Abstract:

This project analyses the reasons behind the recent rise of Dollar against Rupee as shown in the chart below.

Chart showing the fall of Rupee against Dollar in the year 2013-2014(Credits: XE.com)

Contents:

Introduction What happened to Rupee recently? Why did that happen? A detailed analysis. The impact of the fall in rupee. What actions have been taken to curb it Conclusion and References

INTRODUCTION

The rupee has recently fallen to an all time low against the dollar in the foreign exchange market

which has led to several debates, discussions and reforms in the Indian economy. The exchange

rate of a currency has always been a topic of discussion as it indicates a number of things ranging

from the condition of the economy of a country to the policies that the country has followed over

the time.

Trend of Rupee in the past:

Before diving deeper into the most recent trend let us have a look at how the rupee has

performed in the past.

Rupee-dollar post independence:

When India achieved independence in 1947, there were no external borrowings in the balance of

payments sheet. Hence, the exchange rate on 15th August, 1947 stood at $1 = Rs1. But to reform the poor economy, the Five Year Plans (FYPs) were introduced. The aim was to bring about a reform in various sectors such as agriculture, transport, communications, industry etc.

For the reforms, government needed to raise money. Hence, it needed foreign borrowing and this devalued `. The foreign borrowing was further reinforced due to the Indo-China (1962) and Indo-Pak (1965) war. India borrowed mainly from the US and under pressure from the US to continue providing further aid, the rupee had to be devalued against the dollar. So rupee stood at $1 = Rs7 by the end of 1966.

Rise of dollar in 1970s and 80s:

Due to incompetence of Indian politics (ex: assassination of Mrs. Indira Gandhi) coupled with

robust economic growth in the US the exchange rate fell to $1 = `12.36 by year 1985. By 1990, it rose to $1 = Rs17.5

Post liberalization:

India was in huge debts as the forex reserves fell to new lows post liberalization. So, India borrowed large amounts from the IMF at the expense of devaluing the Rupee. As a result, the rupee hit new lows of $1 = Rs24.58 during early nineties.

The major reasons behind the fall:

Following are some of the relevant points. The points shall be explained in terms of demand

supply later on.

1) Huge Trade and Current Deficit: India imports more goods than it exports. This results

in a trade imbalance, known as a trade deficit. The figure was around $185 billion in

March 2012.

2) Reduction in capital inflows: Lately, India has become an attractive destination for

foreign investors. India received $30 billion through FDI, in addition to $18 billion

through FII in 2011-12. But due to uncertain conditions in the Indian market, policy

paralysis within the government and other domestic issues, the inflows have started

reducing in 2013.

3) High inflation: Due to high inflation, most foreigners and NRIs tend to keep money

abroad. This is because keeping the same money in the country reduces its value due to

inflation.

4) US Fed’s Bond Buying programme: One of the most significant reasons is the sudden

withdrawal of FIIs from India. US Fed Reserve made an announcement hinting at

tapering off the fiscal stimulus programme (Quantitative Easing) which they had

introduced in 2008 to help the US recover its economy. In 2008, the US was in an

economic crisis. So, the then Central Banker of the US Fed, Ben Bernanke, announced

the idea of ‘Quantitative Easing’. As a result, billions of dollars were released in the

markets as the Fed bought government bonds and injected money into the economy. Due

to the higher liquidity, the interest rates went down leading to a boom in the emerging

economies such as India, China, Brazil, etc. But this fame was short lived. Ben Bernanke

in June 2013, hinted at the withdrawal of the quantitative easing programme owing to the

recovery of the US economy. Investors started panicking, rates of interest in the US

increased and the exchange rates of these emerging economies once again started to

decline. Due to this withdrawal, not only rupee but several other currencies are at their

own new lows as is shown by the figure below. The picture shows the fall in the prices of

the Asian countries in the past 52 weeks.

A different way to understand:

Lesser the dollar in the market, the more will be its value and hence lesser the value of rupee. Let

us see how excess imports impact Indian economy. The most important thing that India imports

is crude oil.

The countries from which India imports crude oil do not accept the Indian Rupee for payments.

They accept an internationally accepted currency such as Dollar or Euro. As India can’t print

either of the currencies, it has to rely on other methods to accumulate dollars/euros. The three

main ways in which India gets dollars are as follows:

I) By exporting goods and services.

II) Foreign investment in India.

III) Remittance

This tells us that in order to keep importing the oil we need to keep getting dollars from the

above resources. If India runs out of foreign exchange, it will not be able to import oil, without

which nothing will function. This balance of imports and exports is kept track of using the

Current Account Deficit. The CAD is the difference between the imports and exports of goods

and services of the country, which in India’s case is continuously increasing.

Impact of depreciation on the Indian Economy

The weakening of the Indian Rupee has had a variety of influences on the Indian Economy. The

most critical among them are:

Rise in Inflation

India is a net importer of goods and services. According to a recent press release by the

Economic division of the Department of Commerce (Ministry of Commerce and Industry, 2013),

India’s net imports were $ 11244.45 million in June, 2013 alone. Refer Exhibit 3 for exports and

imports data in the month of June. As the currency depreciates more INR would be needed to

purchase 1 USD and this will increase the input prices of raw materials in various sectors of the

economy and the high weightage of close to 35% that global commodities have been given in the

wholesale inflation basket will place an upward pressure on the Wholesale price index (WPI). In

sectors such as petroleum and natural gas, electronic gadgets, fertilizers and organic chemicals

where India is heavily dependent on imports, increased costs for the companies will be passed

on to the customers in the form of an increase in the prices of products.The prices of petrol and

diesel have already been increased as crude oil is the largest item in the list of India’s imports

and due to depreciation, the cost of importing oil has increased. Very recently, Panasonic India

declared that they had factored a level of 62 for USD/INR and would increase prices of their

products if the rupee depreciated further. (Das, 2013)

Investment Climate

With the fall of the Indian rupee, the return that foreign investors get from their investments in

India will reduce. Due to this, Foreign Institutional investors (FII’s) will take out their money

from India and invest it elsewhere due to concerns of a falling rupee. In the month of June alone,

FII’s pulled out more than $7 billion from the equity and debt markets in India which led to

increase in yield of government securities.This is because their returns in dollar terms would

reduce as they would need more rupees to get the same amount of dollars as the rupee continues

to fall. Reduction in capital inflows has occurred due to the rupees depreciation and the RBI’s

tightening of the monetary policy has encouraged companies to delay investment and expansion

plans. For companies that have taken debt in foreign currency, i.e. External Commercial

borrowings (ECB’s), depreciation of the rupee would have an adverse impact on their Income

statements. To repay this debt in foreign currency, the company would now need more rupees

than before to repay debt if we consider that repayment is in monthly instalments. Recently,

Adani Enterprises posted a huge loss in the first quarter of 2013 due to the rupee’s volatility. The

fact that they had to import coal due to shortage of coal supply in India also led to increased cost

of raw material. (Press Trusst of India, 2013).

Possibility of Interest rate rise

In order to control the fall of the rupee, the RBI has tried to tighten the monetary policy and

reduce liquidity in the Indian financial system. By doing this, the RBI hoped that demand for

INR would go up vis-à-vis the USD and rupee would appreciate. But the sale of government

bonds, increase in Cash Reserve Ratio (CRR) did not achieve the purpose. The next possible

move is to increase the Repo Rate. If this happens, bank would have to pay a higher interest on

their borrowings from RBI and this higher interest will also be passed on to customers in the

form of increased interest rates. This situation is in stark contrast to the beginning of the first

quarter of FY2014 when interest rates were expected to fall and this change can be attributed to

the depreciation of the Indian rupee. Interest rate hike would enable inflow of capital from

foreign countries and strengthen the rupee. But it would also mean that borrowers would have to

pay higher interest on their loans and this would deter new investments in projects.

Foreign education and foreign travel

Depreciation has also had an impact on those who want to pursue foreign education or travel

abroad. They would now need more rupees to purchase foreign currency to meet their needs

abroad.

Current Account Deficit (CAD)

Depreciation of the Indian rupee will favour exporters in India. However, considering the

imbalance of imports and exports in India, this advantage is nullified. Hence the Current Account

Deficit (CAD) will continue to widen.

CAUSES OF DEPRECIATION OF RUPEE:It is being talked that Depreciation of rupee has lead us to the 1991 scenario. The journey of

Indian rupee (INR) against the US dollar (USD) can be traced back to the pre-Independence days

when INR was at par with USD. After Independence, India chose a fixed rate currency regime

with the currency pegged against GBP. However, with the passage of time and change in

situation the pegs were modified. In 66 years of Independence INR has depreciated 66 times

against the USD (till April 2014). In the past five years, the rupee has depreciated by a huge

60%.Following are the various reason for the depreciation of rupee.

1. Rising dollar demand by oil companies:The worth of crude oil has been a major bane for India since it has to bring in the majorityof its requirement from outside the country. The demand for oil in India has been going up every year and this has led to the present situation. 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. Oil companies nearly need $400 million a day.

2. One of the reason for the depreciation of rupee is that FII are selling more than theyare buying that’s why net FII has falled from 43533.06 in 2012 to 538.35 in 2013.

3. 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. In the 2012-13 fiscal India’s CAD was measured at 4.8 per cent of the GDP. The government has beenunable to come up with any new destinations for exporting its products and this hasalso hampered the growth in this sector. There are other crucial reasons here like thelack of one window for clearance purposes and procedural delays. Even areas whereIndia has traditionally done well on this front have fared badly this time around.4. Recently ArcelorMittal and Posco decided to pull out from their projects in India.Posco did not go ahead with a steel plant worth INR 30,000 crore that was supposed

to be built in Karnataka and ArcelorMittal withdrew from setting up a steel plant in