Expert Zone

Straight from the Specialists

Hard currency status a wishful dream for the rupee

By R Rajagopal
June 18, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

A hard currency is one that is globally accepted as an exchange currency for trade. It is also expected to remain less volatile in the short term and indicate long-term stability through its purchasing power. The perceived strength and confidence in a currency is also a function of its country’s political milieu, fiscal and trade balances, the policy of its central bank and future economic outlook.

Let us look at all these parameters in the context of the Indian rupee and see where it stands on its journey towards acceptance as a hard currency.

India is still insignificant in global merchandise exports and it may take at least a decade, if not more, to improve substantially. During this phase, it will remain energy deficient and hence import oil and other energy equivalents. Though India in the past has done specific bilateral trades (rupee-rouble for example) and may continue to do so in future with specific countries, it is bound to take a long time for the rupee to find wider acceptance in global trade.

Despite India’s substantial economic progress over the decades to emerge today among the ten largest economies in the world in nominal GDP terms and the top three in PPP terms, the rupee has not kept pace with this progress and has witnessed periods of high volatility. In the last five years, it has depreciated in excess of 5 percent of the Compound Annual Growth Rate (CAGR). This can clearly be attributed to expansionary trends in India’s fiscal and current account deficit. Until India traverses the distance from a trade-deficit economy to a neutral or trade-surplus nation, the rupee will always remain unhinged.

The undisturbed and functioning democratic political system in India does offer comfort to the international community. But the country seems to have increasingly embraced coalition polemics that seem to create periodic uncertainties (every five years) in offering a stable government. Typically, the rupee witnesses volatility for shorter periods before an election verdict.

The Reserve Bank of India (RBI) policy on foreign exchange has been limited to facilitating external trade and payment and developing the foreign exchange market in India. Under normal circumstances it does not intervene in forex markets and allows the rupee-dollar rate to emerge as per market dynamics. But it also maintains foreign currency assets (including dollars) to administer and provide confidence in its monetary and exchange rate policies. It intervenes in forex markets to curb short-term volatility if it feels the slide of the rupee is in excess or unwarranted. The extent of foreign exchange reserves maintained by the central bank also provides confidence to market elements such as rating agencies, trading partners and others that the country can honour its external commitments and payments.

In the recent past, the RBI has also been seen acting independent of the government, signaling it should take requisite steps to manage burgeoning deficits.

Rating agency Fitch recently revised its outlook on India, reiterating its BBB- status albeit with a stable outlook. In its commentary, Fitch noted the curtailment of fiscal deficit, the revival of investment climate and decline in inflation as positives for the outlook change. It also expects India’s elevated public debt would gradually reduce over the medium term. In addition, Fitch also projected GDP growth at 5.7 percent and 6.5 percent for FY14 and FY15 respectively. These indicate that the current economic numbers could improve over the medium trend. A structural depreciation due to widening deficits is largely factored in. This augurs well for the rupee to reverse its current trend.

The U.S. economy seems to be in its early stages of recovery. The easy monetary policy or quantitative easing through the state sponsored bond-buying program may be coming to an end. These possible developments are being factored in by emerging market bond markets as reflected in outflows in the recent past. This has put pressure on most emerging market currencies in favour of the dollar. The rupee, also being part of the emerging market basket of currencies, has slid lower. In the short term, the strengthening of the dollar could cause some weakness.

On a side note, an Indian traveller abroad for the first time realizes the rupee cannot be changed at most money exchanges and even if one could, the spreads are higher. A repeat traveller would realise he is shelling out more rupees for the same amount of dollars he took out some years ago. Cost-effective foreign travel, the dream of every Indian, seems to be far-fetched for now. The rupee does make travel hard.

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  • Editors & Key Contributors