Rupee against emerging market currencies

One common argument by experts who claim that there is nothing to be worried about the decline and fall of the Indian Rupee in recent times is that the Indian Rupee is not the only currency that is falling, and that other emerging market currencies are also falling equally badly. In order to test this out, we will look at the movement of the rupee as a function of other so-called “emerging market” currencies.

I’m just going to offer the graphs here (of movements of various currencies against the rupee) without any comment. All graphs are of the form “how many units of foreign currency does it take to buy a rupee”. So the higher this graph, the higher the level of the rupee compared to this particular foreign currency. And it is on purpose that I’ve drawn all charts starting from Jan 1st 2008, so that the US financial crisis is also captured.

Data for all charts is taken from oanda and charted using quantmod for R.




Arbit Raj

Email alarm made government close arbitrage window“, screams the headline in this morning’s Business Standard. Upon reading further, you will find that the said “arbitrage” opportunity in question consists of remitting rupees abroad now and then bringing it back as remittances once the rupee has depreciated further. There are so many things wrong with this approach that I can hardly get started.

1. Technically speaking, arbitrage refers to a situation where through a set of trades one can make riskless profit. The riskless point is important here. If I were to convert my rupees to dollars today and then convert the dollars back to rupees later, it would be arbitrage if and only if the price at which I would sell the dollars is guaranteed (as of today) to be higher than the price at which I buy dollars. If I buy dollars today in the hope that the rupee will depreciate, it is NOT arbitrage.

2. By calling this process “arbitrage” the government is admitting that the rupee is expected to drop further, and significantly in the coming months (the extent of capital controls being imposed now suggests this). This is bad signaling

3. Regulating arbitrageurs is futile, and can be counterproductive. Arbitrageurs are quick to spot any price inconsistencies in the market and ruthlessly exploit them by means of their trades. Thus, if it is expected that (say) the USDINR will trade at 65 tomorrow, it is arbitrageurs who make sure that this expectation is reflected in today’s price (through a set of spot-future currency trades). By trying to curtail the operations of arbitrageurs, the government is missing out on valuable price signals. In other words, they are beheading the messenger (a la the Khwarizmian Shah, and everyone knows what happened to his empire once he did that).

The measures the government has been taking in recent times to help prevent further depreciation of the rupee are so ad hoc and badly thought out that it would make eminent sense to call the current dispensation an “arbit raj”.

What should we do about the falling rupee?

So the more perceptive of you would have realized that the rupee is falling. And fast. At the beginning of the year, fifty four rupees bought a dollar. Now you need over sixty rupees. That’s a fall of over ten percent in half a year.

People argue based on differences in interest rates and interest levels between India and the United States, and India’s current account deficit, that the rupee deserves to depreciate. Some argue that the rupee should actually trade even lower. That is correct. What makes the fall of the rupee worrying, however, is that it has happened so quickly. No theories on trade imbalance or rates imbalance or inflation can account for the fall of ten per cent in half a year.

The issue, of course as everyone knows, is to do with capital flows. While India has run a persistent current account deficit, the continuous inflow of foreign investment into the Indian markets (either direct or indirect) had ensured that the rupee was relatively stable over the years. With India maintaining a high growth rate in the GDP over the noughties, the inflow was persistent. Things aren’t so good now, however.

India’s GDP is slated to increase at a paltry 5% this financial year. The growth story is seemingly over. And that is not all. Things aren’t looking great in other parts of the world also. Due to this concept of margin financing, sometimes when some of your holdings lose value, you are forced to liquidate other holdings in order to comply with “margin requirements” (we will not go into the technical details here). So with markets around the world not doing great, and India’s growth not as spectacular as it used to be, and with the country’s muddled policies (check out how difficult the government has actually made it to invest in India – irrespective of your nationality), investors started exiting. With some investors exiting, asset values dropped and the rupee dropped. Consequently other investors exited. And so forth. It did not help that there was nothing inherent in India’s government policies to hold them here.

So that’s the story so far. Question is what we should do going forward. As I mentioned earlier, there are two levers that can help shore up the rupee – the capital account and the current account. Within the current account there are two components – imports and exports. What normally happens when a currency depreciates is that exports become more competitive and go up further. Imports become costlier and thus reduce. On the current account front, thus, we have what is called as “negative feedback”.

Notice that in the past whenever an economy staged a recovery, it was generally preceded by a devaluation of the local currency. So since our currency is already devalued the stage is set for recovery, right? Unfortunately it’s not so simple. While it is true that our exports are now likely to be more competitive, fact is that Indian industry is not well placed to capitalize on that. Investment bottlenecks, labour laws and bureaucracy means our entrepreneurs haven’t been able to move fast enough to take advantage of the falling rupee and up exports. This can be borne in the fact that the Reserve Bank of India, which normally shies away from controlling exchange rates (as long as they are not too volatile), has issued several public statements on this matter in the recent past, and taken steps to prevent further fall in the currency levels. That the Central Bank has had to step in to protect the currency shows that we are in extraordinary times. The natural corrector to a falling exchange rate (increase in exports) is absent.

Matters are not helped, of course, by the fact that one of our largest imports is an asset – gold. Thing with asset prices is that unlike prices of “normal goods”, the demand for assets increases with price. When asset prices increase, people see “momentum” in the asset and want to get on to the bandwagon. So there goes part of another natural corrector to a falling exchange rate (less competitive imports).

So coming back to where we started off with – what should the Government do? While this is going to be a time-consuming process, what the government needs to do is to ensure that exporters can exploit the falling rupee. Reforms in this direction are not easy of course – since they require significant efforts in removing bureaucracy and making it easier to do business – which means we need significant administrative reform. There is also the small matter of possibly having to reform labour laws (while on the matter of labour laws, check out this paper by Takshashila Scholar Hemal Shah, who presents some easily implementable reforms in the labour law). While these are difficult things to implement, the fact that there is a crisis gives the government an alibi to push ahead with the reforms. PV Narasimha Rao had done that once in 1991. The problem now is that the government may not have political will given that elections are less than a year away. In this context, it would be advantageous to have early elections, for a new government with a fresh mandate might be more prone to taking tough short-term measures.

Currently, the government is trying its best to shore up on the other levers. Gold import is being curbed – except that it will be hard to implement since they will simply get diverted to the black market. The Finance Minister is traveling the world putting up a roadshow to get investments to India. That, however, is akin to putting lipstick on a pig since there is little in India’s fundamentals and current economic scenario to attract foreign investors. Even if some of these measures succeed, they will only lead to temporary respite to the currency. Fact is that for sustainable improvement in currency, tough reforms are mandatory.

Free float and rupee volatility

Following a brief discussion on twitter with @deepakshenoy I’m wondering what’s preventing the RBI from making the rupee fully convertible. The usual argument for full convertibility is that it will make the exchange rates volatile. My argument is that exchange rates are already so volatile that the additional volatility that could stem out of a free float is marginal, and a small price to pay.

The wise men at RBI, though, might argue the precise opposite. They will claim that in terms of already high volatility they wouldn’t want to do anything that might add to volatility, however marginally. This is a constant battle I faced in my last job, of delta improvements. I would frequently argued that when something was already high, making it delta higher was not so bad. I would argue in terms of making systemic changes that would reduce drastically the already high number, rather than focusing on the deltas.

Coming back to the rupee, you can also imagine the wise men talking about some stuff about black money and hawala money and all that. The thing with making the rupee fully convertible would be that hawala would be fully legal now, and the illegal practice would cease to exist. And when something becomes legalized it comes back to the mainstream rather than remaining on the margins, and that is always a good thing.

Then you can expect some strategic affairs experts to bring some national sovereignty and national security argument there. There will be people who will talk about the increase in counterfeit money (since it’ll become easier to “smuggle” rupees into India then), and about how foreign governments might pose a threat to India’s security by manipulating the rupee (who says that threat doesn’t already exist?)!

I don’t know. I don’t find any of these anti-full-convertibility arguments compelling. If we do adopt full convertibility, though, we can at least pay Iran for the oil we get from them, and that might for all you know help tackle inflation. I don’t, however, expect the RBI to act on this.

Letting the rupee float

I’m midway through Shankar Acharya’s Op-Ed in today’s Business Standard, and I realize that along with the interest rate, the exchange rate (USD/INR) is another instrument that the RBI could possibly use in order to control money supply and the level of economic activity in India. Let me explain.

Given that mad growth in petroleum prices have been fundamental to growth in inflation, and that high petroleum prices also impact the oil marketing companies and the government negatively, and that we import most of our petroleum needs, letting the rupee rise above its current level is a mechanism of reining in “realized petroleum prices”. If we were to let the rupee rise, inflation would get tamed (due to imports becoming cheaper), the government’s fiscal deficit would come down (subsidy will be reduced), but exporters will get shoved, and that can depress economic activity in the country. So letting the rupee rise is similar to increasing interest rates.

There are people who question whether the RBI should be controlling exchange rates at all, and wonder if it would be better if it were to float freely. I’ve also taken that view on several occasions in the past, but now that I think of it, there are liquidity concerns. USD/INR, EUR/INR, GBP/INR, etc. have no way near the kind of liquidity that exchange rates between two “developed currencies” (USD/EUR or USD/JPY) have. In other words, the amount of trade that happens in USD/INR is much lower than that of say USD/JPY.

Given this lack of liquidity, if let to float fully, there is a danger that the USD/INR rates can fluctuate wildly. Higher volatility in rates means higher hedging costs for both exporters and importers, and given that our foreign trade is fairly high, a wildly fluctuating exchange rate does no good in policy formulation. From this point of view, it is important that short-term volatility in the exchange rates is curbed, and to that extent I support the RBI’s decision to intervene in the FX markets.

However, if there is a sustained pressure on either side  (say the exchange rate trades for a sustained period at the edge of the “band” that the RBI is allowing the rupee to float in), the RBI should buckle and shift their bands, and let the markets have their way. While short-term volatility is not great, distorting market signals is worse.

An analogy that comes to mind is circuit breakers in the Indian stock market. Earlier, these circuit breakers were in place for all stocks (basically, they dictate that if the stock price fluctuates by more than a certain amount in a certain time period, trading in the stock will be halted for a certain amount of time). However, recent regulations have removed these circuit breakers for stocks on which derivatives are traded, which are the more liquid stocks. The circuit breakers, however, are still in place for the less liquid stocks

It’s a similar story in the FX markets. Given that USD/INR is still not too liquid (in terms of volumes), it is important that we have circuit breakers (i.e. RBI intervention). Once it reaches a certain “critical mass” (in terms of volumes ), however, the RBI can step away and let the rupee float.

(I haven’t looked at any data while writing this. All judgments are based on my perception of how certain numbers shape up)


o!!! (super) is indeed a super movie. It is so awesome in so many different dimensions, that it’s hard to capture it all in one post. I guess in this post I’ll simply stick to the economic aspect of the movie.

So basically the premise is that in 2030 India is the most powerful country in the world. Bangalore is clean and green, with whites working as chauffeurs and sweepers, with 70 pounds to the rupee, and so forth. The movie is a fairly elaborate nested story about how this transformation is brought about.  (rest of post under the fold. spoilers are there)

Continue reading “o!!!”

Gift List

So over the last few days there have been several people who have met or called me and asked what gift Pinky and I want for our wedding. Hari the kid, one such caller, even suggested that we need to make a wedding wish list and put it up on our wedding website or something.

Now the thing is that gifting is a hard business. Economic research shows that the average value to the gifted is much less than the average cost to the gifter, and thus gifts create a dead weight economic loss. This, however, is compensated by the good will that the gifter earns from the gifted (if it is a good gift, that is).

When the potential gifter asks the gifted what he/she wants, the intangible value (value of a pleasant surprise minus value of unpleasant surprise, appropriately weighted by respective probabilities) is substituted by the tangible value of greater value for the gifted per rupee spent by the gifter. Also, the fact that the gifter cared to ask what the gifted wanted goes some way in compensating for the intangible value.

Anyway the question is if we should put up a gift wish list on our website. Now, one problem with that is that people might perceive us to be arrogant. After all, in this era of “no gifts/bouquets please ” (we haven’t put that on our invite cards) people might get offended at our audacity of not just asking for gifts, but also telling people what to give us. Thus there is reputational risk involved, but we can explain on the same page the collective economic benefits of the wish list, so this might be taken care of.

The bigger problem is that if we were to put up a gift list the onus is on us to come up with a list of things that we want. We need to come up with a range of things such that it fits people’s varying budgets. There should be something in the list for someone who is willing to spend a hundred rupees on our gift, and also something for someone who is willing to spend ten thousand.  So in the middle of all the other wedding work for us, we also need to decide on what we want, what we don’t want, what kind of stuff we want, and so on.

Then there is quality control. We could well put up on the wish list that we want a LCD TV, but it would sure sound too audacious to be much more specific than that. And if the gifters were to get us some LCD TV that we would ultimately end up not liking, the dead weight economic loss to all of us is huge. So we need to be specific without being arrogant, which is even more work for us.

But I think we will end up making all the effort and put up a wish list, and hopefully that will improve the collective economic condition of us and our gifters.

On Large and Small Books

During my last binge at Landmark, I saw a book which I thought I’d like. It was priced at some six hundred rupees – a full fifty percent premium over what I’m usually willing to pay for a book – and was quite thick. My first thought was “ok on a pages-per-rupee basis, this seems to be doing quite well so I should buy it”. Then I had  second thoughts.

The question is – should you look at the size of a book as an advantage or as a disadvantage? I think the normal viewpoint (as reflected by my instinct) treats pages as assets. There might be historical backing for this. When books were read for timepass, the amount of value (the time that could be passed) that could be gleaned from the book would be proportional to the number of pages in the book. If the language was difficult to read, then even better – for now it allows one to pass even more time reading the book.

However, when one comes to “funda  books”, this argument fails spectacularly. When you read funda books, you don’t read to pass time. You read books in order to get fundaes. And once this happens, volume becomes not a benefit but a cost. When you are reading a book for the fundaes, then you are effectively paying two costs – one is the rupee cost of the book and the other is the time COST. The time that you spend reading the book now becomes a cost. And when time is a cost, then more pages need not be a benefit.

Unfortunately, when you are at the bookstore trying to make a decision about whether to buy a book, there is no way you can figure out how much of fundaes the book is likely to offer. It would have helped if you have read some reviews, which will allow you to make an informed decision. If you haven’t, then hard luck. Now, if you have no clue about that book that you have in your hand, and you need to make a decision on whether to buy it, then I won’t blame you for making your decision based on the thickness.

The unfortunate consequence of this is useless padding up of books. Authors and publishers know that a large section of the readers are likely to judge books based on their size. And they make things voluminous. They take 40 pages to tell stories that could’ve been written in 4. They end up saying the same thing time and again, just to increase the number of pages. And overall, end up boring the reader and lowering the net value added by their book.

So you have ideas which could have been communicated in a few blog posts developing into a book – after all, no one wouuld be willing to pay the same amount of money for a 20 page book as they would for a 200 page book right? even if it were to offer comparable amount of fundaes?

I don’t really know if there is a simple solution to this problem. Solving this would involve effecting a major shift in consumer behaviour. It is unlikely that blogging and online publication would become profitable, else we might have expected the disruption to come from there. Still, you can never say. All we can do is to wait and hope. And read reviews before choosing books.

PS: online purchase of books (via Amazon, etc.) might help mitigate this problem a little since you don’t really feel a book when you decide to buy it, and you have reviews available instantly. Nevertheless, I’m sure most buyers would be subsconsciously using the “number of pages” field while making their purchase decision.

PS2: I should make my blog posts less verbose

What rate of interest did Kubera charge?

It is fairly well established that Tirupati Venkataramana (it is Venkataramana and not Venkateshwara – remember that it is a Vaishnavite temple) took a loan from Kubera in order to finance his wedding to Padmavati. And till date, Venkatarmana has been soliciting contributions from visitors to his shrine in order to help him pay off this loan. Given that the loan was for the purpose of getting married, I think we can quickly establish that it was a Personal Loan. What I’m trying to figure out, however, is what rate of interst did Kubera charge Venkataramana.

For starters, I think somewhere in our scriptures, we can find out the amount that Venkataramana borrowed. Rupees didn’t exist in that era, but I’m sure we can find some figures in terms of gold, or other commodities. And we should be able to estimate the rupee value of this loan by suitable backward extrapolation.

What might be slightly tougher is the time period. When did Kubera exist? When did Venkataramana exist? When did he get married to Padmavati? The date is important, for we should know how many years to discount for when we do the IRR calculations. However, I’m sure that with sufficient effort, we should be able to find the date of this particular transaction to the nearest millenium.

Then, there are the loan repayments. Let us assume that Venkataramana is in general a poor man, and his repayments can be approximated to the amount of offerings he receives from visitors to his shrine. Catch a few people sitting for McKinsey interviews, and estimating this amount is also not going to be very tough. We should be able to get fairly accurate figures for the last few years, and then we should be able to appropriately extrapolate backwards accounting for various regime changes (I’m assuming here that the temple, for whatever reason, will refuse to cooperate in this noble endeavour – else we can get the repayment amounts from the temple books).

We also need to remember that the repayment is not complete. People still contribute generously to the Venkataramana Personal Loan Repayment Fund. However, if we assume that the loan has already been repaid, we can get a floor on the rate of interest that Kubera charged. It is intuitive right – that if more money pours in, the interest rate would’ve been higher? Let us also assume that there were no repayments till about five hundred years ago, which was approximately when the temple was built. Assuming zero repayments till then, it again gives a floor on the interest rate.

Obviously, I don’t already have any of the data that I’ve mentioned here, so I can’t actually do the calculations. However, if McKinsey decides to solve this problem, they can do so in March during their interviews at IIMs. My prediction, however, is that the rate of interest will come out to be a number which, in normal circumstances, would be found to be usurious. Thus, we might probably be able to show that people are contributing to funding a greedy usurious rich moneylender when they contribute to the Venkataramana Personal Loan Repayment Fund. I don’t know what further use this might be put to, but I think the process will be an end in itself.

On a closing note, I would like to point out the greatness of our culture – which, even in mythological times, could boast of complicated financial products such as Personal Loans. This one factor, I think, is enough to show that our Indian culture is superior to all other cultures.

PS:  Sometime back, I was wondering if the Venkataramana Personal Loan Repayment Fund could be the largest money-laundering operation in India. However, a little thinking revealed that our political parties are definitely far far ahead when it comes to that.