[Economics] Depreciation of Rupee

[Ranjith]

Depreciation of Rupee:

The decline in the rupee is due to foreign institutional investor outflows, rising trade deficit and strengthening dollar.

 

·         Floating exchange rates, or flexible exchange rates, are determined by market forces without active intervention of central governments.

·         Any economic activity in the international market which leads to inflow of the US Dollar in the country like earnings from exports, remittances of NRIs, inflow of FDI and FII etc result in the enhancement of supply of US Dollar in the country.   à Results in appreciation of Rupee

·         On the other hand payments for imports, domestic investors investing abroad, outflow of FIIs etc leads to enhancement of demand of US Dollar. à Results in depreciation of rupee

·         A country that sells more goods and services in overseas markets than it buys from them has a trade surplus. This means more foreign currency comes into the country than what is paid for imports. This strengthens the local currency. In case of trade deficit country like India, it is vice versa.

 

Reasons for rupee depreciation:

·         Interwoven in the domestic policies(hurdles for investment)& global economic scenario.

·         Widening Current Account Deficit – in a crude term: spend more US Dollar then we earn.

·         European debt crisis has resulted in the appreciation of US Dollar.

·         In order to mitigate the economic meltdown that reached its climax in US in 2007-08, the Federal Reserve of US (Fed) adhered to the fiscal stimulus. Off late there are signs of recovery, Fed keen to stop stimulus. à US dollar dearer.

·         Volatile equity market - the decrease in supply(pull out of FIIs) and increase in demand of dollars results in the weakening of the rupee against the dollar.

·         Role of 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.

 

Advantages:

·         If the rupee falls, import becomes dearer & export becomes cheap. So it will act as stimulus for export.

·         Investors shift focus to more export-oriented sectors like garment design, IT services etc.

·         Companies focusing on exports of goods and services are seeing a sudden surge in demand like garment exporters.

·         India is a major exporter of spices and the recent weakening of the rupee has reportedly boosted overseas demand of certain spices like pepper

·         Technology companies have generally benefitted from the falling rupee because they tend to have a part of their costs denominated in rupees while the revenue is dollar denominated. 

·         NRIs gain

 

Disadvantages:

·         It makes imports expensive, and for a net-importing country, the import bill baloons. Two major import items are crude oil and bullion.

·         Foreign education and vacations will be costlier.

·         Manufacturing and other companies that need to import raw materials or energy are likely to be adversely impacted.

·         longer-term investments/project valuations are likely to be adversely affected if the rupee to dollar exchange rate remains volatile.

 

Government steps:

·         The Indian government tried to arrest through market intervention and other measures, including raising the tax on gold imports.

·         the Reserve Bank of India to supply dollars from its reserves through a local bank to the country’s state-controlled oil refiners and distributors.

·         By allowing banks to increase rates on NRI rupee accounts and bring them on a par with domestic term deposit rates, the RBI expects fund inflows from NRIs, triggering a rise in demand for rupees and an increase in the value of the local currency.

·         FDI reforms. The decision by the government to allow foreign investors to directly invest in Indian equity could bring some capital flows and have a positive impact on the economy and the rupee.

 

Conclusion:

·         Exporters would be expected to benefit from a cheaper rupee. But poor roads, restrictive labor laws and heavy regulation have left India with a manufacturing sector that, although stronger than a decade ago, still struggles to compete with China and other East Asian economies.

·         India grapples with its “new normal” — a weak currency, growth at a decade-low of 5%, stubbornly high consumer price inflation and elevated interest rates that are stifling investment.

 

Reference:

http://www.halfmantr.com/display-ecomonic-issue/1472-depreciation-of-rupee

http://businesstoday.intoday.in/story/rupee-dollar-value-drop-factors-for-fall/1/21881.html