Daniel Altman: New boy Raghuram Rajan has his work cut out as rupee nosedives

Economic View: The RBI is much less protected from political meddling than the Federal Reserve or European Central Bank

How the mighty have fallen. Look where the supposedly world-beating Bric countries are today: Brazil is mired in protests, China's growth is slowing, Russia is addicted to self-destructive spy games, and India's currency is at an all-time low.

Of the four, India has by far the brightest prospects for growth ahead, so why has the rupee taken such a dip?

Even though China is growing faster right now, India has many more years of rapid expansion ahead simply because it hasn't urbanised or adopted new technologies to the same extent.

You'd think that foreign investors would be desperate to get in on the ground floor of this long-term boom, but naturally they're somewhat more fickle – and definitely less patient – than that.

And since the value of the rupee in global markets depends on their demand as well as its supply, you have to consider both to understand what's happening.

On the demand side, the key is to think about why people might want to exchange other currencies for rupees. Buying anything from India – goods, services, financial assets – can require rupees.

When demand for any of these things rises, so does demand for rupees.

Of course, when the rupee gains value, anything bought with rupees becomes more expensive for foreigners, so demand may equilibrate on its own.

That hasn't happened yet for Indian assets. In April 2011, the International Monetary Fund forecast that the country's economy would grow by a total of 37 per cent from 2013 through 2016. The fund's latest prediction, updated last month from the April 2013 figures, is for growth in India of just 28 per cent in the same, four- year period.

It goes without saying that less potential for growth means less interest from foreign investors.

At the same time as India's growth forecasts were falling, other markets were becoming significantly more attractive.

A few years ago, investors frustrated with the slow recoveries in established markets might have taken a risk in India.

Now, with a backdrop of somewhat greater stability, investors are returning to the advanced economies to hunt for bargains and ride the cresting wave.

Not surprisingly, credit is tougher to come by in India; the yield on its government bonds has hit a five- year high. The jump in bond yields may also have to do with expectations for inflation, which is another concern in India.

As prices climb, the value of the rupee in real terms falls, and investors won't give up as much of their own currencies to buy it.

Consumer prices rose by only 3.8 per cent in 2004, but the rate quickened in every subsequent year through to 2010, when it hit 12 per cent, one of the highest in the world.

With inflation still at 9.3 per cent last year and possibly higher in 2013, the new governor of the Reserve Bank of India (RBI), Raghuram Rajan, has his work cut out for him. His job is to decide the supply of rupees, and by slowing the printing presses he could stem inflation.

Yet by curtailing access to credit even further, Mr Rajan could also cool the economy, and not at a good time.

India's leaders are already starting to worry about next year's elections, and the RBI is much less protected from political meddling than the Federal Reserve or European Central Bank.

That said, there is certainly room for improvement on the supply side. Between July 2011 and July 2013, the Indian money supply increased by about 29 per cent.

During the same period, the value of India's gross domestic product in rupees probably increased by about 27 per cent.

In other words, the RBI let the money supply expand by more than the amount necessary to cover inflation and economic growth; the extra rupees dumped into the economy were just more fuel for the inflationary fire. The bank may have made the money available to help foreigners purchase Indian assets, but by cheapening the rupee it may actually have driven them away.

In the longer term, the rupee should be able to tolerate moderate inflation without losing more of its value.

The productivity of Indian workers is indeed increasing as the country urbanises and adopts new technologies. Wages will rise, and so will prices.

With a higher price level, anyone selling a unit of Indian stuff will receive more rupees for it.

Barring a big change in the exchange rate, more rupees will buy more foreign currency, and more foreign currency will buy more foreign stuff.

None of this would necessarily preclude equilibrium in the supply and demand for rupees.

So what's the endgame here? As long as the RBI doesn't start printing rupees like there's no tomorrow –and with Mr Rajan in charge it almost certainly won't – the currency's freefall will be temporary.

At some point, Indian assets, goods and services will seem cheap, and buyers will return.

But for that to happen, the currency markets must be left to their own devices.

The pre-Rajan RBI has moved in the opposite direction by limiting Indians' ability to sell rupees, which investors will interpret as a last-ditch effort to maintain the currency's value at an artificially high level.

In Argentina, similar measures recently led to a black market in pesos and further undermined confidence in the country's economic policies.

For Mr Rajan, reversing course will be job one.

Daniel Altman teaches economics at New York University's Stern School of Business and is chief economist of Big Think

Start your day with The Independent, sign up for daily news emails
PROMOTED VIDEO
ebooks
ebooksA special investigation by Andy McSmith
Arts and Entertainment
This weekend's 'Big Hero 6' by Disney Animation Studios
arts + ents
News
i100
News
Budapest, 1989. Sleepware and panties.
newsDavid Hlynsky's images of Soviet Union shop windows shine a light on our consumerist culture
Arts and Entertainment
Eleanor Catton has hit back after being accused of 'treachery' for criticising the government.
books
News
In humans, the ability to regulate the expression of genes through thoughts alone could open up an entirely new avenue for medicine.
science
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Software Development Manager

£40000 - £50000 per annum: Recruitment Genius: This is an exciting opportunity...

Ashdown Group: Product Manager - (Product Marketing, Financial Services)

£30000 - £35000 per annum + Benefits: Ashdown Group: Marketing Manager - Marke...

Recruitment Genius: Compliance Assistant

£13000 per annum: Recruitment Genius: This Pension Specialist was established ...

Ashdown Group: Market Research Executive

£23000 - £26000 per annum + Benefits: Ashdown Group: Market Research Executive...

Day In a Page

Isis hostage crisis: The prisoner swap has only one purpose for the militants - recognition its Islamic State exists and that foreign nations acknowledge its power

Isis hostage crisis

The prisoner swap has only one purpose for the militants - recognition its Islamic State exists and that foreign nations acknowledge its power, says Robert Fisk
Missing salvage expert who found $50m of sunken treasure before disappearing, tracked down at last

The runaway buccaneers and the ship full of gold

Salvage expert Tommy Thompson found sunken treasure worth millions. Then he vanished... until now
Homeless Veterans appeal: ‘If you’re hard on the world you are hard on yourself’

Homeless Veterans appeal: ‘If you’re hard on the world you are hard on yourself’

Maverick artist Grayson Perry backs our campaign
Assisted Dying Bill: I want to be able to decide about my own death - I want to have control of my life

Assisted Dying Bill: 'I want control of my life'

This week the Assisted Dying Bill is debated in the Lords. Virginia Ironside, who has already made plans for her own self-deliverance, argues that it's time we allowed people a humane, compassionate death
Move over, kale - cabbage is the new rising star

Cabbage is king again

Sophie Morris banishes thoughts of soggy school dinners and turns over a new leaf
11 best winter skin treats

Give your moisturiser a helping hand: 11 best winter skin treats

Get an extra boost of nourishment from one of these hard-working products
Paul Scholes column: The more Jose Mourinho attempts to influence match officials, the more they are likely to ignore him

Paul Scholes column

The more Jose Mourinho attempts to influence match officials, the more they are likely to ignore him
Frank Warren column: No cigar, but pots of money: here come the Cubans

Frank Warren's Ringside

No cigar, but pots of money: here come the Cubans
Isis hostage crisis: Militant group stands strong as its numerous enemies fail to find a common plan to defeat it

Isis stands strong as its numerous enemies fail to find a common plan to defeat it

The jihadis are being squeezed militarily and economically, but there is no sign of an implosion, says Patrick Cockburn
Virtual reality thrusts viewers into the frontline of global events - and puts film-goers at the heart of the action

Virtual reality: Seeing is believing

Virtual reality thrusts viewers into the frontline of global events - and puts film-goers at the heart of the action
Homeless Veterans appeal: MP says Coalition ‘not doing enough’

Homeless Veterans appeal

MP says Coalition ‘not doing enough’ to help
Larry David, Steve Coogan and other comedians share stories of depression in new documentary

Comedians share stories of depression

The director of the new documentary, Kevin Pollak, tells Jessica Barrett how he got them to talk
Has The Archers lost the plot with it's spicy storylines?

Has The Archers lost the plot?

A growing number of listeners are voicing their discontent over the rural soap's spicy storylines; so loudly that even the BBC's director-general seems worried, says Simon Kelner
English Heritage adds 14 post-war office buildings to its protected lists

14 office buildings added to protected lists

Christopher Beanland explores the underrated appeal of these palaces of pen-pushing
Human skull discovery in Israel proves humans lived side-by-side with Neanderthals

Human skull discovery in Israel proves humans lived side-by-side with Neanderthals

Scientists unearthed the cranial fragments from Manot Cave in West Galilee