The run on the rupee

India's currency has hit a new record low against the dollar as the prospect of an end to US money-printing hits emerging markets.

"The rupee is at risk of completely losing its anchor," says Bhanu Baweja of UBS. The Indian currency has slumped to a new record low of 65 rupees to the US dollar. It has lost 20% since early June. The prospect of tighter money in the US has hit emerging markets.

India's economy has also deteriorated. Growth has fallen to 5% and consumer price inflation is 10%. But the main worry for foreign investors is the large current account deficit of 4.8% of GDP. India's deficit with the rest of the world means that it relies on foreign money to fund its economy. Most of this is in the form of so-called hot money'. These are flows that can quickly reverse, such as stock or bond investments, as opposed to foreign direct investment (FDI) money invested in infrastructure or factories, for instance. Hot money can turn tail quickly, removing money from the economy. FDI can't just up sticks and leave.

Once sentiment sours, the fear of investors ditching assets can become self-fulfilling as everyone scrambles to get out first just in case there is an exodus. Another problem is that raising interest rates to bolster yields, and hence the appeal of the currency, would crimp growth and could dent confidence in India further.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

To cap it all, there is little residual confidence in the Indian government's ability to calm the panic, or make reforms needed to lower the current account deficit over the longer term by lowering fuel subsidies, for instance and to bolster growth. The government's structural reforms have proved much more impressive on paper than in practice.

Recent measures to stem the outflow of capital, such as tighter limits on the money Indians can take abroad, have merely signalled desperation rather than fostered stability, says Avantika Chilkoti in the FT. Moreover, capital controls on Indians have raised the spectre of restrictions on the movement of foreign money. Investors worried that their cash could be trapped in India will be all the more inclined to get out.

Capital Economics notes that India has foreign currency reserves worth seven months of imports and relatively little foreign currency debt. These limit the threat that "currency weakness spirals into economic crisis". Still, says The Guardian's Larry Elliott, of all emerging markets, India looks most like "an accident waiting to happen".