Nov 23 2011

Why the falling rupee makes Mr. Welker a happy man! (and may help the Indian economy in the long-run)

Indian Rupee hits all-time low against the dollar – CBS News

A couple of years ago I wrote what I would call a “fantasy” blog post about how the recent depreciation of the British pound would have made a ski trip to India a whole lot cheaper since the tour company I was planning to go with quoted its prices in the British currency. Well, at the time I wasn’t really planning to go skiing in the Himalayas, but this year, because of a fall in the value of another currency, I really AM going to ski in the Himalayas!

The chart below shows how the value of the Swiss franc has changed against the Indian rupee over the last year and a half.

The Value of the Swiss Franc in terms of India Rupees – last 18 months


As can be seen, the franc, which is the currency in which I get paid here in Switzerland, has risen from only 40 rupees 18 months ago to as high as 63 rupees in August this year, and is currently at 57 rupees per Swiss franc. We’ll explore the underlying causes of this appreciation of the franc in a moment, but first let’s examine its effect on my dream of skiing in the Himalayas.

So just yesterday morning I did, at last, after six years of dreaming of this adventure, book a six day guided ski trip in the Indian Kashmir town of Gulmarg, which sits at an elevation of 2800 meters and has lift-accessed skiing up to 4,000 meters, making Gulmarg the second highest ski resort in the world. Okay, enough facts. The strong franc made this trip a reality for me for the following reason:

  • 18 months ago, the 40,000 rupee price tag of this ski trip would have meant a cost of 1,000 swiss francs.
  • Today, due to the strong franc, the 40,000 rupee price tag means this trip is only costing me 700 swiss francs.
Due to the strengthening of the franc, and the weakening of the rupee, my Himalayan ski odyssey is now costing me 30% less than it would have 18 months ago… so… I’m doing it! YEAH!
The Swiss currency has appreciated by 42.5% in the last 18 months against the India rupee. WHY?! What could be going on in the world that accounts for this massive swing in exchange rates? There are a few causes worth mentioning here, which have to do with factors within Switzerland and India, but also external factors beyond the control of either country. Here are some of the major ones:
In Europe:
  • The franc has risen against most world currencies, not just the rupee, due, ironically, to economic uncertainty in the rest of Europe. Since Switzerland has its own currency, and a strong economy, whereas all of its European neighbors have a common currency (the euro), and struggling economies, investments in Swiss assets (primarily savings accounts and government debt) have become increasingly attractive. This has caused demand for francs to rise, causing its value to increase against most currencies.
  • The debt crisis in the rest of Europe, most notably in Greece and Italy, reduces certainty among investors in these European governments’ ability to repay their debt, creating further demand for investment in Switzerland, causing the franc to rise.
In India:
  • According to the Associated Press, “Slowing growth, a swelling current account deficit and waning investor interest in India are adding to pressure on the rupee…” India runs a large trade deficit, equaling about 3% of the nation’s GDP. This means Indians are dependent on imported goods, while foreigners do not demand as many of its exports. This puts downward pressure on the exchange rate of the rupee.
  • In addition, the “slowing growth” rate in India sends the signal that the country’s central bank may lower interest rates to try and stimulate GDP. However, the expectations of lower interest rates in the future make international investors look elsewhere for investments with relatively higher returns.
  • Next, weaker growth prospects make investments in Indian assets (such as corporate stocks or bonds) less attractive to international investors, since they expect demand for Indian output to slow in the future, thus demand for rupees declines now.
  • Finally, the decline in the rupee’s value itself is fueling a further increase in the value of the franc. Not all currency exchanges are for the purpose of purchasing a nation’s goods or its assets. Much currency trading is among forex brokers who buy and sell currencies to hold as assets themselves. The weakening of the rupee may be fueling speculation about the future value of the rupee, which acts as a self-fulfilling prophecy, as forex investors will continue to swap rupees for other currencies, including the Swiss franc.
All this adds up to one thing for me: A 30% discount on my ski vacation to India! Of course, for the Indian economy, a weaker rupee might be just what is needed to boost future economic growth. As the rupee falls and the Swiss franc and the US dollar gain value, not only will ski vacations to India become more attractive to foreigners, but so will other exports from the South Asian nation. That 3% trade deficit that has contributed to the rupee’s decline may begin to move towards the positive if foreigners like me begin taking more trips to and buying more goods from Indian firms.
The weaker rupee could, in the long-run, increase total demand for India’s output, which would improve employment and growth prospects on the sub-continent. Furthermore, if India’s growth rate picks up due to increased net exports, the Indian central bank may be able to raise interest rates a bit, reducing the incentive for investors to flee the rupee and put their money in countries with higher returns.
Through this process of self-balancing, in time the weaker rupee will probably lead to an improvement in India’s economic situation and eventually the rupee will begin to strengthen against the currencies of India’s trading partners. But for now, I’m going to enjoy my week of guided skiing in the Himalayas, and thank the forex traders and currency speculators for allowing me to take this dream vacation for such a bargain price!

courtesy: http://www.gulmargpowderguides.com/


About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

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