By Monish Chhabra ǀ 19th June 2013

The ongoing collapse in the Rupee is much related to

• • the country's current account deficit (always a problem for India, but worsens when the economy slows), and

  • the country's GDP growth (which has really slowed down recently).

Overtly optimistic growth assumptions and chronic fiscal deficits led to the rapid money growth in India. Too much money in the face of falling demand, increased inflation.

That combined with persistent current account deficits meant lower Rupee. However, that outcome was slowed down for many years, primarily due to incoming foreign capital flows.

As soon as the US rates rose and foreign flows reduced – receding of the proverbial tide – Rupee was found swimming naked. Now it is in a downward spiral.

The two biggest imports for India are oil and gold; both of which are holding high. The current account could worsen further. So would fiscal deficit, as oil is a major item under government subsidy expenses. Falling Rupee also worsens government budget by increasing the interest expense on dollar loans.

However, all this is nothing new. This is the business cycle.

Since the mid-1990s, when India liberalized its economy, the Rupee has fallen at a pace of about 4% per annum against the US dollar. That is acceptable in the context of excess inflation of just over 4% in India against the US over this period.

To go down over time, is normal for a higher inflation currency. People are shocked only because the currency didn’t fall in a straight line, year after year.

During the boom times, the Rupee actually appreciated against its long-term down trend. Hence it has fallen much faster now, playing catch-up.

If it fell 4% per annum since 1995 in a straight line, inching slightly down every day and hitting a new record low, we would have seen the same headline for 18 years!

The news isn’t entirely bad for investors.

Indian capital markets don’t penalize the savers by keeping interest rate artificially low. Domestically, the fixed deposit rates have exceeded inflation, at least over a full cycle.

Internationally, the Rupee rates have also covered the depreciation of the currency over longer term. Interest rates have been largely fair and also have been the ROE (return on equity) of the sustainable companies in the country.

Today, one can get 8.5% for Rupee 1-year fixed-deposit, compared to 1.5% for the US dollar fixed-deposit; excess of 7% as a cushion for the depreciation.

People are addicted to the unfair returns when a while back they could get 8-9% fixed rate plus currency appreciation, thus a total return in teens. This was before leverage, which many applied amply on top.

Now it is payback. Late-comers and momentum-chasers are complaining, as the Rupee depreciation exceeded the fixed return. This resulted in a negative total return, which hurt even more if there was leverage involved.

Domestically, there is no doubt that India is in a de-leveraging cycle. Defaults are rising. Small manufacturers are suffering due to cheap imports from China. High interest rates are causing un-competitive projects to be shut down. Real estate speculation is reined in.

This is what one would expect in a down phase.

As long as the interest rates cover inflation and ROEs cover interest rates, it is a working economic model. Cycles are inevitable in any functioning model.

The extreme low of such a cycle would be attractive.