Government and RBI response to contain a depreciating rupee The depreciating Indian rupee was a recurring topic of discussion and debate in the Monsoon Session of the Parliament. The USD/INR exchange rate depreciated 9% during this Monsoon Session, hitting a record low of INR68 to a dollar on August 28. The Indian Rupee also depreciated 11% against the British Pound and 8% against the Euro during this session. The rupee depreciation may feed into inflation by affecting the price of imported goods, especially of oil. However, a cheaper rupee may boost exports, improving the Current Account Deficit (CAD). This post discusses the reasons for the decline in the value of the rupee, and the steps taken to contain it. The Prime Minister and the Finance Minister made statements in Parliament regarding the economic situation of the country and the currency. The key reasons cited by the government for the decline in the value of the rupee are: Large Current Account deficit: The current account (net exports of goods and services, remittances, and net dividend payments) has been in a deficit continuously for the last eight years. Falling growth rate of Indian exports, coupled with a sharp rise in imports, especially of crude oil and gold, have increased this deficit. Weakening capital inflows: The capital account (the net flow of funds through equity investments and borrowings) surplus has been used to finance the current account deficit for many years. Capital inflows have reduced due to the improving economic situation in the US and other developed countries. Investors are exiting developing markets in expectation of the US Federal Reserve increasing the interest rates, impacting the currencies of emerging markets, like India, Brazil, Russia, Indonesia, Turkey and South Africa. Inflation: The PM said that part of the depreciation is attributable to the adjustment of the rupee exchange rate to the inflation differential, i.e. India’s relatively high rate of inflation versus other economies. Figure 1: Excess of Capital Account surplus over Current Account deficit has been shrinking (in USD million) Capital Outflow The RBI reduced the limit for outbound investment and remittances from India. Encouraging Capital Inflows RBI has removed administrative restrictions on investment schemes offered by banks to non-resident Indians, and removed ceiling on interest rates on deposit accounts held by NRIs. The government liberalised the FDI limits for 12 sectors, including oil and gas. A Bill is pending in the Parliament to revise the FDI limit to 49% in the insurance sector. RBI increased the current overseas borrowing limit for banks from 50% to 100%, and allowed it to be converted into rupees and hedged with the RBI at concessional rate. RBI also allowed banks to swap fresh NRI dollar deposits with a minimum duration of 3 years with the RBI. Limiting Imports and encouraging exports The Finance Ministry increased the customs duty on importing precious metals including gold and platinum. 20% of every lot of import of gold must be exclusively made available for the purpose of export. Oil Import Needs RBI decided to provide dollar liquidity to three public sector oil marketing companies (IOC, HPCL and BPCL) to help them meet their entire daily dollar requirements. Government is also considering increasing its import of crude oil from Iran, and pay for it directly in Indian rupees. Trade Deficit Ministry of Commerce is exploring the possibility of using local currency for trade with major trading partners. RBI allowed exporters and importers more flexibility in management of their forward currency contracts. Curbing Speculative in currency RBI increased the short-term emergency borrowing rates for banks. The daily holding requirements under the Cash Reserve Ratio for banks have been modified. International Cooperation Government increased its currency swap limit with Japan from USD15 billion to USD50 billion. The BRICS nations also agreed on a USD100 billion foreign currency reserve pool as part of their plan to create a BRICS New Development Bank. India will contribute $18 billion to this fund from its reserves. In response to questions raised about the economic situation in the country, the Finance Minister and the Prime Minister in Parliament emphasized that there were sufficient foreign exchange reserves to meet the external financing needs. The government targets to limit the fiscal deficit to 4.8% of GDP, and the CAD to under USD70 billion in 2013-14. More recently, the new RBI Governor, upon taking office on September 4, 2013, re-affirmed the central bank’s commitment to sustain confidence in the currency and to gradually liberalize the financial market.At the G-20 summit in St. Peters burg, the G-20 agreed to be mindful of the repercussions of the withdrawal of monetary stimulus by developed countries on emerging markets. The G-20 central banks agreed to “properly calibrate and communicate” their monetary policy to minimize volatility of capital inflows and exchange rates to avoid adverse implications for economic and financial stability in emerging markets. -Haresh G Pandya facebook/HareshgPandya
Posted on: Thu, 12 Sep 2013 04:29:45 +0000
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