The Indian rupee has touched Rs.70 per dollar now. The price of everything is determined by its demand and supply. It's that simple. If the demand for dollar goes up in relation to rupee, obviously the dollar's price relative to the rupee will increase. There may be a number of reasons why demand is up or down: trade requirements, inflation, interest rates, or even speculation, or just anything for that matter. But the basic premise does not change. Currently there are more buyers of dollar than rupee. Until the equation changes, the exchange rates will be in favor of the dollar.
But then, the equation has not changed for a long time. By the end of 1990, a dollar cost Rs.18.136. By the time 2017 ended, rupee was down about 71.59%; that's what happened in a 27-year period. To put into perspective, Rs.1000 bought $55.14 worth of products and services at the beginning of 1991; and by the beginning of 2018, it could buy only $15.66 worth. If you are one of those who needs dollars periodically to make payments, you have been in trouble. Reverse is true for those who have been receiving dollars for their services.
The rupee has always been beaten by the dollar. By 1995, its loss was 12.40% on an annual basis since 1990; by 2000, it lost 9.02% per annum; by 2005, 5.88%. Its first notable gain (5.10%) against the dollar for the year was in 2003 when it ended Rs.45.625 per dollar. The next year it gained 5.49% again. As 2007 ended, rupee seemed to be in demand closing at Rs.39.405. It was to however see its biggest fall in a year (18.95%) in 2008 at Rs.48.620. The rupee gained somewhat in the subsequent two years. But more than 15% loss in 2011 and more than 11% loss in 2013 brought the rupee to Rs.61.810. In fact, it gained 6.45% in 2017 only to stare at Rs.70 per dollar now.
Although the year on year changes have been erratic and non-linear, it is fair to say that the rupee gets rated downward in relation to the dollar every year by about 5% over long term. That's the cost of being in rupees as opposed to dollars. Inflation is a real tax on currencies. If the purchasing power of rupee goes down 7% each year because of inflation, and that of dollar by 2%, the relative prices of both currencies should reflect that. If they don't, eventually market forces will ensure that. That's what has been happening for the last two and half decades at least; remember the rupee's fall of over 70%.
If an investor put money in the Nifty-50 as 1991 began, the annual return over 27 years would be 13.64%. If the investor was based out of India, that should suffice. But if someone based out of the US had invested when the exchange rate was Rs.18.136, the annual return would be 8.46% because of the 2017 closing rate of Rs.63.840. A similar investment for the US investor in the S&P-500 earned 8.06% over the 27-year period. If an Indian investor was able to invest rupees in the US index, the return would be 13.21% adjusted to the exchange rates. It is probably fair because the investment return largely makes up for the difference in inflation rates in both the countries.
In short, the US (dollars) investor in India should look at making at least 5% more than what is possible back home. And the Indian (rupee) investor in the US should be ok if the returns from the US investments are 5% lower than what is possible in India. That is an even-steven situation. The interest rate parity explains it. However, investors cross boundaries and take additional risks to make more than what is otherwise possible. Therefore, I think factoring in a 5% depreciation of the rupee against the dollar on a yearly basis is helpful. Of course over shorter periods anything is possible, but it is not possible to predict it.
For rupee to strengthen against dollar, Indians will have to collect more dollars (through trade and business) than they have to pay. The net dollars collected are then sold to convert into rupees increasing its demand. Reducing inflation differential will be useful in the long term. Two possible, but not plausible, scenarios are reducing gold and oil imports. The first one is a habitual problem, and the second one is not controllable. So 5% is what I am willing to go with.
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