Every few months, a headline appears announcing that the Indian rupee has hit a new low against the US dollar. The thought that crosses most people’s minds is the same. A weaker rupee must mean a weaker India.
If one dollar buys more rupees today than it did yesterday, the rupee has lost value. If the rupee has lost value, surely the country behind it has too.
Sounds about right? It isn’t.
One US dollar can buy more than a hundred Japanese yen, yet Japan remains one of the richest and most technologically advanced economies in the world. If exchange rates were a reliable measure of national prosperity, Japan should be struggling. Instead, it thrives.
The assumption that exchange rates and economic strength are the same thing is a wide misconception.
An exchange rate tells us how much of one currency can be exchanged for another. What it doesn’t tell us is how productive a country’s workers are, how businesses are doing or where the economy is actually headed.
That doesn’t mean a falling rupee is irrelevant. A weaker currency can make imports more expensive, add to inflationary pressures and raise costs for students studying abroad or families travelling overseas. India has also faced concerns about slowing economic growth recently.
At the same time, a weaker currency does not automatically mean a country is getting poorer. Sometimes, it can do the opposite.
Imagine an American company looking to buy software services from Bangalore or pharmaceuticals manufactured in Hyderabad. If the rupee depreciates, those products and services become cheaper for foreign buyers. Suddenly, India becomes a more attractive place to do business.
The same development that creates challenges in one part of the economy can create opportunities in another.
Exporters may benefit. The tourism industry may attract more foreign visitors. Indians receiving remittances from relatives abroad may gain from a stronger dollar. Meanwhile, import dependent businesses, international travellers and students studying overseas may face higher costs.
The more I thought about it, the stranger the assumption seemed.
No one would judge a company solely by looking at its share price without considering its products, profits or future prospects. Yet when it comes to countries, we are often quick to jump to conclusions. We look at the exchange rate and assume it tells us everything we need to know.
The next time the rupee hits a record low, it may be worth asking a different question. What is actually happening to the economy behind it?
The Fiscal Factor 