Final Placements @ FinStreet 2012-13

Rupee Depreciation
India has a Managed float exchange rate system. The exchange rate is basically determined by supply-demand of dollars. However, there is no fixed upper or lower limit set by RBI. RBI intervenes in the foreign exchange rate market only when the exchange rate is too uncomfortable on either side. INR has depreciated against the USD by almost 23.8% from 44.06 in Jul 2011 to 54.7 in Jan 2013. Depreciating rupee has an adverse effect on the economy and the corporate sector.

INR per USD

60 55 50 45 40

2012 Average 2012 Low 2012 High

53.5051 56.4733 49.2776

Causes of Rupee Depreciation:

1. Increasing Current Account Deficit: Indias current account deficit widened to a record 5.4% of gross domestic product (GDP) in the Q2FY13 from 4.2% in the year-ago period, signalling the countrys increasing vulnerability to external shocks. The rise in the current account deficit to $22.3 billion from $16.4 billion was mainly on account of a widening trade deficit and a slowdown in inward remittances from overseas Indians. The deficit in trade balance widened on account of subdued external demand and relatively inelastic imports of Petroleum, Oil and Lubricants and precious metals (gold and silver). Exports have declined to $69.8 bn while imports have hovered around $118 in Q2FY13.

2. Outflows by Foreign Institutional Investors: FIIs lead to a high inflow of dollars into the Indian market. As FIIs are taking their investments out of the Indian markets, it has led to an increased demand for dollars, further leading to a spiralling rupee. Current Affairs Compendium Page 1

Final Placements @ FinStreet 2012-13 3. Adverse Indian Economic Outlook: For over 1.5 years, Indian economy has been plagued by high rate of inflation, low growth in manufacturing sector, uncontrollable fiscal deficit, a widening current account deficit, increasing external debt and high interest rates culminating into so called policy paralysis The cumulative effect of these factors is leading to a shift in investor sentiments away from the Indian market. 4. Grim global economic outlook: Due to the European debt crisis, investors are considering dollars as a safe haven for their investments in the longer run. This led to an increased demand for dollars vis--vis the supply for rupee and thus the depreciation. Also, austerity in the euro region can lead to reduced flow of funds. Also, investors who are shifting away from European markets are not investing in the Indian markets. 5. Speculation: Due to a sharp increase in the dollar rates, importers suddenly started gasping for dollars in order to hedge their position, which led to an increased demand for dollars. On the other hand exporters kept on holding their dollar reserves, speculating that the rupee will fall further in future. This interplay between the two forces further fuelled the demand for dollars while sequestering its supply from the market. This further led to the fall in rupee

Impact of Rupee Depreciation:

Rising import bill: India imports close to 70% of its net fuel requirements. This means the companies importing oil have to shell out more rupees for the same dollar invoices. Even if the price of oil in USD per barrel goes down, not much benefit can be derived if exchange rate too depreciates. This has severely impact on the bottom line of these companies as well as the subsidy bill of the Indian government. Huge buying of dollars from the market in order to meet the import bill has further added to the existing woes. Increasing Inflationary pressure: Imports have become costlier and thus increasing the prices of key commodities such as oil, imported coal, minerals, and metals. This further adds to the inflationary pressure.

Measures for RBI to control Rupee Depreciation:

1. High Interest rates: Historically, rise in the policy rates has been adopted as a measure by many nations to prevent sudden capital out-flows thereby check meltdown of their respective currencies. However, RBI has raised interest rates several times since March 2010 to tame inflationary expectations. Thus, further increasing the policy rates is not the most attractive proposition for Indian policy makers, as it has already dented the economic growth. Most economists are concerned that current interest rates in India, which are already higher than most countries, could not attract capital flows. However, any decrease in these rates could potentially lead to further capital outflows and hence the RBI is adopting a cautious approach in reducing the rates. 2. RBI has also increased rates on Non-Resident Deposits to attract more dollar deposits. 3. Selling Forex Reserves Dollars: RBI has intermittently intervened by selling dollars to tame sharp fall in the currency. The outflow of dollar reserves from RBI coffers has been extremely cautious, mostly due to the dwindling foreign exchange reserves Current Affairs Compendium Page 2

Final Placements @ FinStreet 2012-13 Apart from this, government needs to initiate measure to revive the economy and increase the investor confidence in the economy. Measures like FDI in Retail, Aviation, etc are a step in the right direction.

Sources:
Monetrix Blue Chip Issue 1 (Apr-Jun) http://www.iitk.ac.in/ime/MBA_IITK/avantgarde/?p=618 http://www.livemint.com/Politics/vWyxVAAYjSJSjMl37VwvFO/India-JulySept-current-accountdeficit-at-record-high-54.html RBI website

Current Affairs Compendium

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