Dollar depreciation

In the past year, the dollar has slid 15% eroding dollar centric portfolios. Whether we act or do nothing about it, the reality is that dollar depreciation (or rupee appreciation) will have a tremendous impact in future.

The past year has been an unpleasant surprise to people who thought the dollar would ride high forever. The dollar at Rs13 in 1986, moved to Rs 47 in 14-15 years, which was an era of unprecedented economic prosperity in the US. However, believing the dollar would remain at these levels and keep gaining strength is just wishful thinking. It may not need an economist to point out that currently, India is also witnessing an era of unprecedented economic prosperity. Most people abroad, who have some connection with India, are aware of the economic growth here.

Most NRIs pay no attention to the rupee-dollar exchange rate until it’s time to plan a trip to India. Then they gasp when they discover that a movie ticket costs six dollars then it sinks in that even the mighty dollar, once thought to be as good as gold, is a paper currency that is worth only what others think it is worth. And right now, people outside the US (and economists and professors in that country) have a gloomy outlook o the dollar.

The 30% rise in corporate company earnings have sent the Sensex up from 3,000 in 2003 to 16,000 in 2007. With low interest rates, and low base prices, real estate has also witnessed a boom. The 8-9% growth in the GDP will at some point be reflected in our currency so the rupee will appreciate against the dollar. Indian economy currently is the second fastest growing economy, has received investments from foreign institutional investors, private equity players, and foreign direct investments, which are growing every year.

The weak US dollar just got weaker, hitting its lowest level ever against the euro. The hit to Americans’ buying power abroad is substantial, as any tourist back from a summer vacation in Europe can experience this. But policy makers and market experts seem unruffled.

The dollar decline is a simple fact: America does not save enough. Most Americans live beyond their means, regardless of whether they are creditworthy or not. The world’s most powerful economy has a current account deficit of $800 billion. Going by current information, it is difficult to see this deficit reducing in the future. In the absence of adequate domestic savings, the US borrows about $4 billion a day to keep its economy going. This would put most economies in a crisis but the US managed to keep it up because of the privilege its currency enjoyed until last year. Foreign investors were happy to keep investing in the US. Asian central banks have US dollar reserves of some $2 trillion. A plunge in the dollar would erode their value. So it is in Asian central banks’ interest not to let the dollar fall, and to gradually look at alternatives. Already, India Russia and China are quietly moving money out of dollars and into euros. If this trickle were to become a flood and suck billions out of the US economy resulting in the US seeing a recession which would have a tremendous impact on other countries that rely on exports to U.S.

Central Banks all over the world have started hedging against the dollar. Indian financial strategists at Central Bank say they are certainly not saying the dollar will tumble soon. But how will it affect if the dollar reaches Rs 35 in the next five years, and Rs 15 in the next 15-20 years? Consider this example. An investment say of Rs 3 crore in a dollar portfolio at today’s rate (around Rs 40), the portfolio would be worth about $750,000. If the exchange rate in 2022 is Rs 15 (for the sake of simplicity, and not considering inflation) the portfolio will be worth just US $2 million.

The US central bank announced a 50 basis point rate cut in September 2007. This diminished the appeal of dollar-denominated assets and sent the dollar lower as expected.

The biggest gainers in the dollar depreciation may be American investors in overseas stocks. In fact experts in U.S are advising clients to include foreign stocks in their portfolios to benefit from faster growth overseas.

NRI investors should consider India as a serious investment option, and invest in rupees with a time horizon of 10-20 years. Even though returns will be lower than in past years, it’s still a goldmine. —