29 May 2018 19:30 IST

Why is the rupee falling?

The rupee’s value is simply a victim of the US’ dominance

India’s tax collections — both direct and indirect — are up. The debt to GDP ratio is the lowest it has been in years. The country continues to have healthy foreign exchange reserves. The economy is roaring, back to its original promise, after the slowdown in 2017 caused by GST issues and demonetisation.

Why, then, is the rupee falling?

The simple answer is that India could have done nothing better and the rupee would still be falling. In a Darwinian world, where the fittest survives and thrives, the 64-pound gorilla in the room — the United States — is sucking all of the oxygen around. So powerful is this force that emerging market economies, from Turkey to Thailand, are caught in the downdraft. And there’s no end in sight.

America’s economy under President Trump is so hot that it is beginning to confound economists. Consider the unemployment rate, which is calculated by dividing the number of unemployed by the total number of people in the labour force. Unemployment (or joblessness) occurs when people actively seeking jobs can’t find work. As a practical matter, if the unemployment rate is 4 per cent, the region is considered to be at full employment.

Last month, the US unemployment rate fell to 4 per cent for the first time since the dotcom boom of 1999. There are several states where the rate is actually lower. This means that there are many more jobs than people — a fascinating situation that most countries in the world, especially Europe, would instantly want to have.

Trump’s policies

America’s success did not happen by accident. President Trump signed massive tax cuts into law during the first year of his term. So massive were the cuts — the top corporate taxes were brought down from 35 per cent to 21 per cent, a 40 per cent cut — that businesses began to invest their extra savings in fat bonuses for their employees, stock buybacks or capital improvements. This primed the economy like throwing jet fuel on a forest fire.

America’s economy is now growing at a 3 per cent clip, on average. This number may look small, or even as failing, to many Indians. But when you factor in the size of America’s economy — nearly seven times that of India’s — the 3 per cent growth rate is a remarkable feat.

Convert this growth rate into actual dollars to see how fascinating it is. America’s GDP in 2017 was about $19 trillion. At a 3 per cent clip, America increased the value of its goods and services by $570 billion. This was the increase in the size of the economy in just one year. Just this increase is larger than the annual GDP of every country in the world, except those in the top 20.

Even if India’s economy grows by 7 per cent, the real value of India’s GDP would rise by about $150 billion. But America’s population is only about a fourth of India’s, so if GDP per capita is the measure, the American economy would effectively be performing 16 times more efficiently than India’s.

Lowering business costs

Trump has also been focused on lessening regulation and thus lowering business costs. He pulled out of the Paris climate accords which immediately made American companies cheer as they no longer had to invest in expensive environmental improvements that did not make sense. He has opened up federal lands to oil exploration and suspended Obama-era actions limiting leases in the Gulf of Mexico. He opened up the Keystone pipeline, which Obama had banned, which not only created jobs but also helped America use up its refinery capacity. All of these helped America become the world’s largest energy exporter.

Trump has also been extremely bullish on trade. He got out of the Trans Pacific Partnership (TPP), which he saw was weak for American manufacturing and has imposed tariffs on China which is known to dump its products, often below cost. China is now promising to help narrow the American trade deficit by buying more American goods, which, in turn, will create more American jobs.

Ordinarily, the above fiscal policy moves would have been more than sufficient to make America an attractive place to invest in, causing the dollar’s value to rise.

US Fed moves

But on the monetary policy front also, the dollar is extremely attractive to global investors. As the Federal Reserve pulls back from its Quantitative Easing policies under Obama, it is slowly increasing interest rates. Since President Trump’s election, the Fed has increased rates five times, from 0. 5 per cent in December 2016 to 1.75 per cent, as of March 21.

The Fed is also buying back mortgage bonds which mature, so it is mopping the economy clean of dollars — almost creating a shortage of the currency — making the dollar more valuable. During last week’s Treasury auction, the yield on the 10-year bond breached 3.0 per cent, a remarkably high interest rate compared to a German or Japanese government bond.

Lastly, the geopolitical turmoil around the world (Iran nuclear deal, the upcoming North Korean talks, the rise in oil prices) makes the US dollar a “safe haven” currency.

Emerging market economies hate capital flight. When foreign investors pull money away from emerging countries and seek profits in such a vibrant dollar, the greenback rises and emerging market currencies fall. Since January 1, the Turkish currency has fallen 26 per cent — from 3.75 Lira to a dollar, to 4.75 Lira to a dollar. Imagine if this were to happen to India. The rupee would then be trading at ₹84 to a dollar, rather than the ₹68 it is at now.

So, the rupee’s value is simply a victim of America’s dominance. There’s nothing anyone can really do about it.

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