If India's Really Booming, Why Is the Rupee Crashing?

Meet the banker who could save the country's faltering currency.

How the mighty have fallen! Look where the supposedly world-beating BRIC countries are today: Brazil is mired in protests, China's growth is slowing, Russia is addicted to self-destructive spy games, and India's currency is at an all-time low. Of the four, India has the brightest prospects for growth ahead, so why has the rupee taken such a dip?

Even though China is growing faster right now, India has many more years of rapid expansion ahead simply because it hasn't urbanized or adopted new technologies to the same extent. You'd think foreign investors would be desperate to get in on the ground floor of this long-term boom, but naturally they're more fickle -- and less patient -- than that. And since the value of the rupee in global markets depends on their demand as well as its supply, you have to consider both to understand what's happening.

On the demand side, the key is to think about why people might want to exchange other currencies for rupees. Buying anything from India -- goods, services, financial assets -- can require rupees. When demand for any of these things rises, so does demand for rupees. Of course, when the rupee gains value, anything bought with rupees becomes more expensive for foreigners, so demand may equilibrate on its own.

That hasn't happened yet for Indian assets. In April 2011, the International Monetary Fund forecast that India's economy would grow by a total of 37 percent from 2013 through 2016. The fund's latest prediction, updated last month from the April 2013 figures, is for growth of just 28 percent in the same four-year period. It goes without saying that less potential for growth means less interest from foreign investors.

At the same time as India's growth forecasts were falling, other markets were becoming more attractive. A few years ago, investors frustrated with the slow recoveries in established markets might have taken a risk in India. Now, with a backdrop of somewhat greater stability, investors are returning to the advanced economies to hunt for bargains and ride the cresting wave. Not surprisingly, credit is tougher to come by in India; the yield on its government bonds has hit a five-year high.

The jump in bond yields may also have to do with expectations for inflation, which is another concern in India. As prices climb, the value of the rupee in real terms falls, and investors won't give up as much of their own currencies to buy it. Consumer prices rose by only 3.8 percent in 2004, but the rate quickened in every subsequent year through 2010, when it hit 12 percent, one of the highest rates in the world.

With inflation still at 9.3 percent last year and possibly higher in 2013, the new governor of the Reserve Bank of India (RBI), Raghuram Rajan, has his work cut out for him. His job is to decide the supply of rupees, and by slowing the printing presses he could stem inflation. Yet by curtailing access to credit even further, he could also cool the economy, and not at a good time. India's leaders are already starting to worry about next year's elections, and the RBI is much less protected from their meddling than the Federal Reserve or the European Central Bank.

That said, there is certainly room for improvement on the supply side. Between July 2011 and July 2013, the Indian money supply increased by about 29 percent. During the same period, the value of India's gross domestic product in rupees probably increased by about 27 percent. In other words, the RBI let the money supply expand by more than the amount necessary to cover inflation and economic growth; the extra rupees dumped into the economy were just more fuel for the inflationary fire. The bank may have made the money available to help foreigners purchase Indian assets, but by cheapening the rupee it may actually have driven them away.

In the longer term, the rupee should be able to tolerate moderate inflation without losing more of its value. The productivity of Indian workers is indeed increasing as the country urbanizes and adopts new technologies. Wages will rise, and so will prices. With a higher price level, anyone selling a unit of Indian stuff will receive more rupees for it. Barring a big change in the exchange rate, more rupees will buy more foreign currency, and more foreign currency will buy more foreign stuff. None of this would necessarily preclude equilibrium in the supply and demand for rupees.

So what's the endgame here? As long as the RBI doesn't start printing rupees like there's no tomorrow -- and with Rajan in charge they almost certainly won't -- the currency's freefall will be temporary. At some point, Indian assets, goods, and services will seem cheap, and buyers will return.

But for that to happen, the currency markets must be left to their own devices. The pre-Rajan RBI has moved in the opposite direction by limiting Indians' ability to sell rupees, which investors will interpret as a last-ditch effort to maintain the currency's value at an artificially high level. In Argentina, similar measures recently led to a black market in pesos and further undermined confidence in the country's economic policies. For Rajan, reversing course will be job one.


Daniel Altman

Larry Summers, Anger Translator

Is this who you want after Ben Bernanke?

As much as anyone can deserve a job, Janet Yellen deserves to succeed Ben Bernanke as chair of the Federal Reserve's Board of Governors. Her qualifications and service to the Fed are outstanding. But imagine for a moment if Larry Summers, the economic super-genius and political bull-in-a-china-shop who is rumored to be President Barack Obama's pick for the job, had been sitting in Bernanke's chair during his congressional testimony last month. Here are excerpts of real questions from members of the House Committee on Financial Services, Bernanke's responses ... and what Summers might have said:

Chairman Jeb Hensarling (R-TX): "A recent survey of 55 economists by the Wall Street Journal gives the Fed a D- for its guidance, so can you comment on your guidance?"

Bernanke: "I think it's been very important that we communicate as best we can what our plans and our thinking is. I think the markets are beginning to understand our message, and the volatility has obviously moderated."

Summers [speaking slowly and deliberately, in gravelly near-monotone]: "I don't mind explaining stuff. I like explaining stuff. That's why I teach. But if I explain stuff three times. And people still don't get it. I start to lose confidence." [Looks to the side, slaps forehead] "Now. You guys are blaming me. For the fact that a bunch of jock derivatives traders. Don't understand monetary policy. This is not the place to discuss, in detail. The labor market in finance."

Ranking member William Lacy Clay (D-MO): "Under the sequester, state and federal governments have lost jobs. Any forecast on, if the sequester stays in place, what the condition of the economy will be next year or so?"

Bernanke: "In this recovery, even as the private sector has been creating jobs, governments at all levels have cut something on the order of 600,000 jobs. In previous recoveries, usually the government sector was adding jobs. And so that's one reason why the recovery has been as slow."

Summers [scratches back of head]: "I have not done a systematic study. But my guess would be. That the sequester. Was the worst idea. In the history of economic policy. The Smoot-Hawley Tariff Act of 1930. Probably cost the economy less. In six months. Than the sequester."

Rep. Spencer Bachus (R-AL): "I've not seen a lot of discussion concerning the reduction in Treasury issuance with the deficit coming down. It seems like that would give you more latitude to reduce your purchases of Treasuries, so would you like to comment on that?"

Bernanke: "Well, the Fed still owns a relatively small share of all the Treasuries outstanding. It's true that as the new issuance comes down, that our purchases become a larger share of the new flow of Treasuries coming into the market. Our view of it, which, you know, people disagree, is that what matters is the share of the total that we own, not the share of new issuance."

Summers [slumps in chair, looks at desk, suppresses chuckle]: "I'll make three observations. Observation one. The national debt outstanding. Is $16 trillion. Observation two. The Fed owns less. Than $2 trillion. In Treasuries. Observation three. If a student of mine at Harvard. Asked that question. I would call. The admissions office."

Rep. Maxine Waters (D-CA): "Would you agree with the IMF's conclusion that the austerity policies currently in place have significantly depressed growth in the United States, and to what extent can monetary policy offset the adverse consequences of the current contractionary fiscal policy?"

Bernanke: "Well as I've said many times, I think fiscal policy is focusing a bit too much on the short run and not enough on the long run. The near-term policies which include not only the sequester but the tax increases and other measures, according to the CBO [Congressional Budget Office] are cutting about 1.5 percentage points from growth in 2013."

Summers [shakes right hand in front of face]: "If you guys think. That anything the Fed does. Can completely offset the damage. That this august body. Has inflicted on the economy. You're insane." [Smiles to himself] "You can win a football game. With offense. You can win a football game. With defense. But you can't win a football game. If the offense. Stays in the locker room."

Rep. Bill Huizenga (R-MI): "I would be reticent if I didn't pass along a question one of my friends had -- should he refinance right now? I think that's probably a question a lot of people have, I know I did not that long ago."

Bernanke: "Uh, I'm not a qualified financial advisor."

Summers [groans audibly, stares at Huizenga, starts speaking even more slowly than usual]: "You have been given. The immense privilege. Of serving the American people. In the nation's greatest deliberative body. You have five minutes. To discuss. The most important economic issues. Facing our country. With one of. The world's greatest. Economic minds. And this. Is your question? This. Is my answer."

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