Falling rupee against dollar: Reasons and possible remedies

Thu, Sep 5, 2013

In Focus

The rupee has plunged to an all-time low against the dollar and its fall has become a subject for debate. The usual discussions on the fall of the rupee bring up macro economics matters such as slow economic growth, huge current account deficit, rising imports etc.
At the time of independence when India had no foreign borrowings the rupee was at par with the dollar. With the introduction of the 5 years plan and the subsequent requirements for foreign investments the dollar slowly rose.In 1985, after the Bofors scam, which toppled Rajiv Gandhi’s government, the dollar was equal to 12.35 rupees and since the economic liberalization in 1991, there was a sharp devaluation of rupee and the rupee had dropped to Rs.24.5 against a Dollar. The dawn of the third millennium gave a further worsened the condition rupee against dollar and the rupee has hit an all time low of Rs. 65.42 against a dollar on the 22nd of August 2013. Indian economists are trying hard to chalk out a strategy to counterbalance the falling value of rupee but it seems the attempts are futile.

There major reasons for the plunging fate of the rupee are:

Current Account Deficit (CAD)

CAD is considered to be the key factor behind the steep volatility of rupee against dollar. CAD occurs when the total import of goods and services of a country is greater than the total export goods and services thus making India a debtor to the rest of the world. India’s current account averaged a deficit worth 1.5 billion USD since 1947 until 2013. In the first quarter of 2013 the CAD was 18.1 billion and at present it has gone up over 20 billion. This has hit hard on the rupee.

Strengthening of DollarIn the last six months the dollar has strengthened by 3.52 percent with the strengthening of the US economy. The dollar has been rising on signs of growing economic momentum and talk of an early end to the Fed’s stimulus effort. This is something which is beyond the control of the Indian Government and it is hampering the recovery of the rupee.

Insufficient inflow of FDIs and outflow of the foreign investmentsThe downfall in the Indian economy has worsened the situation and the government is unable to generate heavy capital inflows. Despite all the government effort to allow Foreign Direct Investment (FDI), there hasn’t been significant FDI inflow. The US federation has withdrawn some of its bond buying programmes resulting in a sudden outflow of money that in return has left India far behind in the race .Foreign investors has been pulling out of the Indian economy. The month of May has seen a record outflow of foreign investments of Rs. 44162 crore. With the giants like Posco pulling out of its Rs. 30000 crore steel plant project in Karnataka followed by ArcelorMittal pulling out of its Rs. 50,000 crore project in Odisha due to delays and land acquisition delays. This has shrunk the total inflow of capital in India. Indian investors have been spending more abroad than foreign investors have been spending in India. This has led to the further deficit of current account.
Rising Imports

The rising import bill is one of major concern and is has hindered the government effort to tackle the falling rupee. Oil accounts for 35% of the total imports and gold 11% on India’s current bill. There has been a heavy demand for the greenback from the exporters of oil, the most prolific buyers of dollar in the world market, thus pushing rupee lower. In the gulf countries, the dealing of oil is done in dollars, i.e, if India has to purchase oil, it has to pay in dollars, so for this India needs purchase dollars from USA in exchange of gold. This has led to the further devaluation of the rupee. Also, the sliding prices of gold have triggered the government to lower the imports of gold, thereby increasing the Current Account Deficit (CAD) and concurrently weighing heavy on the currency.

Poor Economic Growth

The Gross Domestic Product (GDP) has hit its lowest patch in the last 10 years. With fall of the GDP to 4.8%, it had significant effect on the stock markets and the falling rupee. The manufacturing, mining and the agricultural sector has faltered and investors have become cautious of investing in India.

The central government has unravelled a multipronged strategy to bring about an increment in the inflow of dollars and limit the outflow to compensate for the sliding value of rupee. A planned increase in import duty has been exercised to shore up the decrement in rupee. Some of the other possible remedies that can be emphasized are:

  • The customs duty on several red-hot imports like gold and silver is on the rise as it’s a strategic movement by the central government to ease the gap between dollar and rupee.
  • NRI bank deposits can be made more attractive and foreign loan norms eased.
  • The government has also decided on three public sector institutions based on finances to raise funds in dollars through bonds.
  • Electronic goods top the list when it comes to making big business. In order to stabilize rupee a significant increase in customs duty on Electronic goods needs to be exercised.
  • Another point that can be kept on the anvil is that some imports should be denied. The products can include crude palm oil, copper and certain varieties of coal.

Economists believe that these measures will bridge the foreign exchange (forex) gap by $1.8 billion. Even finance minister P.Chidambaram anticipates that the government will be able to prune annual imports by $7 billion and thereby increasing inflows by $11billion. This would in return help maintain the Current Account Deficit (CAD) at $70 billion which roughly estimates to 3.7 % of the gross domestic product. This calculated statistic with these measures is lower than that of last year that had estimated to $4.8 billion.

There have been a slew of measures that have been undertaken by the government but to no avail. It clearly shows its urgency to deflect a possible crisis on the left over payments. Way back in 2001, as an aftermath of the 9/11 attacks and Dotcom bust, State Bank of India (SBI) managed to mint $5 billion through Indian Millennium Deposits. This time State Bank of India refuses to play a role in decrementing dollar debt. A quasi-sovereign has been signed by the government and other financial institutionslike Power Finance Corporation and Indian Infrastructure Finance Corporation Ltd. There have been many other efforts to lift rupee but rupee continues to be at 63.20 today, on the 23rd of August, marginally short of the lifetime low of 65.42.

Sources

  1. http://www.tradingeconomics.com
  2. http://stockmusings.com
  3. http://profit.ndtv.com

Chiranjit Mitra
MBA Batch 2013-15

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