The 6th of June, 1966 - a day called devilish for INR by the public due to unpopularity.

This was the day when ​​ the rupee was devalued dramatically in response to the first significant balance of payments crisis faced by independent India.

To be clear, this is different from the usual increase and decrease due to supply and demand. Devaluation refers to the conscious decision when a country’s central bank decides to lower its exchange rate to a fixed or semi-fixed exchange rate.

The then Prime Minister, Indira Gandhi, devalued the currency, which was a devaluation of 57% against the US Dollar. But before addressing the reasons behind this decision, let us clear a myth.

Was Re. 1 worth 1 US dollar in 1947?

It is an illusion that on August 15, 1947, when India became independent, 1 INR was equal to 1 USD. We compared the IN to the British Pound before the USD became the accepted worldwide currency. Furthermore, India did not engage in trade and had no external borrowings in 1947; therefore, INR could not have been equal to USD 1. Additionally, India's 0.8% growth at the time prevented the INR from being similar in value to the USD.

The devaluation in 1966 also happened against the GBP, and after converting INR to GBP to USD, the devaluation figure was 57%.

What was the reason behind this decision?

It had hardly been a decade-and-a-half since India had attained independence. The economy, still finding its feet, needed additional access to foreign exchange. Foreign investments were frowned upon, and exports were negligent. Therefore, India ran up significant trade deficits in the 1950s and the early 1960s. Foreign aid from wealthier nations was what came to India’s rescue.

Things got rough in 1965 as India and Pakistan went to war. Military spending soared, putting extra pressure on the Indian government’s resources. At the same time, countries like the US, which were in those days aligned with Pakistan, withdrew help from India.

This financial crisis decimated her foreign currency reserves, and the INR became unacceptable overseas. India could not pay for imports; the only alternative left was borrowing money abroad. 

Hence, the government resorted to sharply devaluing the rupee in a much-criticised decision. 

In those days, the rupee was still linked to the Pound, which, in turn, was pegged to the dollar. The devaluation meant that the practical value of the rupee went from ₹ 4.76 against the dollar to ₹ 7.50 per dollar. That worked out to be a devaluation of 57%.

The Reserve Bank of India (RBI) marks 1966 as the second episode of rupee devaluation, the first being a consequence of a devaluation in the Pound, to which the rupee was fixed.

The step was also resorted to retain the present exports by creating a better alignment between internal and external prices, thus giving exports greater competitive power. The related new exchange rate was ₹7.50 to 1 US dollar as against the previous rate of ₹ 4.76.

Did this decision work?

This decision was undoubtedly one of the many unpopular decisions taken by Indira Gandhi. While we can only speculate as to what would have happened if this decision had not been taken, it can be said that the devaluation did not work. It led to a spike in inflation and did little to help in the long term as no other reforms accompanied it. 

According to data, inflation levels went up from about 5.8% in 1961-65 to about 6.7% in 1966-70, and the trade deficit did fall after the devaluation. However, it would be tough to argue that there was a sustainable improvement in India’s external economy, which faced another major balance of payments crisis in 1991. The data shows the trade deficit narrowed from a peak of ₹ 930 crore in 1965 to ₹ 100 crore in 1970, led more by a contraction in imports than a rise in exports.

It is said that since then, the Indian government, in ways other than devaluation, has used this as a tool that has led the INR to be depreciated to what it is today. The alarming rates of USD to INR have ripples in many places, but is mainly due to these reasons:

• Fluctuation in prices of crude oil 
• High/low capital flows in the country
•  The Fed’s monetary stance
• Current account and balance of payments
• Political stability in the country

What is the Impact Of Falling Rupee On Funding And Valuation of Startups in India?

Talking about the present day, since January 2023, the rupee has declined over 9 per cent against the dollar, hitting its lowest point at 81.9 last week. 

Most of the startup funding in India comes from funds denominated in dollars, with startups assessing portfolio values and receiving eventual exit returns in dollars. As a result, it is assumed that any sharp movement in the INR-USD rate would impact a startup’s portfolio value and returns.

A sharp movement impacts a startup’s valuation. For instance, it would take longer for a startup to reach unicorn status. A business in India with rupee revenues and a 10x on revenue valuation would have reached a billion-dollar valuation of Rs 750 crore revenues with an exchange rate of 75. They must get nearly Rs 800 crore in revenue to become a unicorn. There’s a high chance that even the multiple of 10x may have dropped to 6x or 7x and, hence, higher pressure on the business to achieve a billion-dollar valuation.

However, it is more complicated. The exchange rate impact assessment is different for enterprise businesses and consumer businesses. For example, for enterprise businesses — where revenues are from global enterprises — rupee depreciation has a positive impact. In domestic books, if companies manage that, there will be a mild incremental revenue.

But for consumer businesses, there is zero impact because the bulk of the cost base (other than marketing costs) and the revenue base are rupee-denominated.

The exchange rate impact also differs from location to location. A startup outside India will benefit from this depreciation, getting more rupees for the same dollar. Another factor would be the potential investments in the pipeline, which differs concerning portfolio companies. 

Regarding startup investments, the rupee depreciation has little impact as investors factor in rupee movements while investing. The rupee investor will, in any case, negotiate the rupee terms, and the USD will factor it in any case. The only impact is on the valuation amount.