Susmit Kumar, Ph.D.

Note: This article is from my book "Casino Capitalism" published early this year. I have written the same, i.e. collapse of Indian currency, in my 2010 article at this blog, titled "Stop Blaming China – It is the Structural Failure of the Global Trade System" (please see the last paragraph).

In 1991, India had to go to the IMF to get a loan because its FOREX was worth only three weeks of essential imports, and India was on the verge of default. One of the main reasons for this economic crisis was imports of luxury items during the late 1980s under the Rajiv Gandhi administration. India had to airlift sixty-seven tons of its gold reserves to London as collateral in order to get $2.2 billion from the IMF. In addition, India had to liberalize its economy and sell several of its profit-making public firms at throwaway prices to US firms such as Enron.

The trade deficit of India is increasing every year. In just eight years, the trade deficit of India quadrupled from $28 billion in the 2004–5 (April through March) financial year to $185 billion in the 2011-12 (April through March) financial year. India’s trade deficit with China has increased from $9.2 billion in 2006-7 (April through March) financial year to $30 billion in 2011-2 (April through March) financial year. On the other hand, the trade surplus of China increased from $177 billion in 2006 to record high of $298 billion in 2008. Since reaching a record high in 2008, trade surplus of China has dropped to about $180 billion a year due to the global economic crisis.

Due to large overseas remittances and foreign investments, India is able to fund its trade deficit. The drop in overseas remittances and foreign investments put pressure on India’s currency. Overseas remittances to India were $45 billion and $58 billion in 2008 and 2010, respectively, whereas for China, these numbers were $35 billion and $57 billion, respectively.  In India the majority of Hindu gods and (India’s) national flags are “Made in China.” During the Diwali festival of lights, cheap Chinese multicolored lights are replacing the traditional earthen diyas. With an increase in number of consumers, the trade deficit of India has the potential to surpass the US trade deficit level (i.e., $600 billion to $700 billion a year), which is unsustainable for India as, unlike the United States, it cannot print its currency to fund it. In order to pay for its imports, countries like India have to “earn” hard currencies like US dollars because foreign firms will not accept Indian currency. On the other hand, the US has to just “print” its currency to pay for imports.

Indians, who purchase cheap imported items, do not realize that they are in fact paying much more than the sticker price. In India, people use the Indian rupee when they pay storeowners, who in turn purchase imported items in the world market. The importers pay in US dollar when they buy these items in world markets, and these dollars are provided by banks in India that are authorized to do transactions in foreign currencies. Hence, in the end, India has to get these dollars from somewhere, say from the dollars earned by exporters or foreign investors. If India does not have enough dollars to pay for imports, it has to devalue its currency so that exporters can export more. Whenever there is a price rise in commodities such as petrol, opposition parties and common people blame the government for the price rise, whereas they should blame their own countrymen, who are purchasing imported items.

In the late 1980s, the conversion rate of Indian currency was 1:15, whereas in November 2011 it was 1:51 (i.e., about 250 percent in the last twenty-two to twenty-three years). Just in the last six months of 2011, the rupee had a record fall of 17 percent, from 1:44 to 1:51. The main reason behind this devaluation was the sharp drop in foreign investment, which tumbled from $6.5 billion in June to $616 million in September.[1] Indian companies borrow money in foreign currencies from outside the country because of lower interest rates. Indian companies borrowed close to $29 billion in foreign currencies, through ECBs (External Commercial Borrowing) and FCCBs (Foreign Currency Convertible Bonds) in the first eleven months of 2011, as against such loans worth $18 billion during the entire 2010. Hence, the sharp fall of about 17 percent in the value of the rupee made the cost of repaying these foreign loans costlier by a similar margin. For example, an Indian company would have to pay an amount of about Rs 51 billion (based on conversion rate of 1:51) toward the principal amount to a bondholder of $1 billion, while a similar loan amount would have been worth about Rs 44 billion at the beginning of 2011. According to Jagannadham Thunuguntla, SMC Global Securities’ strategist and head of research, the additional burden due to the rupee depreciation could be of Rs 252 billion ($5 billion) for the Indian companies on their ECBs worth about $30 billion raised in 2011. The possibility of such a scenario increases the risk of loan default by their issuer companies. The Indian government has to pay back the loan to the lender in case of the loan default.[2]

Therefore if situation remains the same, i.e. trade deficit goes on increasing, we may even see a conversion rate of 1:100 in very near future.

[1] Vikas Bajaj, “With Econmomy Slowing, the Indian Rupee Tumbles,” The New York Times, November 25, 2011.

[2] “Rupee fall may make India Inc foreign loans costlier by $5-bn,” Economics Times (India), November 20, 2011.



Additional information