SOURCE: http://blogs.reuters.com/india-expertzone/2013/08/23/how-to-rescue-the-falling-rupee/

INTRODUCTION :

Rupee has been continuing with its downward trend since a couple of weeks. Moving from bad to worse, The Finance Ministry, however, believes that the ‘unwarranted panic’ in the market will settle down in some time. Chief economic adviser Raghuram Rajan, too, is of the opinion that weakness in rupee could be a temporary phenomenon.

INDIAN RUPEE has been depreciating against U.S Dollar, but the year 2013 has seen its maximum depreciation.The Indian rupee touched a lifetime low of 68.85 against the US dollar on August 28, 2013. The rupee plunged by 3.7 percent on the day in its biggest single-day percentage fall in more than two decades. Since January 2013, the rupee has lost more than 20 percent of its value, the biggest loser among the Asian currencies.

SOME IMPORTANT CONCEPTS:

RUPEE APPRECIATION AND DEPRECIATION:

As per the rudimentary laws of economics if the demand for USD in India exceeds its supply then its worth will go up and that of the INR will come down in that respect. It may be that importers are the major entities who are in need of the dollar for making their payments.

The persistent decline in rupee is a cause of concern. Depreciation leads to imports becoming costlier which is a worry for India as it meets most of its oil demand via imports. Apart from oil, prices of other imported commodities like metals, gold etc will also rise pushing overall inflation higher.

The depreciating rupee will add further pressure on the overall domestic inflation and since India is structurally an import intensive country, as reflected in the high and persistent current account deficits month after month, the domestic costs will rise on account of rupee depreciation. Exchange rate is the price of foreign currency (USD, Yen, Euro, Pound

etc) in terms of domestic currency (rupee) i.e. amount of domestic currency needed to buy one unit of foreign currency.

If price of 1$ = ` 53.74, which means 1$ can be purchased in exchange of ` 54. Exchange rate tells us the value of domestic currency in relation to one unit of foreign currency. 1$ is worth ` 53.74.

Rupee prices keep fluctuating all the time. Sometimes we need more rupees to buy one unit of foreign currency and sometimes we need fewer rupees to buy one unit of foreign currency. This change in rupee price is known as rupee appreciation or depreciation.

Rupee appreciation is when value of rupee increases (becomes expensive) and fewer rupees can buy one unit of foreign currency. This is also known as strengthening of rupee as now INR is worth more than foreign currency. Suppose exchange rate changes to 1$ = ` 50, we say rupee has appreciated as 1$ can buy fewer INR.

Rupee depreciation is when rupee value decreases (becomes less expensive) and more rupees can buy one unit of foreign currency. This is also known as weakening of rupee as now INR worth is less than foreign currency. If exchange rate changes to 1$ = ` 55, we say rupee has depreciated as 1$ can buy more INR.

Currency price is always stated in relation to another currency. So when one currency appreciates the other currency depreciates.

What causes currency to appreciate or depreciate? Like any commodity whose price is determined by its demand and

supply, currency price is also determined by demand and supply of that currency in the international market.

When supply of a country’s currency increases, value of currency falls as more currency is required to purchase another currency causing currency to depreciate. Reverse holds true when demand for a currency increases.

Demand for a country’s currency comes from its export of goods and services and foreign investment in the country.

Supply for a country’s currency comes from its imports of goods and services and its investments in other countries.

Major factors which cause currency to appreciate or depreciate are current account deficit/surplus, capital account flows, interest rate and inflation.

Current account deficit is when imports are higher than exports. When a country imports more, it needs to pay in foreign currency, causing the country’s currency to depreciate as demand of its currency decreases. Reverse holds true in case of current account surplus.

Capital account flows- Current account deficit is funded by capital flows and current account surplus generate capital outflows (invest in other countries). When there is capital inflows in the country, demand for the currency increases leading to currency appreciation. Capital outflow causes the country’s currency to depreciate as supply of its currency decreases and demand for foreign currency increases.

FDI and FII: Capital inflow has two components: Foreign direct investment (FDI) and

foreign institutional investment (FII). FDI is investment made by foreign companies to create specific productive assets. These typically create a more stable availability of foreign exchange. FII is primarily money flowing into the capital markets (investment in stocks etc). This can come in and go out quickly and thus represents a relatively temporary source of foreign exchange.

The current devaluation is attributed officially to excess demand for dollars. This, however, does not explain what is actually happening. The ever persistent excess of imports over exports calls for a continuous inflow of foreign capital. Even if the capital does not go out (as FII sometimes does), even if it stops coming in, India could face a decline in the value of the

rupee. Since the early nineties, when India’s foreign exchange reserve was near zero, India has steadily built up its foreign exchange reserve, which is in hundreds of billions of dollars. The Reserve Bank of India normally uses this to ensure there is no undue turbulence in the value of the rupee.

JOURNEY OF INDIAN RUPEE: The Indian currency has witnessed a slippery journey since Independence.

Many geopolitical and economic developments have affected its movement in the last 66 years.

When India got freedom on August 15, 1947, the value of the rupee was on a par with the American dollar. There were no foreign borrowings on India's balance sheet.

To finance welfare and development activities, especially with the introduction of the Five-Year Plan in 1951, the government started external borrowings. This required the devaluation of the rupee.

After independence, India had chosen to adopt a fixed rate currency regime. The rupee was pegged at 4.79 against a dollar between 1948 and 1966.

Two consecutive wars, one with China in 1962 and another one with Pakistan in 1965; resulted in a huge deficit on India's budget, forcing the government to devalue the currency to 7.57 against the dollar.

The rupee's link with the British currency was broken in 1971 and it was linked directly to the US dollar.

In 1975, value of the Indian rupee was pegged at 8.39 against a dollar. In 1985, it was further devalued to 12 against a dollar. In 1991, India faced a serious balance of payment crisis and was forced to

sharply devalue its currency. The country was in the grip of high inflation, low growth and the foreign reserves were not even worth to meet three weeks of imports. Under these situations, the currency was devalued to 17.90 against a dollar.

1993 was very important. This year currency was let free to flow with the market sentiments. The exchange rate was freed to be determined by the market, with provisions of intervention by the central bank under the situation of extreme volatility. This year, the currency was devalued to

31.37 against a dollar. The rupee traded in the range of 40-50 between 2000 and 2010.

It was mostly at around 45 against a dollar. It touched a high of 39 in 2007. The Indian currency has gradually depreciated since the global 2008

economic crisis. Liberalising the currency regime led to a sharp jump in foreign investment

inflows and boosted the economic growth. the USD INR history summaryThis is the US Dollar (USD) to Indian Rupee

(INR) exchange rate history summary page, detailing 180 days of USD INR historical data from Thursday 21/03/2013 to Saturday 14/09/2013

Highest: 67.9576 INR on 28 Aug 2013. Average: 58.4158 INR over this period. Lowest: 53.6573 INR on 01 May 2013.

CAUSES

Higher Inflation

Increase in import prices of essential commodities such as crude oil, fertilizer, pulses, edible oils, coal and other industrial raw materials are bound to increase the prices of the final goods. Thereby making it costlier for the consumers and hence inflation might be pushed up further.

Prices of Crude oil

All over the world, the price of oil is given in dollars. This implies that as and when the demand for oil increases in India or there is an increase in oil prices in the global market, there also arises a need for more dollars to pay the suppliers. This also results in a situation where the worth of the INR decreases significantly in comparison to the dollar.

Volatility in the equity market

The equity markets in India have been volatile for a certain period of time. This has put the FIIs into a dilemma as to whether they should be investing in India or not. In recent times their investments have touched an unprecedented level and so if they pull out then the inflow will go down as well. Exchange rate risk also drives away foreign investors which in turn depreciates the local currency.

Poor current account deficit

One of the main reasons behind the Indian government’s inability to arrest the fall of the national currency is the critical current account deficit. The government has been unable to come up with any new destinations for exporting its products and this has also hampered the growth in this sector.

Increase in the Import Bill

Depreciation of the local currency results in higher import costs for the country. Failure of a similar rise being experienced in the prices of exportable commodities is going to result in a widening of current account deficit of the country. India’s import bill has been going up of late and most of this can be attributed to gold. This has also hampered India’s efforts to arrest the slide of the INR. Gold alone takes up more than 10 per cent of India’s import bill

RBI can sell forex reserves and buy Indian Rupee leading to demand for rupee. But using forex reserves poses risk also, as using them up in large quantities to prevent depreciation may result in a deterioration of confidence in the economy's ability to meet even its short-term external obligations.

Increase in Cost of Borrowings

Interest rate differentials in domestic and global markets encourage the industry to raise money through foreign markets however a fall in the rupee value would negate the benefits of doing so.

Interest Rate Difference:

Higher real interest rates generally attract foreign investment but due to slowdown in growth there is increasing pressure on RBI to decrease the policy rates. Under such conditions foreign investors tend to stay away from investing. This further affects the capital account flows of India and puts a depreciating pressure on the currency.

Lack of reforms:

Key policy reforms like Direct Tax Code (DTC) and Goods and Service Tax (GST) have been in the pipe line for years. A retrospective tax law (GAAR) has already earned a lot of flak from the business community. Attempts are being made to control the subsidy bills but fiscal deficit continues to hover around 5% of GDP. The government announced FDI in retail but had to hold back amidst huge furore from both opposition and allies. This has further made investors sentiment negative over the Indian economy.

IMPACTSPrimarily the consequences of weak rupee are to be felt through:

A. Increase in the Import Bill

A depreciation of the local currency results in higher import costs for the country. Failure of a similar rise being experienced in the prices of exportable commodities is going to result in a widening of current account deficit of the country.

B. Higher Inflation

Increase in import prices of essential commodities such as crude oil, fertilizer, pulses, edible oils, coal and other industrial raw materials are bound to increase the prices of the final goods. Thereby making it costlier for the consumers and hence inflation might be pushed up further.

C. Fiscal Slippage

The central government fiscal burden might increase as the hike in the prices of imported crude oil and fertilizer might warrant for a higher subsidy provision to be made for these commodities.

D. Increase in Cost of Borrowings

Interest rate differentials in domestic and global markets encourage the industry to raise money through foreign markets however a fall in the rupee value would negate the benefits of doing so. The next two sections of the study assess the impact of rupee depreciation on the:

• Import Bill of the Country

• Import of Key Commodities

Fertilizer

Thermal Coal

Vegetable Oil

Crude Oil

Fluctuations in India’s Rupee Rate and its Economic Impact

The Indian rupee is under great stress as overseas investors are paring their exposure to Asia’s third-largest economy amid international uncertainty and mounting worries over the domestic economy.

Rupee appreciation makes imports cheaper and exports more expensive. According to intelligence reports by the Associated Chambers of Commerce and Industry of India, sectors like petroleum and petroleum products, drugs and pharmaceuticals and engineering goods – which have import inputs of

as much as 77 percent, 19 percent and 21 percent, respectively – will gain if the rupee appreciates. They would have to pay less for the imported raw materials which would increase their profit margins.

Likewise, a depreciating rupee makes exports cheaper and imports expensive. So, it is good news for industries such as IT, textiles, hotels and tourism which generate income mainly from exporting their products or services. Rupee depreciation makes Indian goods and services cheaper for overseas buyers, thus leading to increases in demand and higher revenue generation. The foreign tourists would find it cost effective to come to India, therefore increasing the business of hotel, tours and travel companies.

India’s IT sector is dependent on foreign clients, especially the United States, for more than 70 percent of its revenue. When an IT company gets a project from a client, it pre-decides on the length of the contract and the cost of the project. The contracts with U.S. clients are usually quoted in U.S. dollar terms. So, the fluctuation in the exchange rate can bring about a considerable difference in the performance of a company.

Some companies undertake a range of measures like hedging exchange risks using forwards and futures contracts. This helps in mitigating some of the losses due to exchange rate fluctuations, but none-the-less the impact is substantial.

The exchange rate is a significant tool that can be used to examine many key industries; with fluctuations potentially having a serious impact on the economy, industries, companies, and foreign investors. Rupee appreciation is generally helpful for industries which rely closely on imported inputs while depreciation of the rupee is welcome news for industries which are exporting a majority of their products.

Impact on Common Man

•Imported goods: Buying imported stuff will become a very costly affair. You will have to shell out extra on imported goods.

•Fuel price: A weak rupee will increase the burden of Oil Marketing Companies (OMCs) and this will surely be passed on to the consumers as the

companies are allowed to do so following deregulation of petrol and partial deregulation of diesel.

•Students studying abroad: Students who are studying abroad will bear the brunt most owing to depreciating rupee.

•Country’s fiscal health: A frail rupee will add fuel to the rising import bill of the country and thereby increasing its current account deficit (CAD). A widening CAD is bound to pose a threat to the growth of overall economy.

Tourism: The depreciating rupee will surely be a dampener if you are planning your holiday abroad. Your travel charges as well as hotel charges will escalate drastically, let alone shopping and other miscellaneous spending activity.

Transported Goods: Take, for example, crude oil. A weak rupee will lead to higher import prices. Since petrol is fully and diesel partially decontrolled, oil marketing companies such as IOC and BPCL are free to hike their retail prices in tandem with the import-linked prices. Once the prices of both fuels increase progressively at the filling stations, it is followed by a cascading impact that is manifested in the form of an increase in transportation costs, leading to higher prices of goods that are transported from one part of the country to another, such as food, consumer durables and fast-moving consumer goods.

IMPACT ON BUSINESS :

•The fast depreciating rupee has hit hard Indian auto companies raising sharply import costs in a market which is already under pressure from a continuous slide in vehicle sales over the last seven months.

•Consumer companies are also hit by the deprecating rupee due to their dependence on imported and crude oil linked raw materials

•While the recent rupee depreciation against dollar may have brought some cheer for yarn exporters, the industry players are pushing for export orders to make the most of the situation. This depreciation may prove beneficial to Indian IT companies and other exporters. But this benefit depends on global demand and several other factors also. While this declining value may turn

beneficial for exporters but this is surely is putting a pressure on imports and consumers.

Articles under impacts

Falling rupee has little impact on Indian touristsMonday, Aug 19, 2013, 20:55 IST | Place: New Delhi | Agency: IANS The weakening rupee has had little impact on Indian travellers who remain eager to travel and have not cancelled or altered their plans waiting for the rupee to stabilise, leading travel portals said Monday.According to Yatra.com, which conducted a survey, 62 percent of the respondents are pursuing their holiday plans.The survey said that Southeast Asian countries are the destination of choice, followed by Europe, the US and Britain."While 43 percent of the respondents would like to travel within India, 45 percent said that the location would depend on the expenses involved," said the survey."We have been periodically mapping travel trends amongst our base of travellers to get a sense of their mood, and this latest survey seems to suggest that the market is still upbeat on holiday travel despite the depreciation in the rupee," Sharat Dhall, president, Yatra.com said."Travellers are confident that the currency depreciation will be offset by attractive discounts offered by hotels and flight operators," he added.The survey was conducted among 6,000 individuals, majority of them aged between 25 to 45 years.MakemMyTrip.com said travellers plan their holidays at least a couple of months in advance so currency fluctuation does not really have a major impact."Travellers who are exploring a holiday at a short notice are more likely to be influenced by currency movement. Some end up considering at short-haul destinations instead of long-haul ones to optimize their holiday budgets," Rajesh Magow, chief executive officer, MakeMyTrip said."Despite the concerns due to currency depreciation, we continue to witness growth in both domestic and international travel," he added.However, travel site Expedia.co.in said that there was a dip in Indians travelling to foreign destinations, but the depreciating rupee had also opened up huge opportunities in the domestic markets with the arrival of foreign tourists.Meanwhile, cost-cutting among Indian travellers is evident."Many travellers are looking at shortening the duration or downgrading accommodation or removing a short stopover from the itinerary," said Vikram Malhi, general manager, South and Southeast Asia Expedia

SOURCE: http://www.dnaindia.com/money/1876847/report-falling-rupee-has-little-impact-on-indian-tourists

Depreciation of Indian rupee can affect India’s economy: Indian PMConcerned over depreciation of Indian rupee, Indian Prime Minister Dr Manmohan Singh Friday said there are justifiable concerns that it would have an impact on India’s economy.New Delhi, Aug 30/Nationalturk – Terming depreciation of Indian rupee as a matter of concern, Indian Prime Minister Dr Manmohan Singh Friday said there are justifiable concerns that it would have an impact on India’s economy and advised people that there may be short term shocks to the economy and they need to face it.“The movement of exchange rate of Indian Rupee recently has been a matter of concern. The Rupee has depreciated sharply against the dollar since last week of May. There are concerns, and justifiably so, of the impact this would have on our economy,” Singh said while addressing country’s lawmaker in Lok Sabha, upper house of Indian parliament today.He said what triggered the sharp and sudden depreciation was the markets’ reaction to certain unexpected external developments. “On May 22, 2013, the US Federal Reserve Bank indicated that it would soon ‘taper’ its quantitative easing as the US economy was recovering. This led to a reversal of capital flows to emerging economies which are now sharply pulling down not just the Rupee, but also the Brazilian Real, the Turkish Lira, the Indonesian Rupiah, the South African Rand and many other currencies.”

SOURCE: http://www.nationalturk.com/en/depreciation-of-indian-rupee-can-affect-indias-economy-indian-pm-42284

MEASURES

1. Measures By RBI:

a. Using Forex Reserves: RBI can sell forex reserves and buy Indian Rupees leading to demand for rupee. But using forex reserves poses risk also, as using them up in large quantities to prevent depreciation may result in a deterioration of confidence in the economy's ability to meet even its short-term external obligations. And not using reserves to prevent currency

depreciation poses the risk that the exchange rate will spiral out of control. Since both outcomes are undesirable, the appropriate policy response is to find a balance. Recent data shows that RBI had indeed intervened by selling forex reserves selectively to support Rupee.

b. Raising Interest Rates: The rationale is to prevent sudden capital outflows and ultimately lead to higher capital inflows. But India’s interest rates are already higher than most countries. This was done to tame inflationary expectations. So further raising interest rates would lead to lower growth levels.

c. Make Investments Attractive- Easing Capital Controls: RBI can take steps to increase the supply of foreign currency by expanding market participation to support Rupee. RBI can increase the FII limit on investment in government and corporate debt instruments. It can invite long term FDI debt funds in infrastructure sector. The ceiling for External Commercial Borrowings can be enhanced to allow more ECB borrowings.

2. Measures by Government: Government should take some measures to bring FDI and create a healthy environment for economic growth. Key policy reforms that should be initiated includes rolling of Goods and Services Tax (GST), Direct Tax Code (DTC), FDI in aviation and retail, Companies Bill and diesel decontrol. Efforts should be made to invite FDI but much more needs to be done especially after the holdback of retail FDI and recent criticisms of policy paralysis. The government took steps recently to loosen rules for portfolio investment in the Indian market, indicating its desire to sustain external inflows. The measure to increase External Commercial Borrowings (ECB) to $10bn will help in borrowing in dollar at a less cost. It may take similar steps to encourage FDI as well, helping sustain external funding.

How to rescue the falling rupee

By RAJAN GHOTGALKAR

I can’t predict where the rupee will eventually land and I don’t think anyone else can either.

Of course, we are not the only country at the mercy of the dollar because almost every emerging market is suffering. But surely, that shouldn’t be any consolation.

The rupee has depreciated about 50 percent in the past three years and 15 percent this year. The situation is extremely worrying for us because of the debilitating impact it will have on India’s economic fundamentals that have been pushed to the brink by global factors.

The dollar seems to be flexing its muscle and violently at that. The U.S. Fed minutes did not soothe jangled nerves and markets continue to expect that QE3 tapering will commence in September. The U.S. trade deficit seems far healthier than a year ago and the country’s economy is in better shape. QE3 tapering is a foregone conclusion. But when it does hit us, I expect a lot more pain.

In India, there is a sense of despondency in the wake of policy announcements that haven’t really been executed. There is a sense of loss of credibility. It is unfortunate that these strains have surfaced in the midst of a change of guard at the Reserve Bank of India (RBI).

Sadly, we can’t say we did not see it coming. The RBI has been pointing to the twin deficits – fiscal and trade – for long while waging a losing battle on the monetary front. The International Monetary Fund (IMF) pointed out early this year that our fiscal deficit and inflation were among the highest in emerging markets. Our dependence on hot FII portfolio money was always there for all to see.

Our government, the markets and the rupee hid behind a huge wall of liquidity in the global markets. Looking back, it almost seems as though the RBI commenced its interest reduction cycle a bit too early and the outgoing governor did not wish to leave without correcting what he may believe was an error in policy judgment.

The fall in the rupee is a mere manifestation of the deeper malaise – high inflation, low interest rates combined with low growth.

The root of the problem lies in the consistently negative rate of interest imposed on savers. An open economy has its own ways of correcting artificial imbalances created by its policymakers. Negative real interest rates will almost always break out into currency depreciation. When this happens, no amount of intervention can help till the currency finds its right level.

Holding on to negative real interest rates for a long time has driven household savers into non-financial assets – in India, that means gold.

To begin with, there needs to be a true gold alternative. In the past few years, gold ETFs and loans added to its liquidity. Banks and PSUs pushed gold coins to cash in on the craze. Buying gold in India is as easy as buying a bar of chocolate.

Inflation-linked bonds can never be successful as an alternative to gold unless the government is courageous enough to give post-tax inflation-linked real returns. At the same time, gold loans and ETFs should be made inaccessible.

It’s time to also go back grovelling to the NRIs hoping that they will return for the premiums over international dollar interest rates.

Also, shouldn’t we open up incoming FDI for all sectors, except those considered sensitive to national interests? Especially for infrastructure, capital-intensive and environmentally safe projects. One would rather approve outgoing FDI on a case-by- case basis ensuring that, like in the case of China, they are in national strategic interest.

I do not see anything wrong in heavily taxing imports of luxury consumables and durables; and preventing low-value imports that can be produced locally. Given our vulnerabilities in coal and oil-based

energy, pretending that we can do away entirely with capital controls is

utopian.

The other day, a friend told me that “it was easier to import than transport” in India and there lies the real solution in the long run. Our manufacturing sector has to grow aggressively and has to be provided with enabling infrastructure. India needs to promote its own economic union with the goods and services tax. We spend an estimated $25 billion on defence imports; after 60 years we surely can do something to substitute this.

While NREGA and food security can be justified, inflation led by fiscal deficit has to be controlled by eliminating indirect subsidies and freeing up agricultural trade. To revive the rupee, we need to rein in the twin deficits. At the same time, painful as it may seem, we need to hold on to interest rates at a ‘real’ level to encourage household savings.

Most importantly, we need a majority government with a clear mandate for development. For now, India will have hold on till the next elections.

SOURCE: http://blogs.reuters.com/india-expertzone/2013/08/23/how-to-rescue-the-falling-rupee/