THE IMPACT OF RUPEE DEPRECIATION ON INDIAN ECONOMY (Recently, I delivered a lecture on above topics in Kushagra Institute of Information and Management science (KIIMS).My speech was based on this article) SANTOSH KUMAR MOHAPATRA INTRODUCTION .For quite some time Indian rupee has been under tremendous pressure. As apprehended, on 26th June, 2013 the rupee breached all time psychological low of 60 .00 and touched a historic low of 68.80 against the dollar (greenback) on August 28,2013 before making gradual recovery to is 61.51 on October, 28, 2013. The rupee is the worst performer among major Asian peers (currencies). It threatens to reach subterranean level further sparking worries of rise in the prices of essential commodities. This precipitous sliding of Indian rupee presents a unique set of challenges for Indian economy and has put the government in a tizzy. Given the weak fundamentals of the economy, the plummeting rupee is causing nervousness, consternation and people were considering this as a vicious circle. TYPES OF EXCHANGE RATE Whenever the subject of the impact of rupee depreciation is discussed, it requires elucidation about the different measurements of domestic value of money especially exchange rate. Generally, the domestic value of money is measured in three ways. The first one is the inflation rate which determines the domestic value or purchasing power. The second one is interest rate or the time value of money which measures what savers get or borrowers pay. The third one is the exchange ratio which measures the external value of the currency. Exchange rates are also of different types such as Fixed, Flexible and Managed Float. Fixed or pegged exchange rate refers to the system in which the rate of exchange of a currency is fixed or pegged in terms of gold or another currency. In this case there may be only very minor variation in exchange rates. Flexible or Floating exchange rate refers to the system in which the rate of exchange is determined by the forces of demand and supply in foreign exchange market. It is free to fluctuate according to changes in demand and supply of a foreign currency. Another one is Managed float in which exchange rate is determined by the market forces but Central Bank intervenes when required, warranted usually to prevent excess volatility or to restrict fluctuation in the exchange rate within certain limits. This system helps to avoid the vagaries of two extremes: a rigid pegged exchange rate system on the one side and free float on the other. Most countries including India (since 1993) and many developed countries have used this intermediate system – “Managed Float”. Spot Exchange Rate vs forward Exchange Rates There are two different types of currency exchange rates. The first one and simplest to explain is the spot exchange rate. The spot exchange range is simply the current exchange rate as opposed to the forward exchange rate. Forward exchange rate essentially refers to an exchange rate that is quoted and traded today but for delivery and payment on a set future date. Sometimes, a business needs to do foreign exchange transaction but at some time in the future. For example, an Indian company might make a sale of its goods internationally (in this case we will say America ), but will not receive payment for at least one year. So how is it able to price its products or goods without knowing what the foreign exchange rate, or spot price as it is called, will be between the United States dollar (USD) and the Indian Rupee 1 year from now? It can do so by entering into a forward contract that allows it to lock in a specific rate in 1 year so that they can agree upon a set exchange rate without knowing exactly what it will be. Nominal Effective Exchange Rate - NEER The unadjusted weighted average value of a countrys currency relative to all major currencies being traded within an index or pool of currencies. The weights are determined by the importance a home country places on all other currencies traded within the pool, as measured by the balance of trade. The NEER represents the relative value of a home countrys currency compared to the other major currencies being traded (U.S. dollar, Japanese yen, euro, etc.). A higher NEER coefficient (above 1) means that the home countrys currency will usually be worth more than an imported currency, and a lower coefficient (below 1) means that the home currency will usually be worth less than the imported currency. The NEER also represents the approximate relative price a consumer will pay for an imported good. Real effective exchange rate Real effective exchange rate is defined as “a weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries, relates to the purchasing power parity (PPP) hypothesis”. As the definition highlights, REER takes price differential and inflation into account and, therefore, is said to be a better indicator of the competitiveness of the country in terms of exchange rates. In India, Reserve Bank of India (RBI) complies with REER indices. The first one is based on six country’s trade-based weights and the second on 36-currencies’ export and trade-based weights. The indices are also a better reflection of the position of a currency in comparison with the countries in which India has large export and trade interest. The base is taken as 100 and currently the base year is 2004-2005. A rise in the level of index indicates appreciation of currency and vice-versa. In terms of readings, REER has moved from 107.57 in April to 104.24 in September, indicating a deprecation of rupee in the six-currency basket, though it went up to 106.84 in October. However, data for November is likely to show a fall in the index level again. DEPRECIATION, APPRECIATION AND DEVALUATION Exchange rate or the rate of exchange is the rate at which one currency is exchanged for another. In other words the rate of exchange is the price of one currency stated in terms of another currency. For example if one U.S. dollar exchanges for 60 Indian rupees, the rate of exchange is $ 1 = Rs.60 or Re.1 = $ 1/60. The change in exchange value is expressed in different terms such as depreciation, appreciation and devaluation. Depreciation means the fall in value of one currency by market forces in foreign exchange market in relation to another currency. Appreciation means rise in the value of one currency by market forces in foreign exchange market in relation to another currency. But devaluation refers to the deliberate or official reduction of the external value of a currency or lowering the value of a currency in relation to another currency by a government. When it is said that rupee has depreciated against dollar it implies that dollar has appreciated against rupee and vice versa. It may be noted that a currency may not only appreciate or depreciate against one currency but against two or more currencies. JOURNEY OF INDIAN RUPEE SINCE INDEPENDENCE The Indian currency has witnessed a roller-coaster journey since independence. It was at par with the American currency at the time of independence in 1947, and has undergone depreciation and appreciation ( less occasion) due to various reasons, to hit a record low of 68.80 against the dollar on August 28, 2013. This means the Indian currency has depreciated by almost 69 times against the greenback in the past 66 years.. Here is a broader look at the Indian rupees journey since 1947: - India got freedom from British rule on Aug 15, 1947. At that time the Indian rupee was linked to the British pound and its value was at par with the American dollar. There were no foreign borrowings on Indias balance sheet. - To finance welfare and development activities, especially with the introduction of the Five-Year Plan in 1951, the government started external borrowings. This required the devaluation of the rupee. - After independence, Indian chooses to adopt a fixed rate currency regime. The rupee was pegged at 4.79 against a dollar between 1948 and 1966. - Two consecutive wars, one with China in 1962 and another one with Pakistan in 1965 resulted in a huge deficit on Indias budget, forcing the government to devalue the currency by 36 per cent to 7.57 in 1966 against the dollar. The rupees link with the British currency was broken in 1971 and it was linked directly to the US dollar. In 1975, the Indian rupee was linked to a basket of three currencies comprising the US dollar, the Japanese yen and the German mark. The value of the Indian rupee was pegged at 8.39 against a dollar. - - However, the Indian Rupee has been depreciating roughly in line with the fall in its Purchasing Power Parity (PPP) since the early 1980s. While the PPP was 15 around 1982, the actual exchange rate was Rs 9.30 per US Dollar. It is the inflation that negatively impacts PPP and pushes a currency down -In 1985 it was further devalued to 12 against a dollar. . -. But the biggest change in the rupee-dollar equation happened between June 28 and July04, 1991 when rupee was devalued by 24% from 17.90 when there was severe balance of payment crisis and the foreign reserves were not even worth to meet three weeks of imports. - In 1991, India still had a fixed exchange system, where the rupee was pegged to the value of a basket of currencies of major trading partner’s .The year 1993 is very important in Indian currency history. It was in this year when the currency was let free to flow with the market sentiments. The exchange rate was freed to be determined by the market, with provisions of intervention by the central bank under the situation of extreme volatility this is known as managed float. In 1993, one was required to pay Rs.31.37 to get a dollar. -. In the period 2000–2007, the Rupee stopped declining and stabilized ranging between 1 USD = INR 44–48. In late 2007, the Indian Rupee reached a record high of Rs.39 per USD, on account of sustained foreign investment flows into the country. The trend has reversed lately with the 2008 world financial crisis as foreign investors transferred huge sums out to their own countries. Such appreciations were reflected in many currencies, e.g. the British Pound, which had gained value against the dollar and then has lost value again with the recession of 2008. - Due to various reasons, rupee started depreciating in the early 2013. As a result, the Indian Rupee dropped to 68.80 per dollar CAUSE OF DEPRECIATION Like other prices, the rate of exchange is also determined in accordance with the general theory of value i.e. by the interaction of forces of demand and supply. A currency will depreciate when its supply in the foreign exchange market is more in relation to its demand. Similarly a currency will appreciate when its supply in the foreign exchange market is less in relation to its demand. Hence, when demand of foreign currency especially dollar exceeds its supply, dollar appreciated and rupee depreciated. Reverse happens when supply of dollar exceeds the demand for dollar leading to appreciation of rupee. The demand for foreign exchange such as Dollar is felt: – 1) for import of goods and services (2) by the domestic residents investing, lending and purchasing property/industry abroad. (3) By foreign residents to repatriate funds to their countries invested in India. (4) For sending gifts to foreign countries (5) to visit foreign countries or to undertake study or medical treatment abroad. (7) Foreign Investors withdrawing from our stock and debt market and investing outside India (8) out flow of foreign capital such as FDI etc. (9) foreign companies repatriating their profit to own countries. (10)Repayment of external debt by our nation including repayment of external borrowing by companies. Similarly, the inflow or supply of foreign currency or Dollar is due to following reasons: (1) Domestic exporters receiving payments in foreign currency and the foreigners investing and lending in our country. (2) Larger invisible receipts such as exports of software services and remittances by the workers working in foreign countries and repatriation of funds invested abroad by domestic residents and receiving of gifts from abroad by domestic residents. (3) Non-resident Indians (NRIs) remitting dollars and also making deposits in our country known as non-resident Indian deposits to take advantage of higher interest rate.(4) Indian companies borrowing in dollars in foreign markets (external commercial borrowing) to take advantage of interest arbitrage i.e. lower rate interest rate prevailing in those countries. (5) Foreign investors investing in our stock, debt and other markets. (5) Foreign Direct Investment (FDI), Global private equity fund, contribute to the surge of foreign exchange. Money raised by Indian companies in American stock market and European stock market through American Depository Receipts (ADRs), Global Depository Receipts (GDRs) respectively by selling their shares also contributes to the rise of foreign exchange. Apart from mismatch between demand and supply of foreign currencies especially dollar, the concerns of recent sliding of rupee have been compounded because of the likelihood of the US Federal Reserve (Central bank of US) tapering its quantitative easing (QE) .Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective, say interest rate cannot be further reduced. US Federal Reserve implements quantitative easing by buying bonds in order to inject a pre-determined quantity of money into the economy. This stimulates consumption and also consumption led economic growth. But this also encourages capital to move away from the US in search of higher returns in other currency assets. But now due to tapering of quantitative easing by US Federal Reserve, foreign investors feel investing in dollars is more safe and profitable and shying away from emerging markets like India. This triggered an outflow from emerging markets like India. Foreign fund selling in Indian equities have picked up pace to add to the huge sell-off in debt markets and worsened the supply of dollar and thereby exacerbating rupee`s depreciation. However, it is not simply global forces or U.S monetary policy, but mismanagement of domestic economy that has added to rupee`s woe. Most of the economic fundamentals including India`s balance of payments indicators, are extremely fragile and economy has become more vulnerable to whims and caprices of foreign capital due to unfettered liberalisation. Indian economy has been battling slowdown on growth, spiralling inflation, wobbly, jerky stock market, and burgeoning current account deficit and fiscal deficit. The current account deficit- when a countrys total imports of goods, services and transfers are greater than the countrys total export of goods, services and transfers- is at historically high level of around 5.5 % Gross Domestic product (GDP), while trade deficit - economic measure of a negative balance of trade in which a countrys imports exceeds its exports-- is even larger around 7 % GDP. Current account deficit makes a country a net debtor to the rest of the world while a trade deficit represents an outflow of domestic currency to foreign markets. But current account deficit could have been very less had a significant part of the gold imports including imports of food, fruits, edible oil, toys could have been reduced. Similarly fiscal deficit could have been less had the tax foregone amount could have been curtailed EFFECT OF RUPEE DEPRECIATION Depreciation of rupee otherwise known as weak rupee /declining rupee/ sliding rupee/cheaper rupee/falling rupee and appreciation of rupee otherwise known as costlier rupee / rising rupee / dearer rupee / strong rupee will have both beneficial and detrimental impact on economy. However, the effect of depreciation and devaluation on economy is always same. When a currency depreciates, the exporters rejoice because their volume of exports increases and they get more of the local currency for every unit of foreign currency though the quantum of trade remains unchanged. This can be explained by following example. An exporter was selling a pair of shoes for $ 100 in January 2013 when exchange value of a dollar was 56 rupees. At that time he was earning Rs.5600/-. But on June 2013 when rupee depreciated to Rs 60.00 to a dollar, the same pair of shoes will fetch him Rs.6000 /- a gain of Rs.400.00 to him. If rupee appreciated reverse will happen. In other terms, when one dollar was fetching goods worth 56.00 for an importer of Indian goods, after depreciation same will fetch Indian goods worth 60.00. These will incentives importers of other countries to import more Indian goods and thereby increasing the volume of our exports of good. Just opposite happens when rupee is appreciated. But Importers suffer due to depreciation. While a weak rupee helps exporters, it poses a serious problem for a country like India which meets over 75 per cent of its crude oil requirement through imports. The landed cost of imports becomes expensive, as the local currency loses value against the U.S. dollar. Hence, the falling rupee has become a cause of concern for policymakers as it could further push up cost-push inflation or trigger imported inflation. . Further, this higher import bill will lead to rise in fiscal deficit for the government and will push the inflation, which is already hovering around the double-digit mark. India`s external debt will be increased in rupee term while GDP will be decreased in dollar term. Individually, travelling abroad becomes more expensive as travel cost can go up. Students studying abroad too will be hit as more rupees will go out to pay for the courses... Indian companies who have borrowed externally but have not hedged their currency risk will have to shell out more for debt payment like our nation. However, the depreciating rupee will be positive for the Indian IT sector that generates more than 80-90 per cent of their $70 billion revenue from the overseas markets and this kind of appreciation in foreign currency will enhance their actual realisation of revenue in dollar terms. However, exporters gain only in the short term as overseas buyers may seek price adjustment. Individually, expatriates living outside India too gain by rupee depreciation. But NRI or Non Resident Indian will be the biggest ben¬e¬fi¬ciary as they can con¬vert their dol¬lar sav¬ings to rupee at a high rate. MEASURES TO STEM RUPEE FALL We have already observed that depreciation is caused by market forces, which are global in nature and extremely difficult to control. However, certain measures can and should be taken to arrest this rather drastic fall, some are suggested below: The Reserve Bank, in its capacity as Indias central banking institution and monetary policymaker, has, at its disposal a number of instruments with the capability to arrest depreciation. Some examples of such measures are: Deregulation of interest rates on deposits from non-resident Indians, introducing measures to curb speculative trading and sale of dollars from forex reserves. The reserve banks sell dollar to augment the supply of dollar to match demand so as to stem depreciation. The RBI does this by buying dollars when rupee appreciates too much and by selling dollars when the rupee depreciates significantly..But it has also got limit as our foreign exchange is limited. In order to stem depreciation, Government takes number of measures to moderate demand of non-essential imports, enhances capital flows to augment supply of foreign exchange and curb speculation in the foreign exchange market. As fall in value of rupee in the recent period is due to supply-demand imbalance in domestic foreign exchange market on account of elevated levels of current account deficit (CAD) and volatility in capital flows, particularly FII inflows,a number of measures necessary to contain the CAD to reduce the volatility in the currency market and to stabilize the rupee. These include compression in import of gold and silver and non-essential items, allowing public sector financial institutions to raise quasi-sovereign bonds to finance long term infrastructure, liberalizing ECB guidelines, permitting PSU oil companies to raise additional funds through ECBs and trade finance and liberalizing NRE/FCNR deposit schemes. We should reduce the consumption of oil as it is one major component of our import. India is exploring possibilities of entering into currency swap agreements with trade partners aiming to shore up exports and bring down trade deficit, which is putting pressure on the rupee. India has signed currency swap agreements with Japan ($ 15 billion) and Bhutan ($ 100 million). China has shown active interest in entering into such an agreement with India but it is yet to be signed. Currency swap agreements involve exchange of one currency for another currency and are generally motivated by the comparative advantage. A dollar swap arrangement, it further said, would help India in supporting the rupee, which has depreciated significantly against the US currency over the past few months due to various global and domestic factors. . CONCLUSION . As a person becoming either too fat or too thin is not good for his health, similarly, too much depreciation or appreciation of currency is not good for an economy. It portends the escalating vulnerability of an economy to foreign finance capital, which jeopardise economic sovereignty. Government decision to enhance FDI limit to enhance supply of foreign currency will be self defeating as it will further aggravate the problem as happens to a drug addicted person who requires always high dose of drug to stay alive that ultimately spell doom for him. Hence government should think of reversing neo-liberalism and overdependence on foreign capital. Capital control is the only solution which can be done by imposing Tobin Tax on out flow of foreign capital. The author is an Odisha based fianacial columnist.Email:skmohapatra67@gmail, Mob-9437208762
Posted on: Tue, 29 Oct 2013 14:37:26 +0000
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