Elections and Rupee Volatility

The rupee has tumbled to the lowest point in the last 18 months, when it crossed the Rs68/$ mark this week. Analysts have posited multiple reasons for this occurrence – India’s sluggish export growth and an increasing import bill due to rising oil prices, the dollar strengthening, rising US interest rates, and the inflation differential between India and its main trading partners. However, one other reason could be elections – both the just concluded Karnataka election and the upcoming 2019 Lok Sabha elections.

A chart from 2013 that shows strong correlation between elections and rupee depreciation. Source: The Economist

There has been a historical relationship between elections and the exchange rate. Election time is usually associated with greater volatility of the rupee. Investors generally fret about populist schemes leading up to the elections. They are also afraid of policy uncertainty if a new government is elected. Chances of policy reversals or abandonment of certain policies can create jitters.

Post liberalisation in 1992, the rupee had a bout of weakness in 1997, and then, just after the 2004 elections, again in 2009 before the elections, and the biggest one in recent memory was in 2013. These have coincided with the elections and also major global macroeconomic shocks. There was the Asian crisis in 1997, the global financial crisis in 2009, and the episode of the taper-tantrum in 2013. It is hard to isolate these factors and establish causality between elections and rupee weakness, but there seems to be a strong correlation.

Episodes in other emerging economies can give a clue. Mexican Peso and elections have followed a similar pattern. The Economist explains:

Between 1976 and 1994 the peso regularly suffered a massive slump roughly every six years, around presidential elections—even though the country was effectively a one-party state at the time. Mexico tried to create stability by pegging the peso to the dollar in 1988, but by 1994 suffered a full-blown crisis. The pattern of boom and bust was broken only when authorities reverted to a freely-floating exchange rate—but also, crucially, put in place sound monetary and fiscal policies. There is a lesson there for India.