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