10 October 2022 06:21:19 IST

Two sides of a rising dollar and a falling rupee

Our dollar dependency needs to come down | Photo Credit: Getty Images

American comic WC Fields said, “A rich man is a poor man with money.” That’s confusing, right? But what if you are poor even when you have money? Imagine you had ₹100 and could buy 10 candies with it. But if the price of the candy rises, you would buy less. So even if you have money, you become poorer.  

Now, imagine that you are planning a holiday abroad, and you must shed more cash than you had to, maybe say, a month back. You have the same amount in your account, but it lost a little value because the dollar became expensive. What does it mean for you apart from having to shed more rupee to buy dollars?  

To answer that, let’s understand how exchange rates work. That takes us to economics 101. Every country has a currency, and its value is decided by demand and supply. The demand and supply of a currency are driven by currency reserves, interest rates, political stability, trade deficits, and overall growth outlook.

Recently, the dollar value rose vis-a-vis other currencies, and while the rupee hit an all-time low, other currencies performed worse. Comfort in the sufferance of others? 

Economics 101

Let us look at it a tad differently. The dollar is a product like an apple is one. Let’s assume that trade takes predominantly in dollars. In that case, when India exports goods, it receives dollars; when it imports, it pays dollars. A receipt is tantamount to the supply of dollars, and payment boils down to demand for dollars.

Economics says that if demand exceeds supply, the product price will increase. India has historically been an economy where imports exceed exports. Little wonder then that dollar prices are on the unrestrained rise.  

All the imports are done in dollars, so the pressure due to rupee depreciation is imminent. It is not just the cost of imports now but the existing import bills for which manufacturers and service providers must pay more than what they had to some months ago.  

The reason for an appreciating dollar lies in its demand. With Putin in no mood to get off Ukraine, economic volatility exists worldwide. In times like this, investors rush towards the dollar as it is widely considered a safe haven. You will not know, but during the second world war, our great-grandfather’s generation chased gold.

The US is grappling with high inflation, which has led to its central bank, the Federal Reserve, increasing the interest rates leading to high-yield bonds. No wonder the bees have flown towards the flower.  

Despite protestations to the contrary and a track change, India is still a net importer. Growth targets are down inflation scars are up. So, our difficult economic situation, coupled with our high import requirements, drives the demand for the dollar. 

If you are an exporter, you might be happy with the increasing value of a dollar because now what you receive must be higher. But even when you receive more rupees, what good is it if its value keeps going down? Remember, you are still getting fewer candies for the same money, so none is richer. Unless, of course, you say you no longer need sweets, read dollars.  

Monitoring value

People argue the rupee has fared better than other currencies, but that is little consolation. In life, if you want growth, your benchmark should be you yesterday and not someone yesterday. India’s current position is also the outcome of a hitherto healthy forex reserve, which has now depleted because of the central bank’s constant selling of the dollar.  

To win, we must open more fully by liberalising investment restrictions, eliminating regulatory barriers, and improving the business environment. We must also be seen as an economy where it is easy and comfortable to do business.

The decision to get a trade settlement in INR is good, but it doesn’t necessarily make the economy stronger in the long haul. It does decrease our demand for a dollar, but to win, you must also increase its supply through foreign investments and exports.  

If it is any consolation, the Big Mac Index (July 2022) says the rupee is undervalued by 38 per cent (GDP-adjusted) vis a vis the dollar. There is a margin to win! 

(The writers are chartered accountants.)