Rupee Depreciation

Rupee Depreciation

Posted by

Recently, Indian Rupee depreciation led a historic low of Rs. 71/US $.

• The rupee has depreciated by around 9% from the beginning of this calendar year and is currently trading at around Rs. 71 per dollar, a historic low.

Reasons for the Fall in Rupee:
Crude Oil Prices: Oil imports, amid rising crude oil prices, are leading to an increased demand for the dollar which, in turn, is making the rupee weaker.
Us Bond Yields: Rise in US bond yields which has made the dollar attractive. The 10-year US bond yield has jumped by more than 82 basis points in the past year. Higher US yields are attracting investors to the US treasuries and making Rupee weaker.
Macro-Economic Situation: Foreign Institutional Investors (FIIS) have sold over Rs. 40,000 crores in debt and equity so far this year. A wider current account deficit and continuous outflow from FIIs pushed the currency lower.
Emerging Markets Exchange Rates: It is to be noted that rupee depreciation is in line with emerging market exchange rates, which were largely fed in through dollar strength. A divergence between US dollar appreciation and a moderation in Euro may have amplified the dollar strength, an effect of which reinforced rupee’s depreciation.

Trade War Fears: Increasing tensions between the world’s two largest economies – the US and China – has kept investors on edge amidst fears of global trade war.

Devaluation and Fall in Rupee in the Past:
• The first major devaluation of the rupee happened in 1966 when it was pegged against the US dollar at Rs 4.75/$. With two major wars, against China and Pakistan, and with multiple changes to India’s leadership in the post-Nehru era, led to the steep devaluation of 57 per cent, taking the value of the rupee to Rs 7.5/$.
• From 1966 to 1980, the rupee remained largely stable. However, the global economic problems of the early 1980s followed by the energy crisis of 1991 during which the prices of oil and gold surged, rupee had to be devalued again, to Rs 17/$ by 1991.
• In 1991, India had an economic crisis. The government had a balance of payment problem, and was on the verge of defaulting. The rupee was further devalued to Rs 25/$ as part of the measures to overcome the crisis.
• By 1993, with the liberalisation of the economy, the rupee started to slide towards the Rs 35/$ mark, as the open market had taken control of its exchange.
• In 2008, with the global recession, the rupee rose to Rs 51/$, after having appreciated to Rs 39/$. In 2012 with the Greece-Spain sovereign debt crisis, Indian government’s budget conditions worsened and GoI had resorted to selling dollars which devalued the rupee further to Rs 56/$ in June 2012.
2013: The Indian rupee plunged to a record low versus the dollar, slumping to an intra-day value of 68.85 on August 28, 2013, based on a combination of factors before gradually recovering to 61.7710 by year-end.

Consequences of the fall in Rupee:
Inflation: The eroding rupee is likely to create inflationary pressure in the economy by making imports costlier. The industries that use imported components will witness a surge in their raw material cost and will pass on the increased cost to the consumers.
Interest Rates: Falling rupee will keep bond yields at a higher level and may force authorities to raise interest rates. Higher interest rates will also hurt borrowers. So, home loan EMIs could go up.
Foreign Institutional Investors: Foreign equity investors on the other hand would welcome a strong currency and low interest rates as it will increase the profits of companies and therefore the returns will be higher in dollar terms. Rupee weakness will increase the cost of holding debt for foreign investors and could lead to outflows from debt.
Industries: A weaker rupee could affect companies with higher dollar debts, capital-intensive sectors, firms with foreign currency borrowings and those importing raw materials heavily.
Exports: A weak rupee will actually help exports because the dollar prices of Indian exportable goods will become lower which will increase the competitiveness of Indian products.
Holidays and Education: The dollar is becoming more expensive and those who are planning to go abroad this would cough out more rupees for buying dollars or Euros to meet their holiday expenses. Similarly, those who are sending money to their children abroad for studies will also have to pay more rupees for each dollar.
Remittances: According to the World Bank, the Indian diaspora remitted about $69 billion in 2017, the most in the world. The value of these remittances in bank accounts in India will rise.

Measures taken to Arrest the Fall:
• The Reserve Bank of India has already started to intervene in the forex markets to counteract the outflow and correct the volatility in the rupee’s value. It has tried with some success to bring stability in the market by injecting dollars, and the rupee has somewhat stabilized.
• India’s foreign currency assets fell by around $19 billion since April 2018 in the wake of capital outflows and intervention by the Reserve Bank of India to arrest the decline in the rupee’s value against the dollar.
Earlier in 2013, RBI had taken following steps to arrest depreciation:
The government had hiked the import duty on gold and silver to 10 percent to rein in the imports. The RBI had tightened the norms for gold imports by linking them to exports.
In a bid to attract NRI deposits, the RBI had liberalised bank deposit schemes and some banks raised rates for overseas Indians this month.
The RBI has tightened liquidity to reduce the availability of rupee in the banking system to reduce rupee volatility.

Scarcity: One major factor determining a currency’s exchange rate is its relative scarcity vis-à-vis other currencies. Since central banks are the sole suppliers of national currencies, they can influence the value of their currencies by appropriately regulating their supply.
Interest Rates: Another factor that determines a currency’s exchange rate is the benchmark interest rate, which can be used as a tool to directly attract capital into the country and prop up the value of its currency.
• The Reserve Bank of India can affect both the money supply and domestic interest rates simultaneously through its monetary policy stance. Yet another common way to prop up a currency is through the direct intervention of the central bank in the forex market.
Making government bonds available to a wider investor base: Making government bonds available to non-resident investors will also increase the inflow of dollars in to the country and help contain the CAD, and in turn, the depreciation of rupee.
Improving the climate for foreign investors: The most obvious way to offset distribution is to increase growth and bring more dollars into the system, thus reducing the CAD. Relaxing of norms for FII investments is one of the more obvious ways to do it.

International Scenario of Falling Currencies:
• Other emerging economies like Indonesia, Argentina, Mexico and Turkey have seen a fall in their currencies.
• In 2016, the Argentine peso lost over 18.5% of its value against the U.S. dollar, as a new government had recently assumed power, and commenced the necessary adjustment to a previously expensive currency regime.
• Turkey’s currency, the lira, lost over 17% relative to the dollar last year.
• The Mexican peso took a beating, also losing a whopping 17% of its value against the dollar last year.
• The Swedish krona lost over 7% of its value versus the dollar last year.
Dollarized Economy: Some countries, such as Ecuador and Zimbabwe have “dollarized” their economies, either via outright dollarization – that is, legal use of the dollar in all transactions – or via pegs, like Hong Kong. Both scenarios present an expensive economic straightjacket.

Measures by Other Countries to Arrest the Fall:
• Quantitative easing or printing more money, as tried by most developing countries, including Turkey and Vietnam, to cheapen labour and exports.
• Tax amnesties, as recently Indonesia and Argentina to bring back money held abroad.
• Issuances of dollar bonds, as in Zimbabwe to shore up deficient foreign exchange holdings.
• Oil production cuts among OPEC members to re-boost petrodollar receipts as oil and other commodities are traded in dollars.
• Nigeria and Venezuela used implicit devaluations with official and black market exchange rates. Egypt and Argentina tried direct, telegraphing devaluations well in advance.
• Thus, devaluation can be both implicit and direct.
• China is likely to resort to a gradual depreciation in its currency ‘Yuan’ against the US dollar. This will make Chinese goods more attractive in other countries.

Leave a Reply

Your email address will not be published. Required fields are marked *