NRIs have been hit hard by the appreciating rupee. Here is the first part of a three part series on what the appreciating rupee means for them. Investing tips for beginners
By Akhilesh Tilotia & Ramganesh Iyer
There are many reasons that lead a person out of his country. For the last many decades, one of the strongest was the possibility of leading a much better life economically, outside the shores of India. This was driven by a weak Indian economic growth and job situation, compared to the rest of the world.
There was another big reason for this strategy of working outside to be attractive. The exchange rate of the rupee was very weak compared to its purchasing power; so a lot of NRIs would profitably earn in US dollars or dirhams and send money back to India. Either their families would live in India, or they would return a few years later, and have a sizable chunk of accumulated wealth to spend in India.
For instance, take the case of Rahul, who earns $100,000 per year in New York (say $65,000 after tax). Given New York’s cost of living, his lifestyle would be comparable to a person earning Rs 12 lakh in India. This is because the purchasing power of the Dollar would be Rs 10-12 for most households.
However, if he could even save $20,000 annually out of this, he would have a wealth of nearly Rs. 40-50 lakh to bring back to India in five years’ time at the current exchange rate! A savings that he is unlikely to be able to build up in India in a similar time-frame.
The exchange rate
At the core of this entire example is the exchange rate between the Indian Rupee and the local currency of the NRI’s place of residence. We saw above the disparity between the purchasing power vis-a-vis the prevailing exchange rates. What decides these exchange rates?
The price of the currency of any country is a complex variable, driven mainly by:
▪ Relative size of imports and exports from that country; or what is called the current account balance
▪ Capital flows (i.e. foreigners investing in India or vice versa, NRI remittances, etc) – that depends upon the expectations of growth in India vis-à-vis other countries
▪ Policies of the Reserve Bank of India – it often intervenes periodically to stabilize / weaken the Rupee and keep Indian exports competitive
This last is particularly important in the Indian context since the RBI has closely controlled exchange rates in the past, and continues to do so today to some extent.
Given the nature of movement of the Indian currency as described above, foreign exchange experts classified India as a low-volatility currency, which means that the value of the currency does not swing by much. However, they always worried about, and priced in, what is called the “jump-risk”. Indian rupee is known to be jumpy, and mostly that is due to sudden economic decisions by the government.
In 1991, the Indian rupee was allowed to be devalued in two large tranches to a total of 18%, through a government diktat. Similarly, now, the Reserve Bank of India (RBI, India’s central bank) decided that it can live with a higher value of the Indian rupee, and allowed it to appreciate
Since the RBI is the largest player in the currency market, whatever price the RBI decides, the Indian rupee settles at pretty much that price. Since the market for the Indian currency is dominated by the presence of RBI – and is expected to remain so, Rupee is expected to remain jumpy, even going forward into the future.
What is different now?
Earlier the jump-risk of the Indian rupee was typically one-way: downwards. Invariably, the rupee would weaken against the dollar. The government would allow this to happen because it helped the exporters, who would then generate jobs in India. Thus, most NRIs would keep their money in foreign currency or FCNR deposits – the low yield on these deposits would be more than made up by a continually falling Rupee, thereby making the Rupee wealth of NRIs grow with time.
Now, however, the situation has altered. The Indian economy is going strong and India is sitting on large foreign exchange reserves (> $250 billion). Now, the government and the central bank can let the currency appreciate. Given that India is now more linked globally than at any other time in its recent history, the impact on the value of its currency is that it is buffeted by international trends also.
In effect, while the Indian currency is expected to remain jumpy, the direction of the jump cannot be predicted accurately.
Is the currency market unique?
The question that now arises is whether the currency market is unique in being jumpy? If yes, then we need to craft a strategy that is unique for the currency markets. If not, then surely, the learnings from the other markets can be applied to situations in the currency markets.
Let us take the case of equity markets. On any given trading day, the market moves within a narrow range, say within +/- 0.5% of its value. However, there are some days – which are few and far-between – when the market moves by a large amount, say +/- 2-4%. It is almost entirely impossible to predict upfront when such large-movement days will come. Similar is the case in other markets, for example, commodities.
For those who are inclined technically, this is called the “fat-tail” risk. Or for those, who are fans of Taleb, these days and events are “black swans”. Such events a) do come and b) come suddenly! Given the relative infrequency of their occurrence, we ascribe little importance to their happening, but when the events do happen, they have potentially much wider implications.
So what should I do?
Interestingly, now there is a cacophony of opinions on the direction of the Indian rupee. While there are analysts who predict that the rupee will go all the way up to 35 against the US dollar over the next few years (some experts predict Rs 28 over a decade!), there are others who are not so sure about the continued appreciation of the Indian rupee. The majority view is that, given the strength of the Indian economy and the recognition of the same the world over, the Rupee would appreciate in the medium-to-long term; the rate of course being uncertain.
As we will see in the next article, there are many ways to protect yourself against, and possibly profit from, the jumpy movement of your foreign exchange exposure.
By Akhilesh Tilotia & Ramganesh Iyer
CFP(CM) & IIM, Ahmedabad, Park Financial Advisors