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India's Undervalued Currency

India on the Big Mac Index

Written by Marcelina Hardy
Posted July 29, 2013 at 8:08PM

People all over the world love the Big Mac – except India. That nation isn't liking the Big Mac concept much right now.

No, we aren’t talking about a burger. We’re talking burgernomics – the Big Mac Index.

Do You Know About the Big Mac?

big macIn 1986, the Big Mac index was invented to explain currency levels. It’s based on purchasing-power parity (PPP). It attempts to show exchange rates for the same goods and services in two countries.

If the cost of the Big Mac in dollars is the same in the United States as in China, the yuan is equal to the dollar, which is good. If the exchange rate shows that China’s Big Mac is less expensive, then the yuan is undervalued. If the Big Mac is more expensive, the yuan is overvalued.

India’s Big Mac Value

India doesn’t sell Big Macs, but we can still compare the country to the United States by looking at common products. As of recently, common products in India are selling for much less than those in the United States, which means the rupee is undervalued.

If you understand what’s going on with India’s economy, it will help explain the problems with the rupee. Eighty percent of crude requirements are imported into the country, but exports are not reaching what they should. Crude oil prices rallied 7 percent, which has intensified the problem. Too much coming in and not enough going out creates the perfect recipe for a devastating financial situation.

With crude oil prices rising and the currency weakening, high inflation results. With that, commodities and other goods rise, and this compounds the currency issues when people are not able to afford the products they used to purchase regularly.

The rupee has been declining for three months. It took its biggest hit in July when it lost 3 percent. The Central Statistics Office reported that industrial output decreased by 1.6% in May due to lower manufacturing and mining production. Buyers aren’t meeting the supply, which means less money is rolling. And with lower demands, goods production is shrinking. In May, production declined 2.7%.

Exports aren’t doing well either. They fell by 4.5% in June, equal to approximately $23.7 billion.

India is trying to rebound. The nation has considered selling sovereign bonds, which may stabilize the rupee. It’s hard to say if that and other tactics will help the economy, but it’s wise to keep everything in mind as you invest in foreign currency.

Investors May Be Okay

According to “Doing Business in India” by Ernst & Young, India is one of the most preferred places to invest. Actually, it comes in at #2. But with the recent declines in the rupee, is it still one of the best places for you as an investor?

As Samir Arora, fund manager at Singapore Helios Capital, told CNBC:

…We don’t think the fall in the rupee has crossed investors’ pain threshold yet.

No, the decline in rupee hasn’t caused investors to react too much, but that doesn’t mean it won’t hurt in the near future. The biggest concern to you right now is if the rupee continues to decline. Due to the declines in the past three months, it’s likely it will continue for at least a few more months until India figures out how to stabilize the falling rupee.

It’s important to watch the rupee, but right now, there shouldn’t be a panic. If you’re seeking new investments in India, stick with cash-related products, technology, and pharma-focused funds. These are not as volatile as equity and bond markets that have come under pressure with the declining rupee.

International or feeder funds are also better than other investment options. Mutual funds are risky right now, but you can reduce the risk by choosing schemes with portfolios not as exposed to the high import and foreign currency debt.

If India sold Big Macs, this would be a great time to start eating them there. But as the rupee falls, investments are increasing in risk, just as people consuming large numbers of Big Macs would increase their risk for heart disease with the cheaper burgers. Just like in the case of Big Mac consumption, be cautious with how much you consume in Indian investments.

 

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