How The American Dollar Impacts India

Fin 242

Financial Management

Term Paper

How the American dollar ($) impacts India, a general report

By

Samarth Bahl

Since, 1991 when the then Indian government was run by the Indian National Congress (INC), the political party instituted a plan to implement economic reforms, short and long term to bring the country out of its quagmire, to this end the value of the dollar has played a key role in the economic fortunes of India. This is due to the fact that the dollar has been the world's most dominant currency in the past 65 years. The major currencies in the market today are always measured against the dollar. For example, the value of the Euro, its strengthening or weakening is measured relative to the American dollar. The reason for the dollar to be such a strong market force in the foreign exchange market is due to its reserve currency status, which makes it the most widely distributed and used currency. That is another reason why some of the other major existing and potentially strong currencies are pegged against the dollar. Of course, the value of the dollar is not fixed it depends on various factors. Trade deficit, budget deficit, national debt, foreign investment returns are some of the major factors that play a critical role in determining the value on a continuing, daily basis. When economic reforms were introduced in India, they themselves did not realize that in the next decade the rate of economic growth in their own backyard will be unprecedented due to the untapped potential of its substantial middle class in terms of sheer volume. The economists in the country eventually gained on to the reality that the potential of the consumers was the stepping stone to India's economic freedom. The major factors that have worked in favor of the country are that the labor force is highly educated (and fluent in English) and skilled, yet is still cheap comparatively to the industrialized nations. So much so, that the multinational companies have outsourced jobs to India. These reasons have prompted China, India's direct competitor in economic terms not only in the region but worldwide, to institute programs to teach English to their working population. Most major international brands and corporate bigwigs such as Microsoft, Hewlett-Packard, Intel, General Electric, Pepsi, American Express, Morgan Stanley, Boeing and many more have outsourced and actually have their regional offices in India and also, in some cases have manufacturing plants. The emergence of the multinational businesses in India has brought much needed capital into India, which has helped the Indian government to expand its horizons in terms of being a key player in international politics, economics and policies. To the scope that India is recognized around the world for its prowess in the IT sector and it is fast emerging as the number one medical destination for patients. As a result unemployment has decreased and poverty has decreased by 10 percentage points. Consequently, India has seen higher standards of living in recent years and higher costs of living, especially in urban areas. Strong economic ties that are build on strong foundations has helped India to foster diplomatic, military, strategic alliances with United States. The Indian Diaspora has contributed in the thawing of relations of the two countries by contributing to the US economy. This in turn gives certain assurance that the USA will look to invest further in India's fortunes. 17.08 % of USA's foreign direct investment flows into India and covers almost every sector in India, which is open for private participants. This has given carte blanche to the Indian administrators to further their ambitious claims to overtake China as the number one emerging economic superpower. Further to this argument is the fact that India is primed for the next wave of investment boom, as they plan to free float the country's rupee as fully convertible. This might be a useful tactic, if the rupee is to achieve a status of reserve currency as the weakening US dollar loses its status as the reserve currency of the world. According to Dr. Avinash Persuad, the investment director at GAM (a Julius Baer subsidiary) "The Euro will not be the world's major currency in decades to come. Instead, that title will go to the Chinese renminbi or even the Indian rupee..." All these facts paint a rosy picture in favor of India. But, the country has a long way to go before it can realize full optimization of its resources. There are numerous factors that hinder and will continue to do so in the near future. The main case in point being the high tariff rates and excise duty imposed on imports. The Indian government still has a tendency to protect indigenous businesses from external competitors. In my opinion, this a good move for the future of the Indian economy. While having allowed foreign products to be sold on the country's open market, it has given time for local businesses to upgrade and match the level of expertise of their foreign, more illustrious rivals. This slow and steady allowance of non-local companies has seen India grow at a steady rate of 8% in the past decade. At this rate, in few years India will be able to completely deregulate their market which will endorse high level of product sophistication, differentiation, low prices (benefiting the consumers) and at the same time profiting companies. In the ideal condition of perfect competition or supply coupled with perfect demand, the natural equilibrium will drive prices down, thereby benefiting consumers. While this scenario is unlikely, the economy might come very close to achieving such a stage. It remains to be seen, if the policymakers do eventually take this step. This will only lead to positives, a large influx of funds into the economy and increased research and development. Furthermore, would be the political milieu existing in the country. Corruption is the barrier to economic excellence, often stipulated by the actions of politicians. The continuity of economic reforms that are projected, often are binned and left on a shelf to rot only because of an unstable government coalition at the helm of affairs. To further compound the problems, the opposing party always tries to institute opposite or contradictory reforms, which negates the positive effects of any economic plan. But, in recent years, these