51-depreciation of the indian currency- implications for the indian economy

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W O R L D A F F A I R S S U M M E R 2 0 0 9 V O L 1 3 N O 2148

DEPRECIATION OF THE INDIAN CURRENCY

IMPLICATIONS FOR THE INDIAN ECONOMY

The Indian currency depreciated more than 20 per cent in 2008 and evenbreached the crucial 50-level mark against the greenback on sustained dollarpurchases by foreign banks and a strong dollar overseas. There were severalconsequences of the falling Indian rupee with mixed effects on the Indianeconomy. While exports rose, so too did the costs of imported goods, capital-intensive projects and dollar loans taken by companies, which increased theforeign debt. Overall, economic growth slowed down as interest rates rose andforeign institutional investment flows ebbed. This paper studies the realimplications of the depreciation of the rupee on the Indian economy and showsthat in the long run, the Indian economy has more to lose and less to gainfrom a weaker rupee.

SUMANJEET SINGH

The Indian currency has gone through drastic changes in the recent past.The sudden upsurge in the value of the rupee (Rs) at the close of the2006–7 financial year, which took most market players by surprise and

made it one of the best performing Asian units, lost ground and the rupee sufferedone of its steepest slides against the greenback in the following year. On April 16,2007, the rupee quoted a nine-year high against the US dollar at 41.86. Surprisinglyat the end of May 2007, the dollar strengthened quite significantly against almostall currencies, but failed to impress the rupee. By mid-October 2007, the Indianrupee had appreciated by 20 per cent from Rs 49 a dollar in 2002 to Rs 39 a dollar.Most of the appreciation (11 per cent) occurred after March 2007 (SumanjeetSingh, “Appreciation of the Indian Currency: Implications for the Indian Economy”,

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V O L 1 3 N O 2 S U M M E R 2 0 0 9 W O R L D A F F A I R S 149

World Affairs: The Journal of International Issues, Vol 11, No 4, pp 52–69, Winter2007). While economists and experts predicted an even stronger rupee in 2008,the trend reversed at the beginning of the year. The rupee depreciated more than 20per cent in 2008. Currency depreciation is the loss of value of a country’s currencywith respect to one or more foreignreference currencies, typically in afloating exchange rate system. It isusually used to denote the unofficialincrease of the exchange rate due tomarket forces, though sometimes itappears interchangeable withdevaluation. Its opposite is calledappreciation. The massive 20 per centdepreciation in the last fiscal year againstthe dollar can be divided into fourdistinct phases. In April 2008, the rupee–dollar exchange rate hovered around 40; end-April to mid-May 2008, with a sharpdepreciation of 5 per cent the rupee reached around 42 within two weeks; mid-May to August 2008 the rupee remained at around 42–3 and after August 2008, itdepreciated more than 11 per cent until the latter half of October 2008 (Graph 1).

Graph 1: Depreciation of the Indian Rupee against the US Dollar,January–October 2008

By mid-October 2007, theIndian rupee had appreciated by20 per cent from Rs 49 a dollarin 2002 to Rs 39 a dollar. Whileeconomists and experts predictedan even stronger rupee in 2008,the trend reversed at thebeginning of the year. The rupeedepreciated more than 20 percent in 2008.

D E P R E C I A T I O N O F T H E I N D I A N C U R R E N C Y

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On October 17, 2008, the Indian rupee fell to its lowest in more than 6 years.On June 25, 2002, it was at 48.8775 and on October 17, 2008, it was again at

48.88. On October 22, 2008, the rupeefell to 49.50, at which point it had fallen20.4 per cent in 2008. On October 24,2008, the rupee breached the crucial 50-level mark against the greenback onsustained dollar purchases by foreignbanks and a strong dollar overseas. Ittumbled to 50.05 ahead of the ReserveBank of India’s (RBI) mid-term reviewof the monetary policy 2008–9. Thepolicy’s highlights were as follows:

1. The cash reserve ratio remained unchanged at 6.5 per cent.2. Repo and reverse repo rates remained unchanged at 8 and 6 per cent

respectively.3. Bank rates remained unchanged at 6 per cent.4. Gross domestic product projections were lowered to 7.5–8 per cent for

the 2009 financial year.5. Inflation was to be brought down to 7 per cent by March 2009.6. RBI aimed to bring inflation down to 5 per cent at the earliest.7. The medium term inflation target was 3 per cent.8. Double digit inflation was still regarded as a matter of concern.9. An infusion was made to ensure enough liquidity in the banking system.

While the rupee depreciated against the dollar more than most other Asiancurrencies in 2008 (Table 1), it also depreciated against other strong currencies likethe euro and the yen. On January 1, 2008, the Indian rupee opened at 57.51 and35.29 against the euro and 100 yens respectively and reached 67.95 and 43.85respectively on September 26, 2008, a decrease of more than 15 per cent since thebeginning of the year.

On October 24, 2008, the rupeebreached the crucial 50-levelmark against the greenback onsustained dollar purchases byforeign banks and a strong dollaroverseas. It tumbled to 50.05ahead of the Reserve Bank ofIndia’s mid-term review of themonetary policy.

S U M A N J E E T S I N G H

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CAUSES OF THE DEPRECIATION OF THE INDIAN RUPEE

As the Indian currency sharply depreciated not only against the dollar, but alsoagainst other world currencies, it is imperative to understand the factors

contributing to its fall in the global market. A myriad of factors can cause currencydepreciations—economic, political, the prevalence of corruption, etc. Some factorsrequire greater attention and should be analysed objectively. There were four keyfactors behind the depreciation of the Indian rupee:1. The flight of foreign funds from the Indian market.2. The slowdown in capital inflows, which decreased the supply of dollars.3. The higher global crude oil prices, which widened the current account deficit

and increased dollar buying by oil companies.4. The recovery of the dollar.

The main reason behind the falling rupee was the flight of foreign funds fromthe Indian market. From May to August2008, foreign exchange (forex) reservesfell by $ 25.87 billion taking intoaccount the actual position and effectof the appreciation and depreciation ofnon-US currencies, like the euro, thepound sterling and the yen, held inreserve. Between September 26 and

The main reason behind thefalling rupee was the flight offoreign funds from the Indianmarket. Forex reserves peaked at$ 316.17 billion in May 2008but fell continuously thereafter.


Table 1: Select Asian Currencies against the DollarSelect Asian Countries Value of Currency

January 2008 September 11, 2008 Per Cent ChangeKorean Won 936.95 1109.20 24.77Thai Baht 29.75 34.78 18.38Indian Rupee 39.44 45.53 16.91Malaysian Ringgit 3.31 3.47 15.45Indonesian Rupiah 9368.00 9440.00 4.83Singapore Dollar 1.44 1.45 .54Hong Kong Dollar 7.81 7.80 .17Taiwan Dollar 32.45 32.08 1.67Japanese Yen 109.66 106.58 1.16

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October 24, 2008, forex reserves fell by $ 33.4 billion as the RBI intervened heavilyin forex markets to supply dollars. Forex reserves peaked at $ 316.17 billion inMay 2008 (Graph 2) but fell continuously thereafter. Forex reserves dipped by $15.4 billion for the week ending October 24, 2008 to touch $ 258.4 billion.

Graph 2: Fall in the Foreign Exchange Reserves of India

The barometer index Sensex fell9,759.13 points or 48.1 per centin the first three quarters of 2008from its close of 20,286.99 onDecember 31, 2007. Net salesby FIIs amounted to $ 932.8million in September 2008 and$ 13.00 billion during the year.

Another reason for the depletion (apart from the revaluation of the dollar againstother international currencies) was the net sale in equity markets by foreign funds,which sold equity worth $ 500 million on October 10, 2008. There was fear andpanic on the Indian stock market as bourses suffered heavy losses on the back of

global sell-offs and on data showingdismal industrial production growth inAugust 2008. On October 10, 2008,the BSE 30-share Sensex ended down800.51 points or 7.07 per cent at10,527.86. The index plunged 1,088.50points at the day’s low of 10,239.76 atthe onset of the trading session, itslowest level since July 24, 2006. TheSensex fell 424.33 points from the day’s

high of 10,904.13, in early trade. The Standard & Poor’s Crisil National StockExchange Index 50 (Nifty) fell 233.70 points or 6.65 per cent to 3,279.95. TheNifty hit a low of 3,198.95 in early trade, its lowest level since August 9, 2006.


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From the high of 13,055.67 on October 1, 2008, the Sensex lost 2,527.81 pointsor 19.36 per cent. The barometer index Sensex fell 9,759.13 points or 48.1 percent in the first three quarters of 2008 from its close of 20,286.99 on December31, 2007. It was 10,678.91 points or 50.35 per cent below its all-time high of21,206.77 on January 10, 2008 (Graph 3). This was one of the highest single dayliquidations of equities by foreign institutional investors (FIIs). FIIs stepped upselling from the beginning of September 2008 as major investment banks andother financial firms such as Lehman Brothers and Merrill Lynch plunged intodeep trouble, followed by others such as the American Insurance Group, MorganStanley and Goldman Sachs. According to the Securities and Exchange Board ofIndia (SEBI), net sales by FIIs amounted to $ 932.8 million in September 2008and $ 13.00 billion during the year.

Graph 3: Performance of the Indian Stock Market in 2008

Further, the demand for the rupee dipped, as capital inflows decreased due tothe global financial crisis (Shalini S Dagar, “Economy in Eclipse”, Business Today,Vol 17, No 22, pp 82–6, November 2, 2008). The quantum of FII money in theIndian stock market plays a significant role in the movement of the exchange rate.In the last few years, despite the trade deficit, the value of the Indian currency hadrisen mainly due to the surge in FII inflows into the country. A decline in external


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commercial borrowings (ECBs) was another reason behind the rupee’s depreciation.In 2007, the RBI tightened norms, restricting the use of ECB funds for rupeeexpenditure on capital goods, new projects and modernisation and expansion inthe manufacturing and infrastructure sector. As per its directive, ECB money couldbe used for rupee expenditure up to $ 20 million and only after gaining the RBI’s

permission. The $ 20 million restrictionwas later relaxed to $ 100 million. Asper a study of the Associated Chambersof Commerce and Industry of India, thetotal funds raised through ECBs bycompanies in India declinedsubstantially from $ 11.85 billion inApril–July 2007–8 to $ 6.53 billion inthe corresponding period of 2008–9,recording a negative growth rate of

44.95 per cent. The study also showed a decline in companies raising capital throughECBs by 54.29 per cent from 280 companies in the first four months in the lastbut one fiscal to 128 in the corresponding period in the last financial year.

The deficit in the current account of the country’s balance of payments widenedfurther as the oil import bill (one of the key factors leading to the rupee’s depreciationis the impact of high crude prices on the merchandise account) grew faster thanincome from software services exports and remittances from the Indian diaspora.Figures released by the RBI indicated that the current account deficit amounted to$ 10.72 billion during the quarter ended June 2008 as compared to a deficit of $6.3 billion in the same quarter of the previous year. The current account in thebalance of payments measures the net position of a country’s exports and importsof goods and services. The deficit was despite the surplus in invisibles (servicesincome and remittances among others) being higher at $ 20.8 billion ($ 14.4 billion)to absorb the trade deficit of $ 31.6.79 billion ($ 20.7 billion) during the quarter.While oil imports recorded a significant growth of 50.4 per cent in the first quarter(Q1) of 2008–9 (23.9 per cent in Q1 of 2007–8), non-oil imports showed arelatively modest growth of 20.9 per cent (45.1 per cent in Q1 of 2007–8). TheRBI said that the sharp increase in the value of oil imports reflected the impact of

The total funds raised throughECBs by companies in Indiadeclined substantially from$ 11.85 billion in April–July2007–8 to $ 6.53 billion in thecorresponding period of 2008–9,recording a negative growth rateof 44.95 per cent.


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increasing oil prices of the Indian basket of international crude (a mix of Oman,Dubai and Brent varieties), which increased to $ 118.8 per barrel in Q1 of 2008–9from $ 66.4 per barrel in the corresponding quarter of the previous year.

Another factor for the falling rupee was the general strengthening of the dollaragainst major global currencies like the euro and the pound as well as against manyemerging and developing market currencies. The appreciation or depreciation ofcurrencies is influenced by the strengths and weaknesses of competitive currencies.After a sharp depreciation of the dollar in the second quarter of 2008, it recoveredsignificantly and in the third quarter gained strength against most major currenciessetting a new high for the year against the euro. Part of the dollar’s strength was tiedto the settlement of $ 400 billion of the Lehman Brothers credit default swapswith the euro and the sterling (Rishi Joshi, “The Rupee Conundrum: Is India IncPrepared to Deal with the Volatility in the Indian Currency?”, Business Today, Vol17, No 21, pp 23–4, October 19,2008). The yen however, proved to bethe exception, as it continued to benefitfrom the weakness in the euro and othercrosses. Towards the end of 2008, thedollar was down 0.79 to 101.07 againstthe yen, while against the dollar, the eurowas down 0.0165 to 1.3179 and thepound sterling was down 0.0195 to1.6959. The dollar also gained 0.0173to 1.2084 against the Canadian dollar, with its session high of 1.2138 correspondingto a new three-year low. The loonie was sold off in a dramatic fashion after theBank of Canada opted to cut interest rates to 2.25 per cent.

There is also a relationship between high inflation and the depreciation of acurrency. Generally, high inflation and uncertainty about future inflation discourageinvestments and savings. As high inflation raises uncertainty in the economy, it alsoleads to lower equity values. This was one of the reasons for the Indian stockmarket’s almost daily decline in 2008. On October 27, 2008, the Indian stockmarket crashed, with the benchmark Sensex plunging below the psychosocial 8,000level. According to a list of positions of Indian securities lent overseas by FIIs as on

While oil imports recorded asignificant growth of 50.4 percent in the first quarter (Q1) of2008–9 (23.9 per cent in Q1 of2007–8), non-oil importsshowed a relatively modestgrowth of 20.9 per cent (45.1per cent in Q1 of 2007–8).


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October 9, 2008, issued by SEBI on October 31, 2008, the stocks in which FIIshad lent the largest quantity of shares were among the worst affected in the stockmarket slide.

Tracking the weak global trend (Table 2), the benchmark Sensex lost over 750points to hit an over three-year low of 7,939–7,939.02, a level last seen on November2, 2005. A comparison of benchmark indices indicates that while investors acrossthe globe suffered, those in emerging markets suffered more than in the developedworld. In October 2008, Brazil’ Bovespa lost almost 25 per cent; Russia’s RTSshed 36 per cent; India’s 30-share Sensex fell close to 24 per cent and the broaderNifty almost 27 per cent; Korea’s Kospi came down 24.6 per cent while the DubaiFinancial Market dropped more than 28 per cent. The fall was less stark in developedmarkets. The Dow Jones Industrial Average shed 15 per cent in October 2008;Nasdaq fell 18 per cent; London’s FTSE dropped 13.4 per cent, Germany’s DAXlost 16 per cent; Australia’s ASX 200 came down 12.6 per cent and Japan’s Nikkei

and Hong Kong’s Hang Seng declined20 per cent each. When the going wasgood until December 2007, theemerging markets had topped the listof gainers. In 2007, the Bovespa, RTS,Sensex, Kospi and China’s ShanghaiComposite, had risen between 20 percent and 97 per cent, whereas marketssuch as Hang Seng, Dow Jones, Nikkeiand FTSE had posted returns between11 per cent and 39 per cent. (Tania K

Jaleel, “Emerging Markets Most Hurt in Bear Run”, The Businessline, October 31,2008). In short, the stock market became a moving target, constantly shiftingdownwards as sellers desperately dumped stocks. The declining Indian stock marketthus became associated with the flight of foreign funds. Further, the high prices ofwheat and palm oil inflated the import bill, which was already under stress due tosoaring crude prices in the international market.

Last but not the least, were the policies of the RBI. Generally, the RBI intervenesin the Indian currency market whenever the rupee exhibits signs of extreme volatility.

High inflation and uncertaintyabout future inflation discourageinvestments and savings. As highinflation raises uncertainty in theeconomy, it also leads to lowerequity values. This was one ofthe reasons for the Indian stockmarket’s almost daily decline in2008.


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Although the exchange rate system in India is supposed to be a full float, the RBIintervenes at regular intervals to direct movement in rupee values (“managed float”).The intervention by the RBI in the market can be passive (off-market deals) oractive (dollar buying/selling). Intervention can also be made through statements(to the press or otherwise) in times of exchange rate crises, or in extremecircumstances, through a package of monetary and other measures. Thus, incomparison to currencies like the dollar and the euro, which are determined bymarket movements, the Indian rupee is partially managed by the RBI. The balanceof payment crisis in the 1990s, when the rupee was devalued was a case in point.

Table 2: Bear Assault in Emerging Markets

Name of Index October 30, 2008 Per Cent Fall

RTS 758.71 36.00

DFM 2942.03 28.70

Nifty 2885.60 26.90

Sensex 9788.60 25.02

Bovespa 37449.00 24.70

Kospi 1084.72 24.60

Hang Seng 14329.85 21.30

Nikkei 9020.76 20.50

Nasdaq 1698.52 17.90

DAX 4869.30 16.10

Dow Jones 9180.69 15.20 FTSE 4291.60 13.40

ASX 4018.00 12.60

The devaluation of the rupee in 1991 by about 22 per cent brought about a sharpdrop in its value against the dollar. The decline was hardly surprising, given thegreat strain on the economy during the 1990s, when the external account perilouslyreached breaking point. A host of factors, including the domestic political crisesand an increase in oil prices, contributed to the decline in the rupee’s value. India’scredit rating was downgraded twice (with the second downgrade placing the countryin the “speculative grade”) and with instalment payments against some foreignloans coming due, the economy nearly collapsed.


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CONSEQUENCES OF THE DEPRECIATION OF THE RUPEE

There were several consequences of the falling Indian rupee with mixed effectson the Indian economy. While exports rose, so too did the costs of imported

goods, capital-intensive projects and dollar loans taken by companies, whichincreased the foreign debt. Overall, economic growth slowed down as interest ratesrose and FII flows ebbed.

The first impact of the devaluation of the currency was the stimulation ofmerchandise exports, particularly in the textiles, leathers and handicrafts sectors,which had been reeling under the impact of a rising rupee. The falling rupee broughtrelief as traditional markets in the United States (US) and Europe slowed down.According to industry estimates, about 25 per cent of orders booked at the end of2008 were due to the currency advantage Indian companies enjoyed over othercountries like China. Amid the global meltdown, India’s export orientedcommodities continued to perform well, as shown by the prices of cotton, sugarand sesame seed. However, prices of commodities like base metals, precious metals,edible oils and crude continued to move in tandem with international prices (Table 3).


Table 3: Performance of Various Export Oriented CommoditiesCommodities November 8, 2007 October 27, 2008 Per Cent Change

Cotton Shankar (Rs/Qtl) 5343.00 6327.00 18.42

Sugar M30 (Rs/Qtl) 1452.50 1847.50 27.19

Sesame Seed (Rs/Qtl) 3500.00 6550.00 87.14

Ground Nut Oil (Rs/10 Kg) 650.00 610.00 -6.15

Refined Soya Oil (Rs/10 Kg) 505.00 338.00 -5.94

Copper ($/Tonne) 7021.00 3721.00 -47.00

Aluminium ($/Tonne) 2565.00 1876.00 -26.86

Zinc ($/Tonne) 2720.00 1062.00 -60.93

Lead ($/Tonne) 3505.00 1140.00 -67.47

Nickel ($/Tonne) 32100.00 8810.00 -72.55

Brent Crude ($/bbl) 93.24 59.20 -36.71

Gold (Rs/10 gms) 10605.00 11855.00 11.79

Gold London ($/oz) 841.10 723.09 -14.03

US Dollar 39.33 49.87 -26.80

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Export-oriented sectors like information technology (IT) and auto componentsgained (CNM Lavanya, “The Impact of Rupee Depreciation”, The Hindu,November 2, 2008). Technology is among the more sensitive sectors, with a closerelation to the rupee–dollar movement. Hence, the decline in the rupee value wasgood news and information technology companies’ top lines moved higher as theyearned more rupees per dollar. In 2006,when the rupee depreciated thesecompanies, had made the most of it.They also put systems in place to hedgethe inherent risks from forex earnings.With over 90 per cent of the revenue ofIT companies coming from abroad, therupee’s downward trend over the firstthree quarters of 2008 boosted thepower packed results of the sector. Acase in point, were the June quarter results of 2008, which were in line with goodquarters. On average, a one per cent depreciation in the rupee boosts the operatingmargins of the Indian IT sector by 25–30 basis points. Some of these gains however,were offset by hedging.

According to the Society of Indian Automobile Manufacturers (SIMA),Hyundai, India’s largest car exporter witnessed a growth of 25.03 per cent at1,44,439 units in 2007–8. Maruti, a distant second, registered an increase of 31.49per cent in exports in the same fiscal at 51,669 units. The company’s exports forApril and May 2008 grew by 48.68 per cent at 7,654 units. Table 4 indicates theexport growth of the automobile sector. However, this growth was due not onlyto the depreciation of the rupee, but also to the rising demand for Indian vehiclesin overseas markets. It must be mentioned, however, that not all was smooth sailingfor auto exporters. They have had to contend with clients wanting to renegotiatecontracts due to the softening of the rupee. In many cases, 20–25 per cent ofexchange rate gains have been passed on to clients. Overall, however, exports madeimpressive growths of 25 per cent, touching almost $ 200 billion. This rise gave aboost to economic growth.


About 25 per cent of ordersbooked at the end of 2008 weredue to the currency advantageIndian companies enjoyed overother countries like China. Amidthe global meltdown, India’sexport oriented commoditiescontinued to perform well.

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While a falling currency makes exports competitive, it makes imports costlier.Theoretically, this should curb imports and improve the trade balance. However,imports of commodities like oil, whose demand is relatively inelastic, negate thispossibility (Table 5). Indian industries dependent on imported raw materials forindustrial and capital goods and components have had their access to many advancedcountries blocked by quotas and tariffs. Rising prices of such inputs throughdevaluation raise industrial costs and reduce the intensity of capacity utilisation.According to industry sources, the import of Chinese tyres for commercial vehiclesfell by approximately 30 per cent from 150,000 to 105,000 tyres a month duringJanuary–June 2008. The fall was attributed to a sharp depreciation of the rupeeagainst the dollar. Imports of radial tyres fell by 120,000 tyres to a mere 90,000 amonth. Imports of cross-ply or bias tyres dropped approximately 30,000 to 15,000a month. The falling rupee hurt Maruti Suzuki, the country’s biggest producer ofpassenger cars, as its slated imports increased by about Rs 2,000 crore for autoparts.


Table 4: Total Automobile Exports 2007–8

Vehicles 2007 2008 Growth in Per Cent

Passenger Vehicles 1,03,117 1,57,611 52.76

Commercial Vehicles 10,724 9,487 -11.53

Three Wheelers 68,728 69,879 1.67

Two Wheelers 4,09,038 5,19,684 27.05

Total 6,07,915 7,74,368 27.38

Source: SIAM

Table 5: India’s Trade with Asian Countries (in $ billion)

Time Frame Exports Imports

2003–4 5.82 7.40

2004–5 8.42 9.11

2005–6 10.41 10.88

2006–7 12.60 18.08

2007–8 16.37 22.66

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A major drawback of the depreciation in the value of the rupee was the increasein the burden of servicing and repaying the government’s foreign debt (dollardenominated) and the debt of companies that raised dollar denominated debts.For instance, if a debtor had borrowed $ 100 when the exchange rate was Rs 45 toa dollar, the original debt would have stood at Rs 4,500. After the rupee’sdepreciation to Rs 48 a dollar, the same loan amount would have risen to Rs 4,800.If the interest rate was 10 per cent, the additional interest would be Rs 30, anaddition of 0.67 per dollar borrowed (30/45). Thus, the rupee’s depreciation wouldresult in an incremental outflow of $ 7.34 (6.67+0.67) for the debtor. Thisdrawback was amplified in the case ofshort-term debt as the burden wasimmediately felt. Most corporate loansare denominated in dollars and therupee’s significant depreciation againstthe dollar, resulted in many companiesreporting losses. Notwithstanding the increase in sales, tractor and utility vehiclemajor Mahindra posted a 21 per cent drop in net profits at Rs 227 crore for thequarter ended on September 30, 2008. The lower profits were largely on accountof forex losses of Rs 117.8 crore, due to the depreciated rupee. The exchange lossincluded a notional loss of Rs 96.7 crore because of the revaluation of the company’snet foreign currency borrowings. Bharat Petroleum Corporation Limited alsosuffered an exchange rate loss of Rs 714 crore during the same quarter. Even thoughthe average price for Brent crude for the second quarter of 2008 had been $ 116 abarrel, according to analysts, the benefit of lower crude prices was nullified by theweakening rupee. The Oil and Natural Gas Corporation reported a 6 per cent dipin net profits from the fallen rupee. Due to a Rs 81.57 crore hit on account of theresettlement of foreign currency loans, Orchid Chemicals and Pharmaceuticalreported a loss of Rs 40.66 crore for the July–September 2008 quarter. Ranbaxyposted a $ 73 million loss of its foreign currency debt because of the adversemovement of the rupee and wrote down the value of its inventories by $ 57 millionafter the US imposed an import ban. Tata Motors recorded a forex loss of Rs285.02 crore on revaluation of foreign currency borrowings, deposits and loans,


Overall, exports made impressivegrowths of 25 per cent, touchingalmost $ 200 billion. This risegave a boost to economic growth.

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which significantly eroded its margins. This was also true of Jubilant Organosysand Bicon.

Another fallout of a weaker rupee was higher interest rates in the economy,which the RBI (government) used to fight off the pressure of the depreciation inthe value of the domestic currency. Higher interest rates deterred investmentexpenditures, which in turn adversely effected growth both in the short and longrun, as the creation of new capacity was stunted (Shriram Iyer, “The Rupee is

Likely to Strengthen”, The EconomicTimes, September 19, 2008). Withrespect to the depreciation, thegovernment was placed in a “damned ifyou do, damned if you don’t” situation.This was reinforced by the compulsionto raise petroleum prices, which had itsown constraining effects on growth.

Further, the weaker currency also led to repatriations by FIIs (Calvo G Reinhart,“When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options”,International Monetary Fund, 2000, available at, http://www.lib.umd.edu). FIIsare permitted to transfer money in and out of the country at will and therefore alegitimate fear of a large fall in the value of the currency, made many repatriatefunds. This resulted in a sell-off in the capital market (Srikanth Srinivas, “WillLoose Mean Tight?”, Businessworld, Vol 28, No 24, p 22, October 27, 2008).Table 6 shows FIIs data since 2003.


Most corporate loans aredenominated in dollars and therupee’s significant depreciationagainst the dollar, resulted inmany companies reportinglosses.

Table 6: FIIs Data Since 2003

Year FIIs in $ billion

2003 6.59

2004 8.52

2005 10.70

2006 7.99

2007 17.33

October 9, 2008 -10.50

November 1, 2008 -13.00

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India sent around 83,833students to the US in 2006–7.Due to the depreciation and thecurrent US economic crunch,education industry expertsforesee students looking at newdestinations like the UnitedKingdom and Australia forhigher studies.

Further, the depreciation of the rupee increased the level of inflation in theeconomy. Directly imported products, such as crude oil, fertilisers, pharmaceuticalproducts, ores, metals and components for personal computers and laptops becamemore expensive following the rupee depreciation. Most computer componentslike processors, hard disks and motherboards are imported. Products such askeyboards, mouse and monitors also witnessed a discernible impact on their priceson the account of the rupee depreciation. As input costs increased inflation rose inthe economy. The falling rupee also adversely affected the oil pool deficit. For thenext few years, the government will have to find a balance between high prices anddeficits. The Finance Ministry will also have to take into account the possibleeffects of resisting the depreciation. Raising interest rates to counteract thedepreciation will add to interest costs. This may dampen healthy growth impulsesand lower revenue collections.

Finally, the falling rupee makes the US an expensive destination for education.India sent around 83,833 students to the US in 2006–7. Due to the depreciationand the current US economic crunch, education industry experts foresee studentslooking at new destinations like the United Kingdom (UK) and Australia for higherstudies. The Higher Education Statistics Agency in the UK reported that over23,800 Indian students visited the UK for higher education in 2006–7. Australiawas the second most popular international education destination for Indian studentsafter the US. According to data fromIndo–Australian Education Counsellorsover 63,000 Indian students went toAustralia for higher studies in 2007. TheIndian rupee’s fall against the dollarcaused a huge increase in the expenses ofIndian students in various USuniversities. On the other hand, as therupee remained more or less constantagainst the euro and Australian dollar,many Indian students shifted focus toother countries. Students and parents fear that if the rupee continues to fall theywill have to pay over 20 per cent more.


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CONCLUDING REMARKS

The fall in the value of a currency not only hurts national pride, but carriesmany risks as well. The depreciation of the rupee, dampened inflows of foreign

capital, raised external debt burdens and increased India’s oil and fertiliser subsidybills. A positive impact of the depreciation was the stimulation of merchandiseexports and the discouragement of merchandise imports, which improved the termsof trade. However, despite significant increases in exports and sales in 2008, Indiancompanies have reported huge forex losses due to the depreciation. This decreasedthe overall profitability of companies. For a country like India, imports are necessary

and include essential goods like crudeoil, fertilisers, pharmaceuticals and manycapital goods. Thus, the argument thatdepreciation is good as it discouragesimports is futile.

Further, software and other exportsdepend less on the rupee’s value andmore on the quality and reputation ofproducts. Thus, in the phase of anappreciating rupee, India achieved

significant export growth of 27 per cent, while after the rupee depreciated, September2008, registered an export growth of 10.4 per cent and an import growth of 43.3per cent. According to official data released on November 3, 2008, India’s tradedeficit shot up by 53 per cent in April–September 2008 to $ 60 billion as against$ 39 billion in the corresponding period the year before. The impact of fallingexports on the rupee was offset somewhat by falling imports, though pressure onthe weakened rupee will remain in the near term, not only due to portfolio outflows,but also because of corporates and banks swapping rupees for dollar. Imports increasedby 43 per cent to $ 24.4 billion, widening the trade deficit to $ 11 billion. Theglobal financial and economic headwinds have adversely affected foreign demandfor Indian manufactured goods. Therefore, given the slowdown in FII inflows, thetrade deficit and other reasons, the fall in the value of the rupee was inevitable. Insuch a scenario, while it is not possible to eliminate forex risks, companies thatadopt prudent hedging strategies will have an edge over their peers.

For a country like India, importsare necessary and includeessential goods like crude oil,fertilisers, pharmaceuticals andmany capital goods. Thus, theargument that depreciation isgood as it discourages imports isfutile.


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As far as the future of the rupee is concerned, a reverse trend is expected. Thereare fewer reasons for a strong dollar and the liquidity injected by the $ 700 billionbailout package for the US financial system, to be inevitably followed by othersuch infusions, will itself put pressure on the dollar to depreciate. Substantial inflowsof dollars into capital accounts are likely through foreign direct investments (FDIs)and debt and private equities. India received $ 14.6 billion in FDIs in April–August2008, which surged to $ 17.21 billion in the month of September 2008, up 9 percent over the same month in 2007 andup 137 per cent over the previous year($ 7.27 billion). Easing of internationalcommodity prices will significantly easethe pressure on India’s current accountand rupee. The RBI has already taken anumber of measures in this direction.Interest rate ceilings have been hiked for some non-Resident Indian deposits. ECBnorms have been liberalised as limits for the rupee expenditure for infrastructurecompanies have been raised from $ 100 million to $ 500 million per borrower perfinancial year. The RBI is also looking to ease further ECB and FDI norms toattract more overseas investments. This suggests the possibility of a strengtheningrupee. Nevertheless, rupee volatility is here to stay in the medium to short term.Still, a good policy should be proactive rather than reactive and the time has comefor the RBI to intervene directly, as with the depreciation of the rupee, the Indianeconomy has more to lose and little to gain.

Acknowledgements: L N Dahiya and S D Vashistha for helpful comments and constructive criticism.

India’s trade deficit shot up by53 per cent in April–September2008 to $ 60 billion as against$ 39 billion in the correspondingperiod the year before.


51-depreciation of the indian currency- implications for the indian economy

Documents

interest rates rose

forex reserves peaked

oil imports recorded

indian stock market

economic growth slowed

falling indian rupee

strong dollar overseas

exchange rate