Sunday, September 22, 2013

The Falling Rupee- NRI investments in INR

There are a lot of NRIs out there who keep investing in India due to the higher interest rates available here. Till a few years ago, there was also the added motive to shelter some part of the income from American taxation. Now I understand that the US government is quite fussy about evasion of taxes by American Citizens.

The NRI also has the issue of having to support his dependents out here in India. Maybe it will be so for another generation, but when the NRI’s children cease to come back, that will also obviate the need to have any ties with India in terms of money or otherwise.

The first generation NRI is the one that is not quite sure. Most of them want to come back, so they build a house, keep money in FCNR or other NRI accounts and keep looking at FD’s, Bonds etc that yield higher rates out here. More often than not, they do not factor in the exchange rate damage that happens to their savings out here in Indian rupees. This damage becomes apparent only when there is a sharp fall like it happened recently. Logically, the rupee should decline by about five to seven percent per annum against the US dollar. However, it is not a gradual and calibrated decline because other flows in to the country (FII and FDI) do provide some temporary respite to the fundamentally weak rupee. Fundamentally weak because our imports always exceed exports and hence we are always in search of dollars. Also, our domestic finances are unlikely to ever be anything other than deficit, so this continuing deficit gives rise to inflation. Given the chronic nature of inflation and deficit of foreign currency, our only hope to keep the rupee from falling is to create an environment of legal and political comfort to foreign money that can get invested here.

The problem this year has been the near twenty percent decline in the value of the rupee in a short span. Whether the rate that is prevailing now is the right one or the wrong one, depends upon what time frame we are talking about and what annual rate of depreciation in the rupee one uses. For example, if I start with 1970, when the US $ was worth Rs.7.50 and assume a 6% annual decline, the dollar would be worth nearly Rs.92. If I assume a steady 6% rate, the table would show that the US$ would have been worth Rs.24.05 in 1990 and worth Rs.25.50! As against this actual rate was Rs.18.11 in 1990 and Rs.25.79 in 1991!!!And in 2002, the theoretical rate should have been 48.40 and the actual was 48.23!! It is only post 2003 that we attracted big FII/FDI flows which propped up the rupee. So, the fall in the value of the rupee is never an orderly one. It holds on its own for some time and then it cracks. So, one cannot say that the rupee is undervalued.

So, the investment of the NRI in India keeps deteriorating on an average by six percent each year. This is a simplistic assumption based on the difference between the average inflation rates in the US and India. So, as an NRI one must deduct around six percent returns AFTER TAX to merely compensate for the change in exchange rate. After this, if still attractive, by all means chase rupee investments. This is fine in theory, but if you have just started investing two years ago, you have seen around one fourth just knocked off your savings. There is no escaping the volatility. A tapered decline can happen only if the economic regime is stable and the legal framework conducive to attracting FDI and FII inflows. Our legal system is so capricious that serious foreign money for will hesitate. OF course the lure of such a large population will keep money coming in, even if the legal environment is weak, simply because the world businesses will take risks to keep growing.

And my hunch is that the rupee has a long way to fall. We have been lulled in to complacency since 2002 or thereabouts, on the basis of inflows of FII and FDI. It is important to keep it going, or else, to see US $ at eighty plus is not beyond the realm of possibilities. For NRIs who invest in India, do not forget to do your numbers. And those who can take rupees overseas legally, it is never too late.

No comments: