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Strong Rupee, Strong Indian Economy?

May 1, 2017 | Expert Insights

Money is organic nature that would keep changing depending on the society and its economic conditions. A country’s currency is linked to their economy and the policies that govern the economy. Over the years the value of any currency has depended on factors like inflation, employment, interest rate, growth rate, trade deficit, foreign investment and several macroeconomic policies. Balance of payment which comprises of the trade balance and capital flow would affect the value of a country’s currency. As a governing body, the RBI would manage the value of the rupee by controlling the supply which would either make it cheap or expensive.

On March 16, the rupee hit a one-year high, which was unexpected in the beginning of the year, as it broke the tight range between 66 and 68.85. At Rs.65.41 per US dollar, the Indian currency experienced a sudden spurt of strength which had to do with the recent electoral win of BJP and Prime Minister, Narendra Modi’s move to demonetise 86% of the currency notes in November 2016. Events that spelled a sea change for the global market like the UK’s referendum and the victory of Donald Trump has not affected the Indian rupee.

What makes the rupee strong?

While the inflation is restricted to a safe zone of 6%, India’s CAD (the excess of imports over exports) has improved to $0.3 but there are possibilities of it widening which would be negative for the rupee.  At present the rupee would be considered the third best performing Asian currency after the South Korean won and the Taiwanese dollar.  

India has experienced a 35.85% increase in their exports but this has failed to narrow the trade deficit as their imports have also surged to 39.89%. Major components that have kept the import bills high are crude oil and gold. However, a decline in the oil prices to USD 50 per barrel has silently supported the strength of the rupee. With respect to the geo-political uncertainty between North Korea and US, gold has been gaining which has resulted in keeping the prices rather low at around $1,250 currently which works in favour of the Indian rupee.

Since the US Fed meeting bringing the index to a current level of 98.5 and the ongoing French election has put the dollar under pressure helping the rupee break the recent 66 level. The RBI has helped build the foreign exchange reserves increasing it to 7% but since the appreciation occurred over a short span, RBI could intervene to curb further strengthening of the currency. Hence, experts believe that they would be comfortable with the rupee ranging between Rs.62-Rs.64 per dollar.

Assessment

The Real Effective Exchange Rate would measure the currency in terms of its trading partners that is adjusted to inflation. With regard to the 6 currency trade and 36 currency trade weighted REER the rupee seems to be valued at 106 and 117 respectively. This clearly depicts that the rupee is overvalued and the RBI would have to take this into account while deciding its currency management policy to prevent the rupee from losing its competitiveness in the international market.

Being a net importer, India would benefit as far as the impact on inflation is concerned. With the appreciating rupee, the crude oil prices will decrease keeping both wholesale and retail under check. But on the flip side, exports would continue to suffer which would take a toll on the overall market growth. Among sectors, the Indian software, automobile, pharmaceutical companies and textile would likely be effected the most as their revenues are dollar dominated but sectors like aviation and selected durable companies that import crude oil would benefit from a strong rupee.

In conclusion, the rupee might continue to strengthen for some time with the underlying fundamentals which will have a bearing on the rupee and decide its future course. The only question that remains is how stable would it be?