Today, on the eve of the Independence Day, on the 14th of August, 2018, the Rupee has crossed 70 per U S Dollar (or USD). It is a tough situation if not an outright crisis. Such sudden reduction in the value of Rupee damages our economy as it:
– makes the imports costlier
– reduces our FX reserves
– reduces the inflow of inward investment in FDI as well as in stock markets
– increases the domestic rate of interest
– causes inflation and unrest
– increases default chances by borrowers
– reduces credit flow for genuine purpose
Everyone knows USD is world’s major and Reserve Currency while India’s Rupee is an Emerging Market (EM) currency which is partly convertible on Capital Account (purchasing assets overseas) and fully convertible on the Current Account (for international trading purposes). We are Net Importers and our country is in permanent Trade Deficit (also known as Current Account Deficit meaning imports being higher than exports), thanks to our fuel requirements, only 20% of which is produced in the country.
Things were going on well for India on the Foreign Exchange (FX) front so how has this happened. Every time, the country or the world faces as Foreign Currency crisis some or the other country is responsible and is held accountable for triggering rise of USD and fall of other currencies (mainly those from the EM). In 1998, it was South East Asia (mainly Thailand), ten years later in 2008, it was Greece and now a further ten years later, in 2018, it was the turn of Turkey.
In the last seven and a half months of this calendar year, the currency of Turkey is down by 70 percent. Turkey is a USD 840 b economy and is ranked 17th highest in the world and is an EM economy.
Lira, the currency of Turkey’s currency lira is down over 70 percent against the dollar in 2018. As a matter of fact, this has become the weakest currency in the world this year. But the point here is as to how an internal matter of US and Turkey (USD v/s Lira) has damaged the value of Rupee? The trouble with Lira has been going on for quiet some time now, so, why have global markets, including India, reacted to this currency war now? Why do we Indians need suffer?
Not long ago, Turkey was in the same league as China and certainly ahead off India as the most loved business destinations of the world. But now we also understand that though growth was high, the economy was on a weak foundation. After the 2008 Global Financial Crisis, the developed countries offered reduced interest rates to developing countries and Turkey was one country which borrowed heavily as its businessmen invested grandly in real estate. Turkish banks too borrowed in dollars to fund the fast-growing domestic economy. With a few companies, let alone economies, showing signs of growth at the turn of the decade, foreign banks were more than happy to feed the Turks. According to newspaper reports, Turkey relies on foreign-currency debt more than any other major emerging market. Corporate, financial and other foreign currency debt, mostly dollar-denominated, represents about 70 percent of Turkey’s economy. European Banks have lent heavily into Turkey while the US investors have invested heavily therein.
As the lira loses value, Turkish borrowers now find it difficult to service their dollar-denominated loans. Reports suggest that many companies in Turkey have expressed their inability to repay / service loans. And this has triggered a global panic.
The problem is that Turkey has few options left to prevent its currency’s slide. Its overheated economy, which was funded from cheap foreign money, is likely to come crashing down. Economists have lowered its growth from 7.4 percent last year to 4 percent this year.
The country does not have enough foreign exchange reserves to prevent the slide. Turkey has foreign reserves of $130 billion with a short term foreign debt of $180 billion. Of its overall debt of $460 billion, 70 percent is foreign. If the flight of capital is not staunched, the scenario will turn from bad to worse. However, capital controls have historically worked only to a limited extent and the only option is raising interest rates.
Change in sentiment is a big threat for India as the country is already running a high current account deficit and risks fiscal slippages in an election year. Indian policymakers would do well to focus on macro-economic stability, especially when the US Federal Reserve is in no mood of delaying hiking interest rates.
Turkey is small in the overall global economy, but Greece was smaller and it rattled the world. Thailand was even smaller, but it was enough to trigger the Asian currency crisis of 1997-98.
