Effect of currency exchange rates / depreciating rupee on Real Estate

Today, rupee reached a fresh record low of 65.5, falling almost 23% in past four months or say almost 45% in last 2 years. This makes me think that people who have bought properties or planning to buy one in the near future would surely want to know its effect on real estate. Is this the right time to spend all those life savings into buying property. If yes, then which location would make more sense right now? Let us understand what has happened to rupee and how it affects the real estate market. But before, it is quite interesting to know rupee more closely.  

History of Rupee

It was only the day we got independence that Indian rupee could match the dollar value, when $1 was equal to Re. 1. At that time, rupee was linked to pound and the country had no external borrowings.

With the introduction of first Five Year Plan, government borrowed from outside and as a result we see Maharatnas such as SAIL etc. (Though when we look in hindsight, it’s hard to find any recent industries of such scale set up by the government. Anyways, that’s another discussion all together. )

Post-independence, India followed a fixed rate regime between till year 1966 when $1 = Rs. 4.79. The two wars with China and Pakistan in year 1962 and 1965 resulted in huge budget deficit. The government was forced to devalue Indian currency and $1 = Rs. 7.57. In 1971, government linked rupee to dollar.

1973	7.66	1983	10.11	1993	31.26	2003	46.60
1974	8.03	1984	11.36	1994	31.39	2004	45.28
1975	8.41	1985	12.34	1995	32.43	2005	44.01
1976	8.97	1986	12.60	1996	35.52	2006	45.17
1977	8.77	1987	12.95	1997	36.36	2007	41.20
1978	8.20	1988	13.91	1998	41.33	2008	43.41
1979	8.16	1989	16.21	1999	43.12	2009	48.32
1980	7.89	1990	17.50	2000	45.00	2010	45.65
1981	8.68	1991	22.72	2001	47.23	2011	46.61
1982	9.48	1992	28.14	2002	48.62	2012	53.34

                                Table: Average annual exchange rates of India from 1973 to 2012

Then comes 1991, when India suffered low growth and high inflation. Even forex reserves had dwindled to such an extent that the country couldn’t afford three weeks of imports. As a result, rupee was devalued to 17.90 against a dollar.

In 1993, government switched to a free-floating currency. The exchange rate would now be determined by the market based on supply and demand. In a free-floating currency, government intervenes only when it feels the dire need to control the volatility. High volatility in the currency rate can prove detrimental to a country. Rupee got devalued to 31.37 against a dollar.

Average annual exchange rates - USD/INR

Major factors that affect currency exchange rates?

High inflation: Every developing economy withstands high inflation. Reason being that a developing economy is one where large investments are made that leads to high growth rate. Large investments lead to large inflow of money in the economy thereby increasing the money supply. And we know that increased money supply will lead to increase in demand, thereby causing inflation. If the purchasing power parity has to hold good, the rupee has to adjust to the change in inflation against dollar. Let us take an example to explain this purchasing power theory and inflation. Let say the price of 1 kg rice on India is Rs. 50. The same is available in U.S. for $1. Inflation in India is 10% whereas in U.S. it is 2% per annum. So after a year, the rice would cost Rs. 55 in India and $1.02 in U.S. As a result the new exchange rate would be 55/1.02 = 53.92. During high inflation, depreciation of currency is quite natural.

High Trade deficit: Trade deficit is another reason contributing to rupee depreciation. High current account deficit wherein imports are greater than exports leading to trade deficit for India leads to increasing demand for dollar for imports. As demand for dollar rises, its value appreciates and the rupee depreciates.

Useful read: Association between current account deficit and Real estate market

FDIs and FIIs: These are the medium through which dollar flows into the Indian economy. As FDIs and FIIs decreases, the value of Indian currency depreciates. As you can see in the graph above, Rupee has appreciated in the period between 2002 and 2007 primarily because of this reason.   

Effect of exchange rate on Indian real estate

When rupee depreciates, it is likely to increase Real estate demands amongst the NRIs. This would lead to increase in demand by the NRIs which should lead to rise in prices. but there are other factors too. 

Useful read: NRI Real Estate investors benefit from Rupee depreciation

In the short run, this depreciating rupee will not affect the real estate prices in India. But a sustained depreciation of rupee will eventually lead to prices becoming dearer for buyers. Reason being that Indian economy is more import based with a trade deficit. As a result of rupee depreciation, Indians will have to pay out more for imported goods thereby decreasing there disposable income and making houses less affordable. Also, when inflation rises, central bank (RBI) increase the interest rates and tighten the economy thereby making home loans dearer. This will lead to decrease in demand by local buyers thereby putting a pressure on Real estate developers to reduce prices. On the other hand, inflation in construction material costs will lead to rise in construction costs. Thus, companies will turn out to be major losers in this scenario of increasing depreciation. 

History teaches us the best. When Argentina converted its fixed currency regime to a floating currency regime, its value depreciated by as much as 66% in a few months compared to dollar. But Real estate prices in superior locations did not fall that much. Scarcity of financing did not hinder the market as much as anticipated. A substantial change in the profile of buyers occurred, from home-owners to non-resident Investors. If one measured the market in pesos (the Argentine currency) it generally went up and devaluation benefited the real estate market—if measured in foreign currency (assets in euros or dollars)—depreciated, but not in proportion to the Argentine currency devaluation. ( Devaluation and Real Estate values: The Argentine case by ARQ. JOSÉ R. ROZADOS, ARQ. GERMÁN GÓMEZ PICASSO, AND RICARDO ULIVI, PH.D.)     

Advice for home buyers

One can buy homes in IT hubs or rather export hubs of the country. Bangalore, Pune and Hyderabad make sense to me personally. Or else, the best and riskless strategy for investors is to wait and watch till the currency becomes less volatile. But then we know that there is “no risk, no gain”. J

Any further interpretation of effects of exchange rate on real estate market is most welcome. 
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