India’s Rupee Drops Off a Cliff

The value of India’s currency, the rupee, has nose-dived over the past few days, causing many to worry about Asia’s third largest economy.

Tsering Topgyal/AP

The BRICs (Brazil, Russia, India, and China) may have been the foundation for much of the global growth over the past few years. But now there are signs of cracks in the BRIC wall.

The past year has seen China’s economy slow down. Brazil has been shaken by protests as huge swathes of the populace left out of the late boom took to the streets. Russia always seems to be in the headlines for the wrong reasons.

And now India. One of the biggest growth stories of the past few decades, as well as the world’s largest democracy, India is seeing its currency in a veritable freefall. The rupee has been hammered by the market, and closed earlier Wednesday at 68.80 to the dollar after falling 3.7 percent—the largest one day drop since 1995. The rupee is off more than 20 percent against the dollar in the last few months, and is at its lowest level ever against the American currency.

So what happened?

Blame America. Or, more specifically, the Federal Reserve. As the U.S. central bank signals it may curtail—or taper—its efforts to stimulate the U.S. economy, emerging markets have taken it on the chin. The most proximate cause, says Hanna Luchnikava, senior economist for the Asia-Pacific at IHS Economics, is that when speculation about Fed tapering ran rampant, “emerging currencies all dropped.”

But blame India more. “The reason why [India] suffered more, is because on top of the Fed, India on its own has financial and structural problems” she explains. The biggest economic challenge for India is its current account deficit —i.e. it imports more than it exports. India’s account deficit of 4.8 percent of GDP for the fiscal year of 2012 was a record high. Two of the biggest sources of the deficit are oil and gold. India imports over three quarters of the oil it consumes. And oil prices have gone up in recent months, thanks to production disruptions and uneasiness over conflict in the Middle East. Gold in India is purchased for an investment. But it is also a significant consumer product, used for jewelry and at ceremonies like weddings. The current account deficit data due out in September will “not be pretty,” Luchnikava said.

The second major factor is governance. India’s democracy is famously sclerotic and bound by bureaucracy, making it difficult to enact much-needed reforms or build the necessary infrastructure.

“The fall of the rupee is a vote of no confidence for financial reforms now or any point in the coming few years,” said Jonah Blank, an analyst at RAND and former Policy Director for South & Southeast Asia on the Senate Foreign Relations Committee.

“A lot of the pullout [by foreign investors] goes to politics. There will be no improvements until the 2014 elections,” he said Blank. The current government is weak and often ineffectual (see last year’s failed response to a huge blackout).

“Investors see most responses as being temporary,” explains Luchnikava, as elections (most likely in May of 2014) leave the current government with little leeway to do anything significant.

In perhaps the most relevant sign of a government with few options, Finance Minister P Chidambaram reportedly came out with a 10-point plan to kickstart India’s economy by increasing exports, pushing for manufacturing and cutting the deficit (with a magic wand). “There has been no consistency in the policies of the government and the central bank,” says Luchnikava. The government thinks the central bank is too conservative while the bank thinks the government isn’t serious about structural reforms.

There’s an irony at work here. The rupee is falling in part because foreign investors have decided this is a bad time to be investing in India. But the weak rupee, which makes a dollar go much farther in Mumbai than it did just a few months ago, means it is a great time for tourists to be booking a passage to India.