Indian Rupee vs Dollar: Did Sitharaman Get Economy-Exchange Rate Equation Right?

Nirmala Sitharaman is correct. But is she right? Or, how is her statement relevant to daily economic life in India?

Should we worry? Not if you look at what China has been doing for decades to strengthen its economy. Not if you think exporters deserve a fair deal or that healthy imports are good to manage inflation and manufacturing. Not if you think that exchange rate is something like blood pressure -- to be managed in a healthy mid-range equilibrium.

Representative Image 

"Falling rupee adding to burden. Pay more but still fuel on ration. Govt responsible for creating sense of panic. Can govt get away..?"

Guess who said that? It was Nirmala Sitharaman tweeting on 2 September, 2013. She was then a spokeswoman for the opposition version of the Bharatiya Janata Party(BJP). Now, she is the finance minister for her party's ruling government, and her statement about the Indian rupee is raising eyebrows, chuckles and outrage alike because, as the saying goes, she is singing a different song.

• Ms Sitharaman said that the Indian rupee has performed much better than many other emerging market currencies.

• FM: 10% slide in the value of rupees may not be worrisome despite that a rise in US interest rates pulls in more capital towards that country, making the dollar stronger.

• Dollar prices affect import goods into a country A weaker rupee typically means a higher oil bill for India The global strength of an economy is determined by how much it can export, especially as a proportion of its national income (GDP).

• A healthy foreign exchange policy does not erode a country's competitiveness in the long run. You only have to look at China, which has been in a tussle with the United States because it keeps the renminbi weak through state controls.

• BJP supporters often say in nationalist fervour that a strong currency indicates a strong economy, but often forget despite their love of surpassing China that a weaker currency incentivises exports and restrains imports.

What the Rupee-Dollar Graph Indicates

Here's what she said last weekend: “First of all, I would look at it as not rupee sliding, I would look at it as dollar strengthening, dollar strengthening incessantly." P Chidambaram, the man who once occupied the chair she does now on behalf of the current opposition Congress party, was quick to taunt her with the response: "A candidate or party that lost an election will always say: We did not lose the election but the other Party won the election."

Ms Sitharaman said: "And I’m not talking technicalities, but it is a matter of fact that India’s rupee probably has withstood this dollar rate going up, the exchange rate in favour of dollar strengthening is there and I think the Indian rupee has performed much better than many other emerging market currencies.”

Nirmala Sitharaman is correct. But is she right? Or, more importantly, how is her statement relevant to everyday economic life in India? What is the big deal all about in the value of the rupee?

How Dollar Dominates Global Economy

These questions are best answered by drawing an analogy with a popular joke on relationship status in our times.

Question: Are you Single?

Answer: Depends on who is asking.

A lot depends on whether you are an importer or exporter, or a mix of both — or a consumer of imported products. If you like French cheese or Italian olives, you may not be buying goods in US dollars, but the nearly 10 % slide in the value of the rupee compared with the American currency over the past year would still worry you because most foreign exchange bills are still billed in dollars, directly or indirectly.

Unofficially, the dollar is king and is a language in which international trade is spoken. It is true that a rise in US interest rates pulls in more capital towards that country, making the dollar stronger, but there is more to this than meets the eye.

The minister was speaking facts, but also only a half-truth, because an expensive US dollar does affect the budgets of those who import goods into India. A weaker rupee typically means a higher oil bill for India and since oil has a knock-on effect on nearly everything that is transported.

Exchange Rate and Economy Are Intricately Linked

You only have to go back to her tweet in 2013, which substantially holds true even in the current context. But if you are an exporter, things may be looking up if you are exporting in bills denominated in US dollars such as a typical software exporter selling services to a Wall Street or Silicon Valley client.

In fact, you could argue that a healthy exchange rate policy is such that it does not reduce incentives for exporters because in the long run, the global strength of an economy is determined by how much it can export, especially as a proportion of its national income (GDP) or how much less it has to import so that the trade deficit and its more sophisticated cousin, the current account deficit (which also includes remittances and tourism earnings) do not yawn wide.

Factors Leading to the Rupee Fluctuation 

India’s current account balance recorded a deficit of US$ 23.9 billion (2.8% of GDP) in the April-June quarter of the current 2022-23 financial year, up from $ 13.4 billion (1.5% of GDP) in the January-March quarter, and a surplus of $ 6.6 billion (0.9 % of GDP) a year ago.

You could blame the first quarter tensions on oil prices spiked by the Ukraine war and the year-ago surplus to the low economic activity linked to the Covid-19 pandemic, but the simple fact is that the July-September quarter is more likely than not to have shown a wide if not wider current deficit than the first quarter in no little measure due to the weaker Indian rupee.

However, it is important to bear in mind that a healthy foreign exchange policy is not something that erodes a country's competitiveness in the long run. You only have to look at China, which has been in a tussle with the United States because it keeps the renminbi weak through state controls.

Where Does India’s Foreign Exchange Policy Stand

"The root of the conflict for the United States and other countries is complaints that China keeps the value of the RMB artificially low, boosting its exports and trade surplus at the expense of trading partners," a paper from the Brookings Institute observed a decade ago.

BJP supporters often say in nationalist fervour that a strong currency indicates a strong economy, but often forget despite their love of surpassing China, that a weaker currency incentivises exports and restrains imports.

Now, the rupee can go up or down on account of several factors, but it is undeniable that domestic inflation leads to erosion of the competitive value of a currency.

Economists, looking at the longer term, study the Real Effective Exchange Rate (REER) to address some puzzles on this. An increase in REER implies that exports become more difficult. Therefore, an increase indicates a loss in trade competitiveness. The REER is measured by adjusting inflation into the nominal exchange rate against a basket of foreign currencies —not just the US dollar.

Why Is India’s Economy Lagging Behind?

The RBI itself says: "Effective exchange rates (EERs) serve as a gauge for assessing the fair value of a currency, the external competitiveness of an economy and even serve as guideposts for setting monetary and financial conditions."

Looking at India's REER over a 15-year period, it is clear as day that the Modi government has certainly not performed better than the preceding UPA in managing competitiveness. Maybe it has done a tad worse. A lot has depended on factors like fluctuating oil prices and things like the global economic crisis but there is no denying that India's REER has increased over the past eight years, indicating reduced competitiveness.

Data crunching think-tank CEIC says India's REER with 2005 as the base year hit a low of 94.8 in April 2009 and a peak of 118.3 in 2017 while averaging 118.3 over an 18-year period. Picture it a bit like India winning and losing cricket matches by turn against Australia. You can't immediately put a finger on which is the better team.

Ironically, the REER was at one of its competitive best moments when Ms. Sitharaman was grumbling in 2013.

When the current FM was tweeting in 2013, the rupee had taken a knock of about 15% to Rs 65 against the US dollar mainly because of the so-called "taper tantrums" linked to US Fed policies just like the US triggered fall this year, though it must be mentioned that the fall then was against all major currencies as America sponged off a ton of money pumped in to save its economy after the global financial crisis of 2008.

Though Ms Sitharaman is technically correct, it is undeniable that India's foreign exchange reserves are down by more than 110 billion US dollars over the past year, mostly eroded by RBI's efforts to defend the rupee.The hard reality is that the real effective exchange rate is currently much worse than in 2013.

Should we worry? Not if you look at what China has been doing for decades to strengthen its economy. Not if you think exporters deserve a fair deal or that healthy imports are good to manage inflation and manufacturing. Not if you think that exchange rate is something like blood pressure —to be managed in a healthy mid-range equilibrium.

Only an economy that favours consumers over hard-currency-earning producers would worry too much about a weak currency.

(The writer is a senior journalist and commentator who has worked for Reuters, Economic Times, Business Standard, and Hindustan Times. He can be reached on Twitter @madversity)