The Hindu Business Line : Power of currencies

Weekend is when friends from the western world call you. One of my very close friends from Canada had called me over this weekend. I usually discuss weather with him in this part of the year.

This time, it was different. He was discussing gas (petrol) prices and currencies. He lives in a Canadian town on the Canada-US border, from where Canadian citizens can cross over by car to the US in a very short time. The formalities do not take much time too, except for the long queues once in a while.

Since he was driving, I asked him where he was heading. He replied, “I am going to US (border town) to buy my weekly groceries, fill up gas in my car, buy a present for my wife, etc.” I was taken aback. “Cross country grocery shopping”. He goes on, “the Canadian dollar vis-À-vis the US dollar has appreciated by 28 per cent; so it is cheaper to go to the US and stock your weekly supplies, gas, and so on.” I asked, “Would you go to the US for buying a loaf of bread too?” He said “Yes, it might be cheaper.”

Vacation plans

In London, Christmas and New Year are when people take time off from work and do a lot of travelling to nearby tourist locations around the UK and Europe. This time when I spoke to my friends in London, most of them were planning a trip to New York, US. “No visa necessary, seven-eight hours flight and, most important, the British pound is at an all-time high, everything is suddenly cheaper.”

That is the power of changes in the currency values in open economies, especially the dollar. It can influence the day-to-day decision-making of the common man and for the economy, including moving people from one country (of stronger currency) to another (with weaker currencies). In 2007, the US dollar has depreciated rapidly against the euro, British pound and the Canadian dollar by 11.2 per cent, 7.2 per cent and 28.3 per cent respectively. But for the RBIs intervention (buying dollar), the Indian rupee could have appreciated more than 12 per cent, which it has. What can currency (rupee) movements do to you and me, and the economy?

Currency appreciation

When the rupee appreciates, anyone paying in dollars but draws his balance-sheet in rupees would benefit by paying lesser rupees. And anyone receiving in USD, but drawing his balance-sheet in rupees would lose in the form of receiving lesser rupees. With the rupee rallying sharply, it would be interesting to discuss its appreciation. Probably, the most important impact of a currency appreciation is that it makes whatever India imports, cheaper in rupee terms. For instance, crude oil should be cheaper. If the government does not change import tariffs and prices are stable abroad, everything imported in dollar terms would be cheaper by 12 per cent. The economy will reap the benefits of cheaper imports of raw materials, capital goods and advanced technology.

If the currency appreciation is due to better economic fundamentals, Indian corporates can get cheaper finance at lower interest rates abroad. The rupee appreciation is usually associated with lower interest rates, thus facilitating economic growth. Consumers get to finance houses, durables, cars, and so on, at lower rates.

An appreciating currency also helps to attract FII flows (now in the Indian context) since it adds to the dollar return which, in turn, pushes up asset prices creating positive wealth effects. An appreciating currency also mitigates inflation to the extent it emanates from global factors (‘imported inflation’), especially from commodities.

Relying on exports

Savvy investors can buy more dollar-denominated shares in the $2-lakh scheme. An appreciating currency exposes the domestic industry to competition from foreign goods. On the flip side, exporters and other entities invoicing in dollars lose heavily when the rupee appreciates, since the realisations fall.

Exports become uncompetitive when the rupee appreciates more than its competitor’s currency. The impact is more severe when the country relies on exports to drive economic growth. India relies less. This could have an adverse second effect on employment, wages and investment in economy.

Export subsidies have fiscal implications too. Currencies have the capacity to influence the day-to-day life of a common man as well as the economy, more when they are fully convertible and the country concerned is globally integrated. Nevertheless, enjoy your holidays by planning a trip abroad as long as the rupee shines.

(The author is CEO and CIO, Quantum Asset Management.)

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