It’s not India’s fault

Rajkamal Rao | Updated on November 05, 2018

A strong US economy is making the rupee fall

Not a day passes without a discussion about the falling rupee. On TV and in the business press, the analysis is often dry and identifies common but hard-to-understand culprits — growing current account deficit or non-performing assets.

These may be factors but they are certainly not driving the rupee down so dramatically. From Januray 2 to October 4, the rupee has fallen by an incredible 17 per cent. On January 2 this year, the dollar was trading at INR 63.47. On October 4, the rate had slipped to INR 74.24. That’s an incredible 17 per cent fall for a currency which, over the last five years, had steadily traded in a band of 61-68.

What’s causing the rupee’s fall is the incredible strength of the US economy. Several countries’ currencies have suffered a massive fall including the migthy Renminbi. The tsunami has swallowed every country in its wake and there’s little respite until the tsunami leaves the shore back to sea. According to an analysis by CNBC, Venezuela’s currency is down nearly 100 per cent; Argentina, 53 per cent; Turkey, 38 per cent; Brazil, 20 per cent and Russia, 15 per cent. Even the mighty Renminbi is down 5 per cent.

The four cylinders of the mighty US engine — fiscal policy, monetary policy, regulation and trade — have been firing away with such gusto that unless there’s a calamitous event, the weakness in world currencies are likely to continue.

It helps to look at the strength of the US economy through a contextual lens. In 2017, the US GDP was $19.4 trillion. Assuming it will grow at an average rate of just 3 per cent for all of 2018, US GDP will have increased by $582 billion just this year alone. The change in GDP this year is larger than the entire economies of 190 countries including Sweden, Belgium, Austria, Norway, the United Arab Emirates and Israel.

Since 2000, two cataclysmic events turned the US economy on its head. After 9/11, the country went into a prolonged cycle of deficits as it spent on never-ending wars in Iraq and Afghanistan. Then it was hit by the financial crisis in 2008. Additional deficit spending was like a drop in the bucket and provided little relief.

So the Federal Reserve stepped in unleashing over $5 trillion into world markets. The world was awash in dollars and the Fed primed the economy further by keeping interest rates near zero for many years. There was then little incentive for the world to invest in the US, and help fuel the dollar’s rise.

In that period both President Barack Obama and Treasury Secretary Jack Lew made some gloomy prognoses on the US economy. The situation was so gloomy that President Obama famously said in a 2010 CBS 60 minutes interview, “What is a danger is that we stay stuck in a new normal where unemployment rates stay high.” The 2013 Obama budget declared, “In the 21st century, real GDP growth in the United States is likely to be permanently slower than it was in earlier eras.” In a June 2014 speech to the Economic Club of New York, then US Treasury Secretary Jack Lew said the US GDP growth rate, was now projected to run a little above 2 per cent a year.

But today everything is different in the US. Unemployment rates have dropped to 3.9 per cent, the lowest in 50 years. Second quarter GDP came in at 4.1 per cent. The stock market is near record highs. Corporate profits have rarely been better. The US is about to become one of the world’s largest energy exporters. And inflation is perfectly in line with expectations.

Under Trump, the US is still fighting wars but at a much smaller scale. Deficit spending continues but nearly all of this year’s deficit was because of massive tax cuts for businesses which Trump signed into law. This has put more money into the pockets of companies resulting in investment in plants, equipment and factories.

Trump has also severely cut regulations on companies. This has freed businesses from having to constantly comply with onerous government rules and allowed them to divert funds to hire and invest.

And Trump’s trade wars have been explosive. Markets know that trade wars always hurt the little guy more.

Meanwhile, the Fed slowly began to mop up all the extra dollars it had printed creating a demand for scarce dollars. It also began to raise interest rates.

The net result of all this is that the world is chasing the dollar. Even if the US economy falters, the world knows that Trump has plenty of tools left up his sleeve. Plus the Fed has lots of room to lower interest rates to return the economy to health. And it can do another Quantitative Easing, if necessary.

During this last five-year period, India’s NPA problems weren’t any better. Nor did CAD and NPA suddenly balloon over the last 10 months. As long as the world is after the dollar, the rupee and other currencies will continue to be weak. It’s that simple.

The writer is Managing Director, Rao Advisors LLC, US

Published on November 04, 2018

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