Rupee falling is disastrous

The recent sharp depreciation of rupee is a cause for concern. The depreciation was largely against the dollar, by more than 7.5% in this year 2018. The rupee’s decline is likely to continue due to rise in the current account deficit on India’s balance of payments, intensified by the recent sharp rise in the price of crude oil. The current account deficit rose from $41.6 billion in 2016 to $73.3 billion in 2017. A depreciating rupee affects the local economy in several ways.

• Periodical rupee depreciation is a symptom that India is a bubble economy. 
• The success of India's liberalizing reforms is not because it has transformed into a manufacture & export driven economy, but indicates its emergence as a favored destination for international financial investors resulting in large capital inflows. The large capital inflows resulted in stock market values, but the valuations are not warranted by its potential earnings.
• Large inflows of foreign capital, enhances the liquidity in the system, triggers a credit boom that spurs demand and drives domestic market growth. 
• The debt-financed consumption and investment results in excess liquidity that drives banks to increase lending. This increases the defaults which can lead to systemic fragility that can intensify the capital flight and exchange rate volatility.
• The import liberalization fuels the demand funded by debt and in the absence of matching enhance in exports, the import-intensive consumption and investment results in widening current account deficit.
• The net foreign exchange outflow is due to mismatch between imports and exports and remittances and the deficit gets financed by capital inflows. A country that cannot earn the foreign exchange to finance its current needs is vulnerable to balance of payments difficulties and cannot sustain the value of its currency. 
• The low oil prices, between 2014-17, had depressed the outflows on account of excess import of goods. Now as oil prices have risen to $80 a barrel, the reality is that India is a country that is vulnerable on the balance of payments front.
• Liberalized trade and liberalized capital flows have enhanced India’s vulnerability, of which periodical currency depreciation is a symptom which got concealed so far by the large capital inflows and by the benefits of low oil prices. Both those advantages are now under threat.
• Trade liberalization has increased dependence on imports for consumption and investment and now the depreciating rupee increases cost of imports that aggravates inflation. Increase in the price of crude oil has the potential for much higher inflation. Inflation forces RBI to raise interest rates. 
• Many companies have outstanding foreign currency loans, either as working capital or acquisition-related debt, will be seriously affected.
• The liberalizations results in surge in capital flows that in turn increases private foreign debt. Since large capital inflows make the domestic currency appear strong, much of this borrowing in foreign currency is not hedged for possible losses stemming from any currency depreciation.
• Any plunge in the rupee effectively accentuates foreign institutional investors' losses on their equity portfolios and triggers stop-losses, which forces further sales, dragging markets even further down. 
• A falling rupee, in theory, should help exporters. But due to other factors export gains due to a depreciating currency may be limited.
• A falling rupee impacts tourist & business foreign travelers and students joining foreign universities. 
• FIIs have been supporting the rupee in the last three years, their inflows have dried up. So far in 2018, FIIs have pulled out Rs 46,197 crore from the Indian markets. 
• The Indian currency's vulnerability is particularly heightened by the fact that among its emerging market peers, India runs a high current account deficit.
• Large number of expatriates returning from Saudi Arabia and modified H1B visa rules by USA will hit remittances in coming years and impact current account deficit.

When depreciation actually occurs, the rupee costs of servicing foreign debt rise sharply. When the stagflation afflicts the economy hurts corporate profits and makes the burden of servicing foreign debt too much to bear. The distress sale of assets that follows bankruptcies results in asset price deflation, which worsens the problem. Depending on the intensity of these effects, the bubble can burst and the game of speculation can unravel. It is for this reason the bubble economy becomes unsustainable.

India escaped the last two global financial crises, but it may not be as lucky this time. Rising oil prices & increasing inflation and combined with the bad loans & capital flights already occurring, there is trouble looming. Turkey and Argentina, two of the world's biggest emerging markets, have been plunged into economic turmoil. Both the Turkey's lira and the Argentina's pesos have gone into free fall in recent months due to panic-selling by investors. Emerging markets were under performing by 2.5% so far this year. The strong US dollar is putting pressure on other currencies. Turkey's inflation rate exceeded 10%. The Argentine peso has plummeted by more than 10% against the US dollar. In May 2018, Argentina's central bank hiked interest rates from 27.5%  to 40% to avoid further capital outflows. While Argentina had already requested IMF help to rescue its economy, it is only a matter of time for Turkey to request IMF to help rescue its economy. Other emerging markets may be able to adapt to rising US interest rates without facing such turbulence. The strong $ 400+ billion reserves are sufficient for meeting contingencies but uncontrolled current account deficit will compel FII's to withdraw their exposures in India that will spell doom for our economy. Hence reducing current account deficit and inflation control are paramount.