Rupee crisis for dummies

This post has been co-written by Roshan Venugopal and myself. This post over-simplifies many concepts to ensure easier understanding. This article may be cross-posted on the author’s own blog.


India’s rupee crisis is making news not only in India, but globally. It is cliché to point to the government and RBI, but how many of us really understand what the problem is? This post is an attempt to demystify and explain in simple terms.

The Basics

Every time we import something, we have to pay in the currency the seller is willing to accept. Oil and gold contribute to more than 50% of our imports – this combined with several other factors, we spend a lot of dollars.

Every time we export something, rupees are in demand (the buyers need them). So we get foreign currencies (primarily dollars or euros) in return. In another way of saying, we have to continue to export (which will bring us dollars), in order for us to import (which requires dollars). So if a country exports more than it imports, it will have a trade surplus and the opposite situation will have a trade deficit. Let us say the value of the trade balance is T.

Aside from this, foreign individuals and businesses bring capital to India with business interests. Lets call this C. People, such as NRIs, send money to India. Lets call this R (for Remittances). Finally governments borrow money from financial markets in the form of dollar denominated bonds, L.

The current account balance is a function of T, C, L and R. If the aggregate value is negative, we are in current account deficit. The value of this determines how strong our reserves are, and how long we can keep importing. We now have enough dollars to import for the next 7 months (compared to 3 weeks during the 1991 crisis).

What does this have to do with the value of the rupee?

The value of foreign exchange is simply a function of supply and demand. If I am desperate for dollars, the asking price for a dollar will shoot up. 3 months ago, India could afford to buy a dollar for ₹53, but given the demand and shortage of forex reserve, the value went down to over ₹64 [Went “up” or “down” is relative to how many dollars it takes to buy a rupee, not the other way round].

What does this have to do with yield rates?

The government from time to time issues bonds denominated in rupees. When the relative value of rupee goes down, the bonds become less attractive to buyers and as a result, their expectation on the interests go up and hence the yield rates go up. This further burdens the government, because they would now have to pay higher rates.

Why is the government unhappy with gold buying?

Pretty simple – we buy about $62bn worth of gold every year, almost all paid for in dollars. And unlike many other countries, gold in India has minimal economic value, since most of it goes to jewelry and jewelry has no utility. So the government wants you to discourage you from buying gold, thereby helping narrow the deficit a bit. The same funds, if applied to oil or other essential commodities, can help increase the export levels.

How did we get here?

We have always had debts, deficits, import burdens etc.…Last few years, we have been in this situation where investors found economies like US very unattractive (due to slow growth, risk of another recession, easy money etc.), and resorted to investing in emerging markets, such as India, for better returns.

When Ben Bernanke spoke last May of taking the foot off gas pedal, it sent a signal to the markets that US might, once again, be attractive for investments. The markets responded by retracting their capital from “risky” investments (such as the ones invested in India, Brazil etc.…). This had a huge impact on the “C” aspect of the TCLR illustration above.

Some more on this ‘foot off gas pedal’ speech:

Since November 2008, the Federal Reserve started an unconventional policy of buying financial assets (mortgage bonds, treasury bills, p-notes) known as Quantitative Easing .The mandate of QE is to buy 65-80 billion dollars of treasury bills (T-bills) every month and Bernanke was referring to a reduction in purchase of these bills.

The effect of this vacuuming of T-Bills was the yield on T-bills was net zero or even negative i.e. US government was able to charge people to lend money to it, leading to lowest rates for borrowers and migration of smart money to emerging markets like India, Brazil, Turkey etc. Suddenly after the May speech smart money wanted to play safe and bailed out of emerging markets to back home.  This instability caused the rupee and its classmates like the Brazilian Real, the Turkish dinar to fall 16-18 percent since May 19 of this year.

So should we blame US for this?

Not really. While the latest announcement from Fed almost certainly caused this commotion, the fundamental issues always existed. The truth is we are still a very foreign-capital-dependent, import-burdened economy.

Can I send more money to India?

If you are a NRI, this is a good time to send money to India. Because dollar-for-dollar, it fetches more rupees and remittances are one of the best ways to transfer money to poor nations because this goes directly to the pocketbook of the consumers or builders. Obviously buying more gold with this wealth is not the way to move forward.

What is the way out?

There is no magic pill. RBI and the government always have this arduous task of striking the golden mean to balance inflation, unemployment, foreign exchange, balance of payments etc. An organization like RBI may have the experience and skills to maneuver this, but also under pressure from the political powers, because of upcoming elections in 2014. In addition, we are getting a new leadership for RBI – which the markets have thus far greatly welcomed. There are also several areas (such as import of coal, iron and other minerals) where we can expedite policy reforms and changes that allow us to improve the intrinsic strength of the economy. The current stopgap measures, such as limiting imports of gold and other goods, will have but a small effect on the problem we are trying to solve. The biggest risk we have is of a downgrade of our risk rating. This alone has the potential to send us in a downward spiral, which the RBI folks know pretty well.

How does this affect domestic economy?

On the positive side, this crisis makes India a better investment and improves the export climate for India (because of the cheapened rupee). However this will come at a cost – which is inflation. We already have inflation struggles – this crisis merely adds to that. We may see days of tight money, slow growth, and some increase in unemployment levels even.

References used:

  1. India’s trading partners and what it trades – The Guardian
  2. India’s External Debt – RBI
  3. Its an internal crisis, not a foreign one – Easy Money
  4. Foreign Exchange reserves – RBI

Trackbacks & Pingbacks

  1. Rupee crisis for dummies | KVPPVRAO pingbacked Posted August 22, 2013, 9:58 pm

    […] Rupee crisis for dummies […]


  1. Quote

    Excellent post RK and Roshan. It answered most of the questions I had in my mind around the rupee’s crash. Good work.

  2. Quote
    RK (subscribed) said August 22, 2013, 9:37 pm:

    Thanks Sukumar for your kind words.

  3. Quote

    Thanks Sukumar for posting and moderating this post.

  4. Quote
    ramanan (subscribed) said August 23, 2013, 10:11 am:

    Dear Sirs

    Thanks a lot for clearing up the rupee depreciation issues. This was an eye opener article

    Please see

    Scroll down a bit and you will see a table containing the historical INR USD rates

    My simple question(s) to you is

    1975 10.409
    1980 7.887

    2006 48.336
    2007 (Oct) 38.48

    What did we do right or what happened in our favour during 1980 (more than 3 rupees gain ) and 2007 (more than 10 rupees gain) , how did the rupee strengthen ?

    I know this rupee gain must have been due to a combination of a million factors but can you single out a factor or two which made the rupee very strong in 1980 and 2007 ?

    Expecting a reply which will enlighten me,


  5. Quote
    RK (subscribed) said August 23, 2013, 8:53 pm:

    Macroeconomics is a complex subject. When you analyze trends over long periods, you need to have an understanding of trade history (balance of payments, import trends specifically for oil and gold), foreign policies, US economic trends (specifically bond yields) etc…

    It would be myopic to make fast conclusions based on subsets of data. Suffice it to say, a point-in-time value of INR against USD, inherently does not mean good or bad. You could have a really good conversion to the USD (1:1) and have a poorly managed economy; you could have a steep conversion (let us say 100 to a USD) and have a well-managed economy.

    Sorry I am not able to pinpoint. If I find any information along the lines of your question, I will follow up in this thread.

    For further reading, please consider this Bloomberg article by Swaminathan Aiyar ( ) and this Economic Times article ( )

  6. Quote

    This has helped me understand why this is happening.
    This definetly needs to be shared, there are many like me who would like to know these information.

    Thank you Guys.

  7. Quote


    Here are some stats which can help answering your question. So in 2007 we received nearly 95 billion in inflows causing the rupee to be stronger.

    Dec 2006 Forex reserves = $175 B
    Dec 2007 Forex reserves = $272 B
    Dec 2008 Forex reserves = $245 B

    Here is the link to the database.

    Hope this answers and thaks for your comments.

  8. Quote
    RK (subscribed) said August 24, 2013, 8:50 am:

    Thanks Ranju for your kind words. Please share it socially.

  9. Quote
    ramanan (subscribed) said August 24, 2013, 12:07 pm:

    Thanks Roshan and RK for the answers.

    Roshan, sorry for talking like an unsatisfied kid !! 🙂

    Ok rupee in 2007 strengthened because of the 95 Billion inflow. Fair enough. Good point.

    This must have been due to something we (or our politicians or RBI rules etc) did maybe in 2005, 2006 and its effect is seen in 2007

    Did we market India more rigorously so that we got more investments? Were our policies better in 2005,2006,2007 ?

    In other words what caused a huge unprecedented inflow of 95 Billion in that year only ?

    Thanks again


  10. Quote


    Look at the Sensex data for 2005-2007. You can see a lot of inflows flowing directly into the stock market.

    8000, 8 September 2005
    9000, 9 December 2005
    10,000, 7 February 2006
    11,000, 27 March 2006
    12,000, 20 April 2006
    13,000, 30 October 2006
    14,000, 5 December 2006
    15,000, 6 July 2007
    16,000, 19 September 2007
    17,000, 26 September 2007
    18,000, 9 October 2007
    19,000, 15 October 2007
    20,000, 11 December 2007

  11. Quote
    Yuvaraj (subscribed) said August 28, 2013, 1:09 pm:

    I have read a similar article about rupee Crisis. In short it said to reduce max pertol consumption for 7 days, and it would get the Rupee on track. Also it insisted on consumers to buy Indian products.,d.cWc

    Can you please help me relate these two articles.

  12. Quote
    RK (subscribed) said August 29, 2013, 3:42 am:

    Thanks Yuvaraj for your comments. Not eating food will reduce my monthly expenses and thus my savings will go up. But that wouldn’t be a wise idea, would it?

  13. Quote

    Thanks a lot for the post, It did make things easier to understand. I shared with my friends as well.

  14. Quote
    RK (subscribed) said September 1, 2013, 10:52 pm:

    Thanks Veena for your comments and kind words.

  15. Quote
    RK (subscribed) said September 7, 2013, 11:23 am:

    There is lot of social and media attention to the appointment of Raghuram Rajan as the new governor of RBI. I have written a post on what to look forward to from Rajan and why he is no Bond (as ET thinks he is). The post is available at

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