Weak currency, strong economy: How India is on the path to becoming ‘aatmanirbhar’

“You have power over your mind ― not outside events. Realise this, and you will find strength.” These words are from a famous Stoic Philosopher and one of the greatest rulers of the Roman Empire, Marcus Aurelius. Similar thoughts were articulated by Yogeshwar Shree Krishna in the Bhagavad Gita more than 5,000 years ago to Arjuna:

उद्धरेदात्मनात्मानं नात्मानमवसादयेत्

आत्मैव ह्यात्मनो बन्धुरात्मैव रिपुरात्मन**:**

Elevate yourself through the power of your mind, and not degrade yourself, for the mind can be the friend and also the enemy of the self.

What holds well for the mortal body, holds good for organisations and even countries. Strength, courage, and fortitude originate from within and not from outside. This should be the simple matrix to evaluate oneself, not what others hold the opinion about oneself.

When one looks at the present world, one witness, a disturbing trend of the organisation’s interests superseding national interests, year-end bonuses and compensation along with valuations driving the decision-making, collective good being replaced by individualism and narcissism, and myopic short-quick fix overtaking vision, mission and longer-term perspective.

It happens with companies, countries and markets as well. Not only in equity, debt, or commodities but the currency market as well.

Recent furore on the Indian rupee cracking to an all-time low of 77.4150 to a US dollar on 12 May 2022 has brought naysayers back into the game, the rumour-mongering collapse of the Indian economy, reflecting its weakness, its vulnerability, and its dependence.

The fall of the Indian rupee and the RBI’s intervention are known to all, but what’s not visible to the human eye and what’s beyond the realm of human understanding is: What does the strength of the dollar indicate? Why does this strength still exist? (The US GDP declined by annualised 1.4 per cent in Q1CY22 and Indian GDP is expected to grow 4.5 per cent+ in Q4 FY22; GDP data to come on 31 May 2022).

Before we move forward, let’s reconnect with the basics in brief.

***

Also Read

***

What is currency? Currency is a medium of exchange for goods and services, a standardised system used by a nation or a country. Currency is just a mechanism to ease the complexities of the barter system and facilitate the free movement of money.

What is an exchange rate? The price of a country’s money or currency in relation to another country’s money.

Price of the currency: The currency is more valuable if the demand for the currency is higher than its supply. Based on basic economic principles, the valuation of currency is nothing but the demand and supply of it. Since the collapse of the Bretton Woods system (discussed further in the note), currency is fiat money where a government issues a currency that has no backing of any commodity and thus has no intrinsic value attached to it, apart from the ability of the government issuing it to honour its commitment. (Currency, in turn, is a promise made by the Central Bank on behalf of the government to pay the equivalent amount of gold to the bearer.)

But for the US dollar, it’s different and it’s tricky. To understand this, let’s dive into the past.

In July 1944, immediately after World War II, the US along with 44 Allied nations decided to peg their currencies against the US dollar. The US and the Allied states also decided that the US dollar will keep sufficient gold reserves (physical) before issuing incremental US dollars and every US dollar will be issued at a fixed gold rate of $35 to an ounce.

This meant that, if the US needed to issue more US dollars, it needed to have more physical gold in its safe custody. This was also known as the Bretton Woods Agreement. (Everyone agreed, as after World War II, there are no opposition, the only other power Great Britain which commanded GBP as the reserve currency in the last century before WW-II was under severe debt on account of War and was giving countries independence it had plundered and subjugated for years as the cost of maintaining as compared to the cost of incremental plunder was not worth it.)

But, in less than 27 years of the agreement, the US government had already printed more currency than the gold reserve it had or it was supposed to keep as a peg. The result of which was the complete collapse of the Bretton Woods Agreement as well as the system by 1973.

Then came the system of petro-dollars in July 1974. The Organisation of the Petroleum Exporting Countries (OPEC) had embargoed the US for supplying oil, quadrupling the oil prices, especially when the entire US economy was dependent, and emerging as the largest consumer of crude oil in the world.

Inflation was soaring as it’s happening now, the stock market crashed as it’s happening now and the US economy was in a tailspin as is happening now. A quick agreement was called out between Saudi Arabia and the US that the latter would buy oil from the former and provide the kingdom with military aid and protection. In return, the Saudis would plow billions of their petro-dollar revenue back into treasuries, whereby Saudi Arabia could buy US treasury bills even before they were auctioned in the open market and thus financing America’s spending. Also, the condition was attached that oil will only be settled in US dollars and not in any other currency.

The cycle that the US followed was simple and easy. The US bought crude oil and paid Saudi in US dollars. Petro-dollars came back to the US when the Saudis bought the US treasuries. (And it continues till today.)

The US (with a 332 million population), despite being the largest producer of crude oil, remains the 4th largest importer as well, thus being the largest consumer of crude. What has currency to do with crude?

For over 80 years, crude has been the most important medium of energy and transportation. As demand for crude is settled in US dollars, thus the dollar remains always in demand.

Whosoever produces crude, the US, instead of oil producers holding US dollars, swaps US treasury with them, thus bringing back US dollars within the country, creating an artificial shortage in the world.

As the world progressed and Japan became one of the biggest technology and manufacturing hubs post-World War II, it started exporting to the US and emerged as the fourth largest exporter to the US. The process carried on and Japan today remains the largest holder of the US debt.

Next came, China with its mass and cheap manufacturing, and the US being the biggest market, found its favour. The cycle continued and today, China is the largest exporter of goods to the US and remains the second-largest owner of US treasuries.

Russia from nowhere (till the turn of the century) emerged as the world’s largest exporter of oil to global markets. Oil here does not mean only crude, it includes crude oil and its other variants including refined oil, fuel oil, naphtha, vacuum gas oil (VGO), Gasoline, LPG, jet fuel, petroleum coke, etc.

But Russia was not happy settling energy products in US dollars. Slowly Russian domination of energy sources outside the US dollar has and could have threatened the petro-dollar system. One can see the Ukraine-Russia war in this backdrop.

In the midst of all this, where do India and the Indian rupee stand?

When the US was engaged in pushing US debt to its exporters and supplier of goods, India smartly engaged in bilateral ties to ensure its energy needs are met constantly with the least pressure of US dollar outflow.

Largest among them being Iraq, Saudi Arabia, and the UAE with over 50 per cent of India’s oil supplies. With the Middle East, India has pushed serious exports of rice, meat, electrical equipment, and more importantly refined petroleum. The idea is to get the oil-importing country to have essential commodities dependence on India to curb any future uncertainty concerning the ever-changing currency and political landscape. As a first, India included government procurement in a Free Trade Agreement (FTA), whereby national treatment and status is given to UAE companies, on a par with Indian companies, while bidding for Central government tenders.

But today’s case in point is the weakness of the Indian rupee against the US dollar.

The exchange rate between currencies is dependent on multiple factors and the list is huge. However, some of them that have a major impact include:

·               Inflation differential between two countries

·               Interest rate differential between two countries

·               Current account deficit which reflects the exports and imports differential

·               Fiscal deficit that puts signifies income and expenditure of the government.

·               GDP growth differential

·               And finally sanctions and geopolitical stability.

In the present day, across all parameters, India stands tall against the US dollar. However, the dollar continues to remain strong and moves from strength to strength despite the crumbling US economy which is expected to move into recession maybe the 4th quarter of CY22 or 1st quarter of CY23. (Strength of the US dollar signifies deflationary/recessionary symptoms and fall in US dollar signifies growth in inflationary assets like equities, commodities.)

The US dollar has not only strengthened against INR but against basket currencies.

If one compares trillion-dollar economies, the Indian currency has been most stable vis-à-vis the US dollar.

Let’s dig deeper into what’s happening with the dollar and other currencies. Why is it happening, and does it have any repercussions on USD-INR trade as well?

The simple measure the world uses is DXY which determines the value of the US dollar versus a basket of global currencies and estimates the mood (risk-taking ability or risk aversion) of the investors.

The index is currently calculated by factoring in the exchange rates of six foreign currencies, which include the euro (EUR), Japanese yen (JPY), Canadian dollar (CAD), British pound (GBP), Swedish krona (SEK), and Swiss franc (CHF).

The euro is the largest component of the index, making up 57.6 percent of the basket. The weights of the rest of the currencies in the index are JPY (13.6 percent), GBP (11.9 percent), CAD (9.1 percent), SEK (4.2 percent), and CHF (3.6 percent).

The dollar index crossed 104, which is the highest in the last four years and can further go up to 107 (20-year high) indicating risk aversion, a rise in inflation, and higher interest rates to follow in the US by the Fed. (If the rise in interest rates will not cool off the inflation, the Fed will have to increase interest rates rather quickly at a faster pace pushing the US economy in recession; fall in commodity prices are indicating the same as well.)

Now comes the twist in the tale: Why is the Japanese yen falling the most and why is the US dollar strengthening beyond what’s mentioned above?

The US and the EU imposed sanctions on Russia, thus creating inflation in their economies (rise in prices of food, fertilizers, gas fuel, etc).

Japan is heavily dependent on food, mineral fuel and other essentials for running the economy (Japan imports all of its oil and gas) from the US and China. Thanks to the Ukraine war, the energy imports bill had surged for Japan, making Japan’s trade deficit an 8-year high which till a year back was in surplus. (Exports declined due to shortage of semiconductor chips and Covid-related supply chain disruptions.)

As dollar demand surged due to oil and gas, the Japanese yen kept declining. Thus putting pressure on yen-denominated bonds, which are outstanding in the market equivalent in dollar terms amounting to $12.78 trillion (240 percent of the Japanese economy), sparking fear of Japan’s bankruptcy.

To make things worse, Russia is adamant to pay for its gas, crude oil and coal in the ruble, and hence euro and JPY continue to weaken and thereby pushing the USD northward. (Euro and JPY have limited use if they can’t settle their energy bill in their currency or USD. To top it all, both Japan and the Eurozone have mammoth sovereign debt.)

If Euro and JPY further their losses, USD will keep strengthening against the basket of currencies, and thus all global currencies will continue to sink against the USD. Thus, one can see that the strength of the USD vis-à-vis the rupee has very little to do with the rupee itself, especially during a period when India’s economy is expected to remain the fastest-growing economy for the next three years.

Coming back to where we started from the statement of Marcus Aurelius and the Bhagavad Gita, true strength and true power comes from within rather than from outside and India is on its path to becoming self-reliant not only in the case of services, agriculture and manufacturing, but also in energy and currency and in the mode of exchange.

The author is Managing Director & COO, Leading Full Service Investment Bank. Views and opinions expressed in this article are those of the authors and do not necessarily reflect the official view or position of any company or sister concerns or group company where the author is presently employed.

Read all the Latest News , Trending News ,  Cricket News , Bollywood News , India News and Entertainment News here. Follow us on Facebook , Twitter and Instagram .