US Dollar At Rs 70? Don’t Blame It All On Demonetisation And It’s Not Panic-Worthy

The rupee has lost about 3.5 per cent against the US dollar since demonetisation was announced on 8 November. It is now quoting at 68.78 to the dollar against 66.43 on 9 November. Some forecasters are predicting Rs 70-71 by December-end, but the Reserve Bank of India (RBI) has enough dollars in its kitty to prevent any undue volatility. And Rs 70 to the dollar is not a bad level for us.

While demonetisation has sparked a correction in the rupee, there is absolutely no need to think this is some kind of catastrophe. It is not, and it could even be mildly beneficial to us in the short run. Of course, if the pace of fall is maintained for a few more months, we should indeed worry. But a fall to around Rs 70-71 is entirely within the range of normality – and would constitute a 7 per cent correction.

Currencies tend to correct jerkily after being stable for long periods of time. They usually over-correct when trigger events happen. In our case, the trigger was demonetisation, but the drop ought to have happened even otherwise given inflation differentials between India and the US.

For perspective, let’s look at what happened over the last five years. From around Rs 48-49 in February 2012, the rupee went all the way down to Rs 68-69, before settling at the Rs 66-67 range in the last few years. This means, in less than five years, the rupee has lost 36 per cent of its value against the US dollar. That gives us an average 7-per cent-plus annual decline.

If this has been the average in the recent past, a further decline by 7 per cent is hardly a disaster. It was on the cards even without demonetisation, only it would have happened over a longish period.

However, the rupee’s decline has not been precipitated only by demonetisation. There are other factors too at work.

First, there is the Donald Trump victory. Dollars have been returning to the US after he won because investors expect a sharp spike in government spending on infrastructure to revive growth. The US Federal Reserve, after holding back rate hikes for an unduly long time (Trump believes that the Democratic-appointed Fed Chair Janet Yellen held back a hike in September to prevent an early tanking of the economy), will probably take the plunge next month.

The Dow Jones has been hitting new highs, above 19,000 and US short-term Treasury yields are spiking, with the two-year bond hitting a yield of 1.15 per cent, a six-and-a-half-year high.

This is why foreign investors are moving cash to the US, with November (till 22nd) seeing net sales of Rs 11,762 crore in equity and Rs 11,144 crore in Indian debt.

Second, the November-December period is also the time when foreign fund managers lock into gains in Indian equity in order to capture higher net asset values (NAVs) that determine their performance fees. This pattern has often been seen in the Indian markets for some time now.

Demonetisation is only the proximate cause for money leaving Indian shores.

However, it would be wrong to think that the rupee’s fall is a problem. For three reasons.

#1: Exports are showing signs of life after nearly two years of continuous drops. In October, exports grew by a healthy 9.6 per cent and imports by 8.11 per cent, signalling that the export engine has begun firing again. Growth may slow in November due to the demonetisation shock, but exports need not suffer. When domestic demand is flagging, and the US economy is looking up, one should see exports rising and imports slowing. The fall in the rupee will help marginally, giving exports another leg up.

#2: Demonetisation is bringing down inflation rates as consumption demand drops. This will, in the short term, reduce the inflation gap between India and the US, thus giving less scope for a dramatic fall in the rupee’s value. If at all the rupee’s drop accelerates, it will only be due to capital outflows, but that too will be short-term in nature. Once growth revives in India by, say, the first quarter of 2017-18, the FIIs haemorrhage will stop.

#3: When there are deflationary forces at work due to demonetisation, the RBI should not be intervening too much to keep the rupee stable. It should intervene only to prevent excess volatility. This is because it will have to sell dollars and buy rupees to shore up the latter’s value. On the other hand, when rupee resources are short in the economy, the RBI should be buying dollars to release rupees to keep growth on an even keel. This is probably what the RBI will do – let the rupee float gently down to around Rs 70.

And that is nothing to panic about.