking speculative positions, which is what happening now. Over a period of time, rupee should find its range and stabilize there. 

When comparing two currencies, we need factor in inflation as well. Compared to India, US has been a low inflation economy. To maintain purchase power parity, the value of currency of the high inflation economy would fall against the currency of low inflation economy. This is one of basic economic concept. Imagine a situation where US has an inflation rate of 12% and India 3%. Ceteris paribus, then over a period rupee would start appreciating as we are a low inflation economy. 

So as much as we look at exchange rate, we need to understand the purchase power parity as well. Indian economy was poorer in 1947 when 1 USD was equivalent to 1 rupee. Whereas in 2013 we are much better off country though 1 USD is now around Rs.65+. The exchange rate differential has nothing to do with economic condition. The media is creating a picture that we are going to dogs because rupee is falling. This is not true. What has rattled the market is sudden spike in volatility and fast depreciation. Orderly upside or downside would not have had the same effect. 

Before writing further I want to clarify one thing. I’m neither a congress nor a BJP supporter. Like most Tamils, I invariably end up voting for a regional party depending upon the local issues. 

So much criticism in media against UPA 2 is over done. When you criticize a person beyond limits, it can even end up creating sympathy instead of the pursued goal of hatred. No doubt that fiscal discipline was given a go by Pranab Mukherjee. But the government has done well both on fiscal and reform front during the last one year. It may take another 12 to 18 months to start seeing the results for these actions.

Again food security bill has been extremely criticized by media. Given the fiscal situation, the timing of the bill may not have been appropriate. But looking at the content and objective, the depth of criticism is unjustified and the bill has many useful things as well. Media is for 30% of India (business media is for 0.1% of India) only. The remaining 70% too need be thought about, at least before elections.

As we’ve written time and again, economies, markets and businesses go through cycle. We are now in the tough part of the cycle. This too shall definitely pass. When our goals are long term ones like retirement or child’s education, this kind of phases provides us opportunity to acquire assets like equity at a lower cost. There is a saying that you can either have good monsoon or good roads. Like wise, you can either have good news or good valuations. This is the time for good valuations and not good news. When the news is good, valuation invariably tend to be expensive.

However there are certain precautions which need to be taken in these tougher times. As I read in a column recently, one cannot aspire to have a life style of 9% growth rate when the economy is growing at 5%. This is the time to reduce aspirational spending and focus more on needs.

Time and time again, I write about the need for emergency fund. Please have not less than 6 months of your expenses and EMI in your SB A/C and fixed deposits. I see a tendency to rely on credit card for contingency. Nothing can be more dangerous than this. Especially in a time like job loss, relying on credit card instead of emergency fund can financially kill you.

New loans can be avoided especially the ones for the up gradation of life style. More important, for people who are in employment, staying with the current employment may be more beneficial than experimenting new ones or entrepreneurship. Tough times require lying low and nourishing continuity and stability. Aspirations and growth would happen once the cycle turns for better, hopefully sooner than later.

Happy Vinayaga Chaturthi.

One Response to “Plus & Minus”

  1. Shankar said

    Thanks for the article. I don;t really feel how this rupee appreciation and depreciations are affecting our day to-day life. If out economy is really doing well, then everything will be taken care eventually.

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