RETIRING
RUPEE
Dr. Akansha Jain
M.Com(gold
medalist),PGDBA((Fin)Symbiosis-Pune)
Introduction
These days, when we surf in T.V.
channels, zapping one channel to another, we find news flashing; rupee hitting
new low, rupee down in early trade, rupee free fall to raise crude prices,
rupee to slip further. Many questions arises in layman’s mind…….why is rupee
depreciating? Are we going into recession? How are we affected by rupee fall?
This article provides an overview of how
the currency movement is determined? What path rupee had followed since 1991?
What is the current scenario of rupee v/s dollar? What are the reasons behind depreciation
of rupee? What is the impact of rupee
depreciation; the losers and the gainers, RBI’s corrective role and why it has
failed and last but not the least the suggestions to improve.
Determinants of currency movement
Foreign Exchange Rate in India
was determined by Reserve Bank of India by fixing the exchange rate of Rupee
into Sterling Pound upto Sep. 1975. Thereafter, Rupee's exchange rate was
linked to a basket of currencies in view of the diversification of India's
foreign trade. This policy existed upto June 1991. In July 1991, a two step
devaluation of the Rupee was engineered and US dollar was introduced as an
intervention currency. Liberalized Exchange Rate Management System was
introduced in March 1992. This was beginning of the dual exchange rate system
and the forex market in India effectively, became a two-tier system, with a
dual exchange rate system in force. One of which was the administered rate at
which specified type of currency exchange had to be transacted. The other rate
was determined by the demand and supply in the market and applied to the remaining transactions. In March 1993, this
system was abolished and a single market determined rate was applicable for all
transactions. The market spot and forward rates are determined by demand and
supply.
Currency movements are very
difficult to predict as there are many variables affecting the market movement.
However, over a longer term currency movement is determined by following
factors:
— Balance
of Payments
— Interest
Rate Differentials
— Inflation
— Fiscal
Deficit
— Global
economic conditions
— Speculation
and fear
Multiple factors determine an exchange rate
with each one playing an important role over time
1) Balance
of Payments: It is the sum of current account and capital account of a country
and is an external account of a country with other countries. Both current
account and capital account play a role in determining the movement of the
currency:
a)
Current Account Surplus/Deficit: Current account surplus means
exports are more than imports. In economics we assume prices to be in
equilibrium and hence to balance the surplus, the currency should appreciate.
Likewise for current account deficit countries, the currency should depreciate.
b)
Capital Account flows: As currency adjustments do not happen
immediately to adjust current
account surpluses and deficits, capital flows play a role. Deficit countries
need capital flows and surplus countries generate capital outflows. On a global
level we assume that deficits will be cancelled by surpluses generated in other
countries.
2) Interest Rate Differentials: This is based on
interest rate parity theory. This says that countries which have higher
interest rates their currencies should depreciate. If this does not happen,
there will be cases for arbitrage for foreign investors till the arbitrage
opportunity disappears from the market. The reality is far more complex as
higher interest rates could actually bring in higher capital inflows putting
further appreciating pressure on the currency. In such a scenario, foreign investors
earn both higher interest rates and also gain on the appreciating currency.
This could
lead to a herd mentality by foreign
investors posing macroeconomic problems for the monetary authority.
3) Inflation:
Inflation can be high inflation over a
short term or prolonged one. Over short-term foreign investors see inflation as
a temporary problem and still invest in the domestic economy. If inflation
becomes a prolonged one, it leads to overall worsening of economic prospects
and capital outflows and eventual depreciation of the currency.
4) Fiscal Deficit: Fiscal deficits play a role
especially during currency crisis. If a country follows a fixed exchange rates
and also runs a large fiscal deficit it could lead to speculative attacks on
the currency. Higher deficits imply government might resort to using forex
reserves to finance its deficit. This leads to lowering of the reserves and in
case there is a speculation on the currency, the government may not have
adequate reserves to protect the fixed value of the currency. This pushes the
government to devalue the currency. So, though fiscal deficits do not have a
direct bearing on foreign exchange markets, they play a role in case there is a
crisis.
5) Global
economic conditions: Barring domestic conditions, global conditions impact the currency
movement as well. In times of high uncertainty as seen lately, most currencies
usually depreciate against US Dollar as it is seen as a safe haven currency.
6) Speculation
and fear : Speculators play significant
role in determining the movement of currency in short term. Their deliberate
large positions in currency leads to increase and decrease in value of
currency. Sentiments also affects the
currency movement.
Rupee Movement Since 1991
Source : RBI
CURRENT SCENERIO
— Rupee hits
record low at 57.37 vs US$ on 22 June 2012…………….
— From a steady 1$
= 45 rupees till late last year the rupee has lost by a whooping Rs12 or it has
depreciated by 27%(as on 22 JUNE 2012)
— The depreciation
is far larger than what we saw during some of the other episodes of economic
turbulence in the last two decades, such as the Asian financial crisis of 1997
(13.86%) and the global shock after the collapse of investment bank Lehman
Brothers in late 2008 (9.2%).
Reasons for Rupee Depreciation
Growing European debt crisis fueled
global risk aversion weak domestic fundamentals coupled with policy paralysis
aided sharp rupee depreciation
Real reason
behind depreciation
•
Sentiments of people (Withdrawal by FII’s, no firm policy by congress, gold accumulation, dollar strengthening)
•
Speculation
•
Global
investors dumped currencies of emerging countries like India to buy U.S.
dollars
Supporting facts
• The foreign
exchange (Forex) reserves as of June 15, 2012 were around $289 Bn, just around
$ 20 Bn lower than a year ago, and about $ 2 Bn higher than a week prior. The
Forex situation has been fairly stable for the past year, with only minor and
‘routine’ fluctuations.
• FII remains long-term bullish based on equity inflows, with massive net
inflows of around Rs 36,000 Cr so far during 2012. Though there were net
outflows in April and May of Rs 1,600 Cr and Rs 3,100Cr, respectively, the
amounts are minor. In the current month to date, there have been minor net inflows
of around Rs 500 Cr.” (to June 26th).
Impact of rupee
fall
The gainers…………
— Exporters
(particularly who are using the resource and raw materials by paying them in
INR and getting return in USD)
— Companies
earning in USD
— Families of
those working overseas
— Tourism may get
small boost as foreigners will have to pay fewer dollars for vacationing in
India.
— Companies that
manufacture export substitutes will get protection through cheap imports.
— Indian Origin
people sending foreign currency to India and converting them into INR and
making permanent investment in India , the reason being they would be
getting more INR for lesser amount of USD.
The losers……….
— The worst-hit
will be companies that import components and other raw materials for products
they manufacture in India. These include auto-makers, and producers of consumer
durables like air-conditioners and televisions, or sellers of imported
electronic gadgets like speakers and headphones. These companies are already
facing the prospect of shrinking domestic sales as inflation has been high in
India, and now they will have to pay more rupees for their imports
— Companies will
have to pay more for repaying foreign debt.
— Higher oil
import bill could put greater strain on govt finances, given clamor for higher
subsidies
— Students will
have to pay higher fee and living charges in rupee terms. Medicare to also get
more expensive.
— Overseas travel
to get more expensive as you will have to shell out more rupees for the same
amount of dollars.
— Imports to get
costlier, hit oil and commodities.
— Foreign car
makers Toyota Motor Corp. and Honda Motor Co. have already voiced concerns that
imported parts could turn costlier and Toyota has said it may raise prices of
its cars and sport-utility vehicles.
— Infrastructure
companies which build roads, highways and airports could find it difficult to
raise money overseas to pay their projects as foreign investors may be deterred
by India’s volatile currency.
— The weak rupee
is also likely to stoke inflation, reducing the room for the central bank to
further cut interest rates. High rates have already made it very expensive for
companies to take loans from banks. And currency weakness could hurt the
financial performance of Indian refiners and oil marketing companies as it
makes oil imports more expensive
RBI corrective
role
Actions needed
— Work on investor
confidence
— Check demand
for crude products by rationalizing prices
— Promote exports
— Focus on
fast-tracking infrastructure projects
— Administrative
measures have been taken to curb market speculation
Remedial
measures
— Focus on
Knowledge Capital that can spearhead the growth in agriculture, industry and
trade (either borrow it or create it)
— Simplify trade
procedures in order to promote economy and entrepreneural spirit within
population
— Build infrastructure in every sphere for
augmenting growth and proper utilization of resources
— Promote Export
of manufactured goods and ban export of natural resources
— Promote technologies and systems that could
cut green house effect and improve our trade balance
— Develop Bulk
Water Transport system for inland sales within India's long coastline
— Promote Railways for bulk transfer of
resources within the hinterland
— Promote use of renewable energy in every
sphere possible: Solar Cookers, Air Conditioners, etc
— The RBI should
sell dollars from its reserves only to smooth out sharp volatility in the rupee
What can we do
as individual………..
— Be Indian Buy
Indian
— Return of NRI to
Own Country
— Stop to Import
All Zero Technology Products
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