Taking a closer look at these issues, the fall in rupee can be attributed primarily to 3 broad factors.

• Firstly, the grim global economic outlook, essentially due to the European debt crisis. Due to turbulence in European markets, investors are considering dollars as a safe haven for their investments in the longer run. This led to an increased demand for dollars vis-à-vis the supply for rupee and thus the depreciation. Another line of thought could be that while investors are shifting from European markets, why are they not investing in the Indian markets?  The Indian economic scenario for the entire 2011 has been plagued by high rate of inflation, hovering above 8%, and extremely low growth in manufacturing sector. The HSBC-PMI (Purchasing Managers index) fell to 51 in the month of December 2011.  The cumulative effect of these factors is leading to a shift in investor sentiments towards dollar market.

• Secondly, the fall in rupee can be largely attributed to the speculations prevailing in the markets. Due to a sharp increase in the dollar rates, importers suddenly started gasping for dollars in order to hedge their position, which led to an increased demand for dollars. On the other hand exporters kept on holding their dollar reserves, speculating that the rupee will fall further in future. This interplay between the two forces further fuelled the demand for dollars while sequestering its supply from the market. This further led to the fall in rupee.
• Lastly, there has been shift of FII’s (Foreign institutional investors) from the Indian markets during the current financial year 2011. FII’s leads to a high inflow of dollars into the Indian market. As per a recent report, the share of India’s FII in the developing markets has decreased considerably from 19.2 % in 2010 to 3.8% in the year 2011. As FII’s are taking their investments out of the Indian markets, it has led to an increased demand for dollars, further leading to a spiraling rupee.

Encompassing all these factors, there is a lack of firm initiative by government on issues such as allowing FDI in retail. Recent debacles such as 2G have further rendered the Indian market unattractive to a certain extent.

Evaluating the impact of the falling rupee on the Indian economy -

The first major impact of the falling rupee can be seen on the rising import bill. India imports close to 70% of its net fuel requirements. This means the companies importing oil have to shell out more rupees for the same dollar invoices. As is clear from Fig.1 although the price of oil has gone down from $118  per barrel to $109 per barrel, not much benefit can be derived since exchange rate too shoot up from Rs. 44 to Rs. 52.7 a dollar.. Instead, the price of importing oil increased to an extend of RS 489 (as is clear from Fig2 (b)). This has severely impacted the bottom line of these companies as well as the subsidy bill of the Indian government. Huge buying of dollars from the market in order to meet the import bill has further added to the existing woes. Additionally, the falling rupee has added further to the inflationary pressures, as imports have become costlier and thus increasing the prices of key commodities such as oil, imported coal, minerals, and metals. However the falling rupee has substantially appreciated the revenues for the exporters, who receive more rupees for their dollar receipts.  These industries include the IT Services industry, textiles and other export oriented industries. Increasing imbalance in trade i.e. increasing imports over exports is bound to have severe impact on country’s fiscal deficit, which is pegged to increase by .8 percentages to 5.4% of GDP from the originally estimated value of 4.6% of GDP.

Figure 1 – oil prices and exchange rates

Source – RBI

Role played by RBI: RBI has been extremely cautious in its intervention during the entire rupee depreciation crises. RBI has however reacted with timely interventions by selling dollars intermittently to tame sharp fall in the currency. The outflow of dollar reserves from RBI coffers has been extremely cautious, mostly due to the dwindling foreign exchange reserves. The foreign exchange reserves of India in December 2011 stood at 270 billion USD. Recently RBI has intervened with key policy initiatives such as intervening in the forward contracts policy. As per new RBI policy the cancelled forward contracts cannot be rebooked. Exporters in order to rake in more profits, were booking forward contracts, then cancelling the contracts, and again rebooking at better rate. This process led to a further depreciation in rupee and fuelled speculations.  Also, RBI intermittently put trading limits for the banks in the foreign exchange market in order to tame the speculative forces.

Looking at the current economic outlook, the currency crises seems to stay for a much longer period this time around. However, a structuring of Greek debt coupled with higher inflows from FII’s can lead to an arrest in the falling rupee.

Source of Data:

http://www.hsbc.com/1/2/emerging-markets/em-index/purchasing-managers-index http://www.rbi.org.in/scripts/statistics.aspx

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Contributed by:

Himanshu Joshi

himjoshi@iitk.ac.in

MBA – 2011-13