Sample Materials of SSC CGL (Tier -3) Study Kit

Subject: Essay

Topic: Historic Depreciation of Indian Rupee

Indian Rupee breached the Rs 55 per dollar mark and closed at 56 on 30th May, 2012 - its weakest since May 14, 2009. Most forex dealers In Mumbai during the week predicted that in the absence of any positive news, the rupee could soon touch the 60 mark against the dollar. From an investors’ perspective, the movement of rupee may not matter much as only a few can figure out that unlike Sensex, the rupee going up is not positive news, but on the contrary, it actually means rupee is becoming weaker. Many wrongly think that if rupee goes up it is something good for them not realising when the Indian currency depreciates against any foreign currency it has many negative impacts from the economic point of view. Due to Risk Aversion on the part of Currency Investors, the Demand for the US Dollar has gone up world over. Uncertain Economic Situation around the globe is another reason. FII’s turning Net-Sellers and withdrawing funds from the Indian Market. The concept of Risk Aversion is the same irrespective of what timeframe you are talking about. But, the current situation is much more riskier & pronounced than what was in 2007-08. Back then, the problem was localized to debt problems (loans & mortgages) in USA and had only a ripple effect across the globe. Right now, the problem is more profound and markets world-over are in a crisis and some countries are on the verge of Default. So, people are much more risk averse than what they were in 2008 and hence the situation is much worse than during the mortgage economic crisis.

The RBI has maintained strong foreign exchange reserves, to the tune of US $ 350 billion as at March-end (with foreign currency assets accounting for about 90% of these reserves). However, it has refrained from (and has neither indicated in near-future) direct intervention in the forex market to curtail the depreciation of the rupee until now. Assuming that global uncertainty continues to prevail, exports growth is maintained and capital outflows persist, it is expected that this   depreciation would continue. A worsening  in any of the above variable would aggravate rupee depreciation. Historically, 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. But the present spike was rather sharp on the back of debt default concern in the euro zone and after the downgrading of two largest French banks, besides Lloyds Insurance withdrawing its deposits from European banks have led to euro losing its value against dollar. As large banks, investors and financial institutions started selling euro and bought dollar, the latter appreciated against all major currencies including rupee.

Buy Printed Study Kit for SSC CGL (Tier -3) Examination

The main driver of rupee depreciation in the last three months  has  been  the  withdrawal  of  funds  by  foreign institutional investors (FIIs) from domestic economy. The rather pessimistic view of FIIs is being governed by global developments. The   ongoing   Euro-zone   debt   crisis   seems   to   be intensifying  and  rescue  packages  have  been of  limited assistance in truly resolving the crisis. While the risk of sovereign default by individual Euro states is a concern, the risk of an impending contagion is also significant. The scenario in the US does not provide an upbeat picture either. Delays in policy formulation on the setting of debt ceiling  for  the  state  have  reflected  some  lacunae  in management  of  government  finances.   The  real  estate  problem,  weakening  local  government finances, lack of transparency in operations and systems of  the  government and deterioration the assets of the banking  system  observed  in  the  Chinese  economy  are further drags to the global macro-economic outlook for the coming months. Domestic macro-economic prospects  as well are weighed  by high  inflation  and  sagging  industrial production, which have led to downward revision of  growth estimates to just 7.6% for FY12. Consequently,   FIIs   have   withdrawn   funds   from emerging  markets  and  invested  back  in  the  dollar which  has been strengthening.

When a currency loses its value it creates many problems for the economy. It leads to high inflation, as India imports around 70 per cent of its crude oil requirement and the government will have to pay more for it in rupee terms. Due to the control on oil prices, the government may not easily pass the increased prices to the consumers. 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. Individually, traveling abroad becomes more expensive as travel cost can go up by at least 10 per cent. Students studying abroad too will be hit as more rupee will go out to pay for the courses and stay. Depreciation of rupee also affects the money flow in the Indian stock markets. FIIs, the main investors in the Indian equity markets, also start withdrawing their investments from the markets fearing loss of value. In terms of portfolios, if you hold stocks in oil and gas, infrastructure, fertiliser or tyre business, your returns will take a hit as the shares of these companies will fall when the rupee falls as they procure their raw materials from abroad. On the other hand stocks of Information Technology (IT) companies and export-oriented units should do better.

A falling rupee will make oil imports costlier, again increasing pressure on oil retailers to hike prices of at least de-regulated fuel like petrol. Depreciation  of  the  local  currency  naturally  manifests  in higher  import costs for the domestic economy. Assuming that both imports  and exports maintain their current growth rates through the year,  higher import costs would widen the trade and current account  deficit of the country.  Commodities prices that are internationally denominated in US dollars would naturally be priced higher on the back of a stronger Dollar. The fiscal  deficit  for  FY12  was  budgeted  at  4.6%  of  GDP  in February, with the price of oil pegged at US $ 100 per barrel. Throughout FY12 so far, however, the price of oil has been well above  this reference rate, hovering at an average of US $ 110 over the last three months. Oil subsidy for the year is about Rs 24,000 crore for FY12. This will rise on account of the higher cost  of  oil being borne by the government. While there have been moves to link some prices of oil-products to the market, there  would  still  tend  to  be  an  increase  in subsidy  on  LPG, diesel,  kerosene.  The  government  has  already  enhanced  its borrowing programme in H2 FY12 by Rs 52,000 crore, to bridge the fiscal gap.

Higher rates will come in the way of potential borrowers in the ECB market. Today given the interest rate differentials in domestic and global markets, there is an advantage in using the ECB route. With the depreciating rupee, this will make it less attractive. Further, those who have to service their loans will have to bear the higher cost of debt service. Usually exports get a boost in case the domestic currency depreciates because exports become cheaper in international markets. However,   given   sluggish   global conditions, only some sectors would tend to gain where our competitiveness will increase such as textiles, leather goods, processed food products and gems and jewellery. In case, imported raw material is used in these industries they would be adversely affected. Therefore, exports may not be able to leverage fully. However, When a currency depreciates, the exporters rejoice because they get more of the local currency for every unit of foreign currency though the quantum of trade remains unchanged. But this time, many exporters were caught off guard. For one, there is little dollar supply in the market as most exporters seem to have covered themselves in the Rs 45-46 range. “Sudden changes in the position of the rupee do not really matter much.  The depreciating rupee will be positive for the Indian IT sector who generate 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. Every one per cent change in rupee-dollar has a 40 basis points impact on the margins on the net profit numbers of IT services companies like TCS, Infosys, HCL to mention a few. However, IDBI Bank chairman R M Malla was of the viewed that “exporters gain only in the short term and after that overseas buyers seek price adjustment.” Individually, expatriates living outside India too gain by rupee depreciation. In fact, the expat Indians understand the currency movement lot better than the resident Indians. 

Bearish sentiments took a strong grip on domestic equity markets which led to foreign investors selling their interests, again leading to increased demand for the dollar. The Indian rupee has lost 20 per cent in the past four months itself. Analysts expect pressure to continue on the rupee at least in the short term because of the country’s large current account deficit, which has tripled to $15 billion in the April-June quarter of current fiscal, when compared to the previous quarter. The difference between a country’s imports of goods, services and its exports is called current account deficit. For the whole of 2012-13, current account deficit is expected to be around $70 billion.

Buy Printed Study Kit for SSC CGL (Tier -3) Examination

<< Go Back to Main Page