Indian Rupee.. the game changer..

 

Well, our economic fortunes are tied with the value of the Indian Rupee (INR) against the currencies of the major developed market viz. USD/ Euro/ Pound etc. We got  immensely benefitted with the onset of Y2K projects of software companies at the turn of the millennium, which had opened altogether new avenue of earning the foreign exchange. We continue to enjoy this benefit till the global financial crisis erupted in 2007. Alas, though US, the epicenter of the crisis is now stabilizing, yet we are sinking into another one.

 

All these years since 2007, we are now facing problems which we were ignoring during hey days. Actually we could not anticipate that our export are dependent on external demand while imports are mostly inelastic to local demand. Further, due to persistent higher inflation and uncertainty associated with financial and real economy, citizens decided to move into physical assets like Gold and Real Estate.  This has boosted import of Gold manifold over the years which has required foreign exchange. In fact, our foreign exchange reserve did not grow in last six years. Anecdotally, demand for Gold was further fuelled due to investment of unaccounted funds. In addition, attractiveness of the gold was magnified as it was appreciating year after year since global financial barring last one year. What more one can want from gold: easy to store with steady appreciation.

 

All this has precipitated into demand for USD not commensurate with enough supply. Market was waiting for a catalyst to let INR reach to its fundamental level. This moment has arrived when  US Federal Reserve gave a whiff of withdrawal of quantitative easing as US economy is strengthening. Leveraged investors across the world started deleveraging bonds and thus outflows from emerging markets has started. This has created demand for foreign currency in the system which was already short of supply and prompted INR to touch life time low in line with other emerging market currencies.

 

The worrisome part is depreciation of INR witnessed when growth in the economy is at low point. This will put further pressure in terms of higher fiscal and trade deficit as well as higher inflation. This if we combine with policy paralysis prevailing in recent years, cast a doubt over any imminent recover in the economy.