Falling Currency Exchange Rates

The Big-Mac index, an index developed by The Economist, tracks the cost of the Big-Mac across nations and idealizes that the purchasing power parity across the globe, since the cost for the same item should be the same anywhere in the world. The most recent index shows that the cost of a $4.56 big-mac in the US is $1.50 in India. This figure is broadly in line with prices for most commodities in the developed world when compared to that in India, be it house rents, prices of groceries, stipends paid to interns, etc which vary by a factor of 3 in the US to that in India.

My interest in this difference arises because the value of $1.50 (~Rs. 90) in India is equal to the value of $4.56 in the US. In other words, the true exchange rate between the rupee to the dollar should be Rs. 90/$4.56 or Rs. 19.73 to a dollar, as compared to the current “free market” trading value of ~Rs. 59. This is of tremendous importance, when it comes to the value of the dollar in India and similarly the rupee in the US. A parent sending her child to the US for a “world-class” education is paying approximately 3 times more than the value the education has been deemed. On similar lines, a tourist to India from the US gets three times more for the money she has saved up for her travels. In more real terms, I am paying three times more for gas in India than I should be paying.

But if we are trading in a “free-market”, shouldn’t the currency value reach an equilibrium where we only pay as much for a dollar as it is worth. The US hegemony over the world is through its currency being the “most trusted” currency, and hence the universal currency for all trades. When an Indian buys oil (our major import) from the OPEC, we need to pay for it in dollars. Not rupees, or dinars. And thus, since we are slaves to our oil requirements and we become slaves to the inflow of dollars into our country. And this increased demand for dollars results in US investors getting three times more for their money in India than it is worth. How can the local kirana store compete with Walmart, when the balances are already tipped in their favour, both because of the size of its investment and the fact that Walmart’s investment takes it three times further in India. Protectionism is essential if any indigenous industry is to thrive. I hope I am not the only one who smells a hint of currency driven imperialism and shades of the East India Company.

Perhaps the only shining beacon in this tale of misery are services industry in the form of companies such as Infosys, Wipro, TCS, etc. They used this gradient in currency rates to undercut IT services around the world, and helped set up huge hubs of technology in India. It created a void for engineers which is now being filled by the youth and has helped increase the wealth of India as a nation. China, by providing cheaper rates so that large chunks of the world’s manufacturing takes places on its southern shores, increased its wealth and contributed to events such as Detroit declaring bankruptcy.

It indeed pays to be rich in America. Your money earns 3 times in slave countries such as India and other developing nations. Successful western companies by analogy would find it easier to expand in the world as compared to their eastern counterparts. But in times like these, it certainly doesn’t pay to be poor in America, with jobs being exported and profit margins thereby increasing. When Obama speaks of protectionism for the American worker, he has completely misread the problem, that of a universal currency shortage, which also by sheer coincidence, the US Dollar.

(More analysis on this shall follow along with solutions.)

3 thoughts on “Falling Currency Exchange Rates

  1. Interesting perspective. The 19 INR to an USD that you calculate represents the theoretical maximum exchange rate. The above rate is the “equilibrium” rate that matches supply with demand if the only demand for USD came only from domestic consumers in India under the argument “Like costs like in a free interconnected global market”.

    In reality domestic Indian consumers do not influence market forces that determine the “true exchange rate”. This is impacted by two factors. First – Interest rates. When inflation rises, the central bank raises rates to protect real value of domestic savings. When this happens, the FX rate falls. (If it didn’t, you could borrow 100k in he US at 2% convert it to INR, put it in an NRI fixed deposit account at 10%, wait for a year, convert it back to the USD at the same exchange and make a 8% risk free return) Question is – Why is the ratio (1+10%)/(1+2%) not equal to 3 (the purchasing power parity). The reason is emerging markets exchange rates are forward looking to balance growing inflation vs growth thus is typically a few percentage pts more than it needs to be whereas developed markets have stable inflation.

    Second.Think of it purely as a supply demand issue. The value of INR falls when its demand falls. i.e. someone no longer wants to hold his rupees and wants to sell INR and demands USD in return. So who sells or buys rupees ? Not domestic consumers (your big mac analogy) because you are paying rupees for a goods which has also been manufactured by expending rupees (assuming no component of big mac is imported). Thus you are exchanging a rupee for a rupee – net impact on FX markets is zero. Supply demand impacts exchange rates when someone sells a rupee and asks for dollars in return. Eg: Large corporates who have invested in India earn INR from their india operations, but believing that growth prospects in India are bad – (corruption, red tape, etc.) decide to pull their profits out of India and convert it to safe USD. When many many foreign corporates do this at the same time – there is a sudden demand to sell rupees – its price falls. Who else “sells” rupees ? Every importer. When trade deficit rises – more goods are imported than exported. What an importer does is – he sells his rupees, buys dollars, and uses dollars to buy foreign goods. Again – when trade deficit rises, there is a greater demand to sell INR, which again leads to a fall in price of the Rupee.

    Bottomline is – Live abroad, invest in india, vacation in India and profit from arbitrage 🙂

  2. Strongly agree with your point on protectionism btw. You should read S Gurumurthy’s op eds in the New Indian Express. He presents a similar line of arguments

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