The IMF has cut India’s economic growth for 2022 to 8.2% from its previous projection of 9%.


The chart above is a graphical history of the Indian Rupee against the US Dollar over the past five years. It should therefore come as no surprise to anyone that the INR fell to an all-time low of Rs 77.4 per US dollar a few days ago. What happened was inevitable. The reality is that the Indian economy is weak, and this is reflected in the value of the currency.

The immediate reason was a hike in US interest rates by the Federal Reserve which made US Treasury bonds more attractive to foreign investors, leading to an outflow of funds from India to a relatively safe haven in the United States. Foreign investors had already withdrawn a whopping Rs 1.22 lakh crore from Indian equity and debt markets in the year 2021-22. In the current financial year 2022-23, global investors have already realized a net sale of shares and debt of Rs 25,594 crore in the month of April alone.

The second factor was a 40 basis point increase in repo rates from India’s central bank, the Reserve Bank of India (RBI). The RBI’s objective was to bring down runaway inflation. Nevertheless, rising interest rates dampened business confidence, which weakened the INR. The repo rate is the rate at which the RBI lends money to commercial banks in the country if they face a shortage of funds. The central bank grants short-term loans to commercial banks against government bonds or treasury bills. The repo rate is essentially used by the central bank to control inflation by regulating liquidity.

High fuel prices caused inflation

Inflation was already high, as daily increases in fuel prices had a cascading effect on the prices of everyday items. This had affected the spending of the middle class as without much disposable income they were forced to spend only on essentials. The poor were in even worse shape and reduced their diet. Millions of people had been pushed into poverty during the pandemic lockdowns, inflation has now hit them when they were most vulnerable.

Figure 1% of India’s GDP Source: Statista

Policy mistakes have weakened the economy

But these are only a fraction of the reasons why the rupee has been on a slope for five years or more. The root cause is simple: India’s economy has simply not been doing well since the government, in its inexplicable wisdom, pulled the handbrake with a drastic decision to demonetize the currency in November 2016. In one fell swoop, almost 80% of the economy’s liquidity has been sucked out. Millions of jobs were lost as businesses went out of business. Commerce and industry are plunged into total chaos. Micro-small and medium-sized businesses, which make up nearly a third of the economy, have been hit the hardest as thousands of units shuttered never to reopen. The GDP (Gross Domestic Product) fell by nearly 2%.

This was followed by a late implementation of the Goods and Services Tax (GST) which further created hassles for small and medium-sized businesses, increased the cost of compliance and made business very cumbersome. The double whammy of demonetization and GST had dealt a heavy blow to the Indian economy, weakening its ability to withstand shocks. And more serious shocks came when Covid19 hit the world in 2020. In March that year, India announced a harsh lockdown. Not only has this caused catastrophic human suffering, but it has simply crippled the economy. Unemployment rose further, further worsening an already shaky economy. About 230 million Indians have been pushed into poverty during the pandemic lockdowns, according to a report by a private Azim Premji University think tank.

The shock of the Ukraine-Russia war

As if that were not enough, the economy made vulnerable by the government’s policy mistakes could not withstand a new shock of high oil prices triggered by Russia’s attack on Ukraine. India imports 80% of its oil needs and any increase in its prices will affect its economy, leading to a trade deficit, despite rising exports. India’s trade deficit increased by 87.5% to $192.41 billion in 2021-22 from $102.63 billion the previous year.

indian economy rupee vs dollar gdp covid-19 lockdown
Figure 2 India’s debt to GDP ratio (Source: Statista)

A gaping trade deficit

India still has a trade deficit. According to Acuity Ratings, the cumulative trade deficit for 2021-22 widened to an over-decade high of $192 billion. That was in 2012-13, when the trade deficit peaked at $190 billion. Given rising crude prices, Acuity Ratings expects the trade deficit to widen further. A higher trade deficit will put pressure on the current account deficit (CAD), which in turn will increase the demand for foreign currency, especially dollars, to finance the deficit, and will affect the value of the INR against the American dollar.

High debt to GDP

One of the most worrying signals from the economy is the debt-to-GDP ratio. India’s total public debt (Central plus states) to GDP ratio increased from 48.8% in the 1980s to 89.6% in FY21. Public debt (central government liabilities ) rose from Rs128 lakh crore in FY21 to a high of Rs135.87 lakh crore in March 2022.

This means that there is a debt burden of nearly 90% on the total value of goods and services produced by the country. Servicing this debt will weigh heavily on the economy. Meanwhile, the International Monetary Fund has further slashed India’s economic growth outlook for 2022 to 8.2% from its earlier projection of 9%, which itself has been lowered from 9.5% .

Research firm CRISIL has reiterated its December 2021 forecast of India’s GDP growth at 7.8% for the fiscal year 2022-2023. Ongoing geopolitical unrest in Europe between Russia and Ukraine has offset any upside due to an early end to a third wave of Covid-19 infections, he said.

A weak currency is a symptom

In this context, it was not at all surprising that the rupee fell to its lowest level against the US dollar. The value of a currency is only a symptom of a deeper malaise that afflicts the economy. If the economy is weak, obviously its currency will also be weak. Raising interest rates without addressing fundamental issues such as rising fuel prices will not be enough to fight inflation. It’s like changing gears in a car, without pressing the clutch.


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