Living poor with a low value Rupee

India should take a leaf from China, which kept Yuan strong while creating an Export engine in its 35 year growth story

During Vajpayee, Indian Rupee (INR) moved from 49 to 39, current account deficits and fiscal deficits were still there, but the market saw reforms and factored in potential future GDP of India.

Specifically, post 2014, under Modi, we all know reforms have picked up pace of the kind never seen before in India’s history. Raghuram Rajan (R3) has been able to accumulate $100 billion while keeping INR in range of 67. Considering size of Indian economy, $100 billion is a big amount which could have moved the currency rate.

With reforms, FDI has boomed, so for a small economy like India’s, had R3 accumulated much less USD’s ($’s) – wouldn’t he have taken the INR to 40’s range again? And the case I present here is that he should have.


BJP Government

BJP Government

China has kept its currency Yuan (RMB) strong vis-a-vis USD all along its 30+ year success story, which started in 1979. Yuan, today is 6 to a USD and China’s GDP is USD 10 trillion (in Dollar terms), largely built on exports. India, on the other hand, had INR at 4.75 to USD till as recent as 1965. It was 39 in 2003 and now it’s 67. Hence India’s GDP is only USD 2 trillion (in Dollar terms). Congress inherited a USD 2 trillion economy in 2004 from BJP Government and handed over to BJP an economy of same size 10 years later, in 2014 – proving its sheer incompetence and mismanagement of the economy. The public suffered because of mindless inflation from 2005-2014 under Sonia’s Congress, besides INR devaluation by 77%.

We know China has kept Yuan strong all the while growing its GDP at 7-13% annually. Why has India let INR slip to record lows? There is some false theory floating around that a weak INR is good for exports – but evidence says it’s not – most importantly, China is the example. Why is India accepting FDI at low INR? Why do we buy Oil and Gold, largest import compositions, at such poor INR value?

An article below, which throws some light:

Market watchers say that the RMB exchange rate is not overvalued, so there is no technical reason to expect it to fall sharply. It has played a minor role in affecting Chinese export growth, which is predominately a function of global demand, and the contribution of China’s net exports to GDP growth has been negative since 2009. All this argues that exchange rate plays only an auxiliary role in helping China’s GDP growth, and the significant costs involved in devaluing it far outweighs the benefits. This also reasons why USD depreciated 35% against RMB from 2009 to 2015.


Now I digress on the India side – I am trying to draw attention to the fact that INR should be continuously stronger vis-a-vis USD – per Purchasing Power Parity, INR to USD is 10. Even after discounting India’s poverty, it should be in a much stronger range in near term and in 10 range by 2025 – for the India story to play out like the 30+ year story of Japan initially, then Asean nations, South Korea and then China.

My friend Vivek Krishnan opines:

“I’m afraid there is quite some delving into economic history that is needed to figure out monetary policy stance, economic structure and Govt initiatives of both countries at different points in time. Only then is it possible to identify all possible reasons for the currency’s tribulations to date:

  1. China has forever fixed the Yuan through its super growth cycle. The stable currency has helped exports of course. A very clear peg to the USD continued till very recently and so for most of the period you mention, they had a simple fixed exchange regime. The fix in essence means that China also imports US monetary policy effects.
  2. Accumulation of FX reserves also went in tandem with rising exports. Should the fix not be there, regular, circumstances would have called for the Yuan to strengthen and export competitiveness to decline. But that was not to be. Now, here there is a very important economic concept that comes to play. Called the Impossible Trinity or the Trilemma, it states that it’s impossible to have all three of the following at the same time
    – a fixed exchange rate
    – free capital movement and
    – independent monetary policy
  3. Obviously, China has traditionally controlled the first two and so has had lost control of the last one. But heavy-handed manipulation of the foreign-exchange market by the PBOC makes changes in the price and availability of the Yuan opaque and uncertain. I’d therefore say that your comparison of a heavily manipulated currency with the INR is in itself faulty. You can try and reason out movements over time but they’re almost always going to be a waste of time.
  4. India has on the other side gone with a currency float and independent monetary policy with rather limited capital controls. Needless to say, this exposes the FX to swings that impact both trade flows and capital flows. We all know the economy plateaued and confidence worsened since 2011. A major part of the reason for INR depreciation is this. No complex reasoning involved in here. Another point you should note is that it is easier to keep a currency from appreciating. That was China’s position for many years. The PBOC needed to keep buying USD with the Yuan, which technically speaking, they had in unlimited quantity. But when you need to prevent a currency from depreciating, you need to sell USD and buy the local currency. That is by no means an easy job as the Latin Americans will suggest. The RBI has the same issue to contend with
  5. Now, as of Aug 2015, the PBOC tried to do some Hodge podge efforts to de peg the Yuan. Earlier the fix was simple ‘I set it where I want it’. The Aug 2015 announcement was intended to move toward a market determined exchange rate. Going back to the Impossible Trinity, this meant that the PBOC started losing their control over capital flows. As you may know, in January 2016, Dollars were haemorrhaging out of the government’s coffers at a rate of more than $100 billion a month. Of late, things have stabilized owing to better communication and thanks to the PBOC moves to clamp down on capital flows. But this episode also shows that China is not going to be able to de-peg easily. In fact, exiting a pegged rate smoothly is possible only when there is confidence in the economy. This may have been true of China once; it is no longer true today.”


China has always kept the Yuan strong

China has always kept the Yuan strong

Vivek Krishnan’s points are well accepted – Stable currency indeed helps exports by fixing a reference rate at which planning can be done, but how are China’s input variables different from India’s, that it could create a booming manufacturing export story with Yuan @ 6 and India is sputtering with INR @ 67? India continuously devalued INR in hope of a weak-currency led export growth which proved to be a chimera. R3 even said INR should be 72 as per REER and patted his back saying he has held it at 67 (But he accumulated $100 billion, had he not done so – it can be prophesised that INR would have reclaimed 39). India is a consumption and services driven story with huge technology import and a capex requirement in infra led by import of heavy equipment – Not to mention huge imports of Oil and Gold. Instead, we have companies catering to huge India market by first importing capital equipment/ technology at an extremely bad INR rate.

And now, we are importing even Food, to curb Food inflation in India! On the other hand, RBI, under R3, blames CPI for high interest rates (IR’s) and instead of utilizing this interest rate differential (High IR in India vs low abroad) to strengthen the INR, R3 accumulated $100 billion in Forex reserves! Mostly, because out of all the components of CPI, the only item which has led to a CPI in range of 5+, is Food – and economists certify that Interest rates have a direct relation to Food inflation and not inverse! Sample below:

Low interest rates lead to supply side capacities in agriculture and dampen Food inflation. Then, Government actions like reasonable MSP (Min Support Prices) of Food play a role and Indian Government under Modi has been wise on that count.

Under R3, INR has been almost fixed – with variation of +-1 from 67, but owing to interest rate (IR) differential and also attractiveness of Indian economy to FDI, INR could have appreciated a lot. Did R3 collect $100 billion and not let INR appreciate, since these were largely liquid portfolio flows and not capital inflows? Then, R3 is on record to say he was anticipating a US recession, hence was accumulating USD’s. So, on one hand – because of high interest rates in India, the Government was bleeding on deficits, Indian companies could not deliver growth of the kind it could have and NPA’s were increasing – on other hand, we were accumulating USD’s and parking them at US Treasuries at 0.25% p.a.! Even if we factor in that RBI had a pact with Government on inflation targeting, how can it be ignored that the CPI which R3 was blaming for not lowering IR’s, was actually led by Food inflation, which has a direct relation to IR’s? Had R3 lowered IR’s, with better growth, FDI would have further jumped and INR would have appreciated even more – thereby leading to lower fiscal deficit and improvement in Bank’s balance sheets.

Little bit of background: US, Japan, Europe have been printing record amount of currencies in circulation. Post the East Asian crisis, when a group of investors led by George Soros shorted Asean currencies and led to a crisis, most countries started keeping foreign currency reserves to stave off chances of a currency crisis and country default. Because of legacy of Oil getting transacted in Dollars and with the world keeping their reserves in Dollar, Euro and Yen, even such large printing of currencies by US, Europe and Japan hasn’t led to their currencies losing purchasing power. Concurrently, with US, Europe and Japan keeping their interest rates to near zero and even negative, such forex reserves kept by countries in Treasury bills of these 3 countries earn a pittance. So, out of $375 billion of India’s forex reserves, $100 billion is parked in US treasury bills earning 0.25% annual interest! On the other hand, Indian Government has such huge foreign debt that most of the budget goes in interest and capital repayments.

Instead of keeping quantum of forex reserves as months of net of imports & exports, shouldn’t RBI keep the quantum as a proportion of net foreign debt of the country? Now, that our forex reserves have risen by $100 billion in past more than a year, isn’t it time to continue on that formula and instead of accumulating more dollars, use them for repayment and also let INR rise against the Dollar?

Gold had a bull run for 10 years, went down for 4 years and has started rising again. It shows impending drop in value of US dollar. China is also diversifying part of its $1.2 trillion reserves away from US Dollar. Further, development of Shale gas and stress on renewable energy with signing of Paris Climate Accord, also means less dollars would be required for Oil trade in the future. Dollar value will ultimately lower down and recent US actions of making the country itself as a Tax haven is to attract any kind of money into US – Be it black money, tax evasion money or any color of money. US just needs Dollar inflow to meet its current account deficit because money printing cannot continue ad infinitum.

Isn’t it smart to follow China, which kept the Yuan artificially strong and is still defending the value of it? Yuan has appreciated against USD by 35% since 2009, only recently has it somewhat depreciated. INR should be not weaker than 10 to a USD and be in line with PPP (Purchasing Power Parity) by 2025. Till 1965, it was 4.75 to a USD – RBI should let INR rise and stop accumulating more USD’s.

Agreed to worsening economy from 2011-14, but what about from 2014 till now? China issued huge Yuan paper for USD’s it was accumulating. Now, as you know, the component of GDP is consumption, investment and exports. By releasing such mammoth Yuan paper in the economy, it risked inflation – to curb inflation, it created huge supply-side capacities by pumping investment to world records. Biggest dam in the world, biggest Mall, biggest over-the-sea bridge, highest railway line, world-class high-speed railway being case in point. And since consumption was always low, inflation was under control. Hence, China could align its monetary policy with US to maintain the Dollar peg.

Indian scenario – inflation has a propensity to rise here since supply-side capacity creation is so slow. Instead of pumping investment, Congress put money in crony social sector schemes like NREGA, Right to Food etc which only boosted consumption, without creating supplies – and see the monster inflation from 2009-2014! So, R3’s actions can be seen as justified till 2014, but what beyond 2014? R3 was part of Government from 2007 till now and under his watch, Congress Finance Ministers Pranab Mukherjee and P. Chidambram did QE (Quantitative Easing) in India, under garb of West doing QE. The explanation for doing QE in India was shoddy, since there was no recession in India, only GDP growth had lowered. Under pretence of QE, Congress gave INR 10 lac crore of loans to businessmen, all of which are now NPA’s on books of Banks. How much did R3 contribute to the mess? How much money was made by Congress in the process? How come while it was distributing these crony loans, it was also passing the Land acquisition bill, which crippled these projects and led to NPA’s in many instances?

By letting Yuan appreciate 35% against USD from 2009 to 2015, China showed the world the inherent bias in Yuan is for appreciation, thereby getting even more USD flows into China. By contrast, India, since 2014, has played the role of a beggar which wants more and more USD’s and who is interested in a weak INR! Things seem to have stabilised in China, also because USD has been strengthening and PBOC released a formula to fix Yuan peg, which involved mixture of currencies like Yen, Euro and USD (Some kind of REER-based). Simultaneously, it has been pumping in record Yuan into the system – creating a debt bubble and boosting consumer credit and thereby, consumption.

So, fully agree that de-pegging would prove to be a huge challenge but when will China’s $3.2 trillion of Forex reserves come in handy. Amongst that, China has $1.2 trillion of forex reserves in USD’s. China’s companies like Anbang have been wanting to make up for coming depreciation in Yuan by buying up US companies. Confidence in China is rightly low given the mammoth debt bubble which it is creating

Vivek Krishnan – “I’d rather not get into what is an appropriate absolute level of the INR USD. I believe that the price in FX markets is a determinant and any genius amongst us can still not fathom what the combined wisdom of FX market participants can (at least for a free float).  Plus, even if I were to believe that the absolute level of INR USD were to be a certain no, I’d surely not make a trade and theory has not been my forte. I surely do not believe that the RBI should start manipulating the currency to take it to a level that someone believes to be right and so have nothing to add on that front either.

A constant refrain of yours is that the INR should be stronger. In fact, a little understood fact is that between April 2014 and March 2015, there was only a meagre 4.5 % depreciation of the INR vis-a-vis USD. Same time, the USD appreciated by a larger margin against other major currencies – 24 percent against the Euro, 16 percent against the Yen and 14 percent against the British Pound.

Now, we can find all kinds of logic, correlations and causations for currency value but it need not be all that complex. There are surely some things that matter more than others. In the Indian scenario, till date it’s been oil prices & the trade deficit, inflation differential and equity market flows (more than bond flows). The status quo on all these tells traders that the INR is where it is today. As for whether R3 could have taken the INR to 39 by selling $100 bn in markets, frankly I do not think so. And I doubt if any FX trader that I’ve known believes demand supply can shift to a long run equilibrium by simply expending a few $100 Billion.”

Another friend Sonaal Kohli had this to say:

“The long term 25 years depreciation of USD is about 4% Vs INR and has been lumpy including a 10 year period 2002-2012 when it was flat primarily driven by flows where crude prices and gold prices had in fact multiplied.

Currency is most liquid market in the world with 100’s of factors at work though in different degree depending upon different circumstances both absolute and relative, fundamental and non-fundamental i.e confidence in the country, past records of defaults, reforms, expectations, competiveness, interest rates, choice of monetary policy, liquidity policy, pegs, fiscal, size of bond market for foreigners, FDI,  current account, GDP growth, inflation, expectations of long term inflation, PPP, monetary system of the world, forex reserves, nature of those forex reserves i.e short term, long term, liquid, illiquid.. Moreover, it also depends on change in magnitude of one, one big outlier as in case of stock market can have higher impact than all others depending on the situation. At times some of these factors are positive some are negative

If it was easy to know the magic formula we would all be in place of Soros trading currencies making billions.

China sold 1 trillion of forex reserves but still could not protect its currency or appreciate it even over couple of months. We have limited dollar reserves comparable to small city like Singapore and less than 10% of China. If we would have sold 100 or 200 billion of forex reserves than after looking at our depleted reserves currency, fall in exports leading to out flow in stock markets, unemployment, currency would not have appreciated but eventually for all you know may be even collapsed to 3 digits or higher.

One more point – China was perhaps the only exception in the history of large economies which had both current account surplus and capital account surplus for a decade or if I remember correctly 2 decades plus and hence its actions were very different. This can’t be role model for any other economy in the world, it is no more the case for last few years for China and Chinese model is a big question mark for China itself and explains what is happening in China.

China now has to choose between independent monetary policy and currency it cannot have a fixed strong exchange rate and also have loose monetary policy which it requires to bail out internal situation, if it defends exchange rate and keeps it pegged to dollar then monetary policy will become tight due to accumulation of USD and depletion of Yuan’s causing stress in the economy.”

While I agree with Vivek Krishnan and Sonaal Kohli that a mix of internal and international factors lead to creation of the currency exchange rate, I don’t believe that if the RBI Governor can have the power to devalue INR or keep it stable while accumulating USD’s, then sure at a time when Government of India is going all guns on reforms since 2+ years and results are showing, the Governor does have the tools with him to take the INR much higher.

That I believe is the way forward for a strong India – a strong INR, aiming to reach 10 to a USD by 2025 and letting Indians live rich in the process of graduating to a high seat amongst developed economies.

Author: Tushar Kansal

Tushar has been associated with the Project Assessment, Fund-raising & Financial Advisory realm in India for 2 decades. He has straddled multiple roles in Financial Advisory in Deloitte Touche Tohmatsu, PE Deal-maker in Times of India’s Brand Capital, in Corporate Finance roles in Aircel, as an Entrepreneur in Education field and as a CFO (Chief Financial Officer) till 2014. Prior to that, he was the Head of Debt for MTS India, where he was instrumental in raising $2.5 billion structured debt. Tushar has been involved in $6 Billion of transactions in Debt/ PE/ M&A across all asset classes. He has major experience in Education domain – From 2001 to 2006, Tushar led his Education entrepreneurship venture which provided Entrance examination training for Engineering colleges in India. The venture grew to 800 students and then was bought out by a marquee pan-India player in this space, as a strategic sale. Tushar is a panel member at CNN-News18. He is also a Columnist @ Business World, Indian Defence News, Business & Economy, Indian Economist, Digital Market Asia, OpIndia & Growing India.

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