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Rupee, the driver of $2.26 trillion Indian economy, has fascinated every economist but lately with a fall and stipulated inflation situations at the horizon, it has started fascinating those who dwell on politics too. The currency of the world’s fastest growing economy is on a growth, but beware, it’s negative. Where will it end, a precursor to something like what happened in Venezuela or Turkey, or is it a situation which existed before the gates of Indian economy unbolted for the world? Or is it just a normal situation arising out of external conditions which was long overdue?

The Indian Rupee has been one of the worst performing currencies amongst the major emerging market currencies in the last quarter. The Indian Rupee has lost around 9% of its value in the past few months, and around 2000% since Indian independence. However, one thing must be noticed that this fall has been a gradual one. There are several dimensions of views on this depreciation of Rupee, some being positive and some being negative. Having breached the psychological barrier of 70 against the USD, anticipations of Rupee crossing 80 against the dollar is gaining tumult in the market. Amidst all these anticipations and expectations, there is a need to signify the fact that the current situation is rather strengthening of the dollar than the weakening of the rupee. Almost all the major currencies have lost a significant chunk to the USD except the Japanese Yen.

Economists have attributed several external factors for the current depreciation of Rupee, like the Turkish Lira crisis, global trade wars, hike in interest rates in developed nations and the rising demand for more stable currencies. The depreciation of the rupee has been regarded as a spillover effect of the crashing of Lira, however, it is worth noting that an 18% decline in Lira led to approximately 1.5% depreciation of the rupee, thereby inferring that the effect of Lira on Rupee is rather apparent and not that real! Global trade war fears, under the present scenario of retaliatory import tariffs by the US and China have also contributed to the weakening of the Rupee. The other significant reason for weakness in the value of Rupee is the rise in US bond yields which has made the dollar attractive. Higher US yields are attracting investors to the US treasuries and making the currencies of the emerging markets such as India, weaker. Economists see this as a contagious effect, where with the ‘Bolivar crisis’ in Venezuela and ‘Lira crisis’ in Turkey, investors are attracted towards making more investment in safe markets like the USA. This situation has been fuelled by higher interest rates in developed countries throughout the world.

So now the question that pops up in our minds is how this depreciation of Rupee is going to affect ‘us’ as an economy, and ‘you’ as an investor. It is important to analyse the various possible consequences on the different sections of the economy.

The free fall of Rupee has significantly affected Foreign Institutional Investments (FIIs). Imagine a situation where you are an investor with 10,000$ in your pocket. In year 1, when 1$ = ₹60, and interest rates in the USA and India are 2% and 10% respectively. At the same time, Rupee falls in the year in which you are going to invest, from ₹60 to ₹66. So when you invest that sum in the US market, at the year end, you get 10,200$ and when you invest the same in the Indian market you get ₹6,60,000, i.e, 10,000$. So despite better interest rates, Indian markets are not able to provide same return as US market, due to which investors are withdrawing their money from the Indian economy, leading to further depreciation of the Rupee. In this year, until July, investments worth almost ₹32,000 crores have been withdrawn from the Indian economy. According to Bloomberg Intelligence, the equity inflows into the country have moderated, averaging $2.9 billion (Rs 19,823 crore) a month in January-February 2018, compared to a monthly average of $3.6 billion (Rs 24,608 crore) in October-December 2017. FIIs are primarily concerned with volatility in currency since it affects their returns in equity and debt segment. The weakening of Rupee would increase the cost of holding debt for foreign investors. Falling rupee will keep bond yields at a higher level and may force authorities to raise interest rates — high interest rates can arrest the fall by attracting foreign capital. This, however, will adversely impact long-term debt funds as their net asset value (NAV) and returns fall when interest rates go up. In addition, it will affect the performance of the government bond schemes in the NPS. Higher interest rates will also hurt borrowers. The stock market is expected to see heavy outflows attributed towards concern over high current account deficit (CAD) along with political and economical worries.

Now talking about the effect on the exports of the country, it is technically supposed to rise. Depreciation of rupee makes it relatively cheaper in terms of Dollar. Suppose earlier $1= Rs. 60, this implies that one would get 60 Rupees in exchange of one dollar, and now rupee depreciates and $1 = Rs. 70, which means that for the same one dollar, one would now get 70 Rupees. This means that a depreciation of Rupee against Dollar would increase the purchasing power of Dollar, i.e. for the same good, the importer will have to pay lesser in terms of dollar to an Indian exporter. So technically, this would lead to a rise in exports, leading to a hike in export incomes of the country. Analysts are of the view that Pharma and IT sectors are the ones which may make the most of the present scenario. However, it is worth noticing that not every exporter makes the most of this depreciation of the currency. Usually, renegotiations of export contracts happen and the exports consequently attract a very thin margin. Also, it must be noticed that around 40% of India’s exports is dominated by goods having very less value addition like export of polished imported diamond.

Imports play an important role in a country’s Balance of Payments situation and thus inflation situation in the economy. So how does depreciation affect imports? Technically it is supposed to fall, as imports become more expensive when a currency depreciates. For instance, the price of a commodity is 10$ when 1$ =₹60, so an Indian customer will have to pay ₹600. However, at the same time, another commodity is available, domestically produced, at ₹630. But now rupee depreciates and 1$ = ₹70, so the Indian customer will have to pay ₹700 for the same commodity, so he will clearly prefer the domestically produced commodity, which is available at ₹630. So there is a fall in imports. However, due to certain necessities and habits, the demand never goes to zero and despite fall in the quantum of imports, generally, there is a rise in import bills, as increased price of imports overpowers the decreased quantity of the same.

Let’s take a closer view of a rather intriguing aspect of Rupee and its depreciation. Many Indians, including noted economists, are interested in fiscal and current account deficit (CAD)situation of India, in which Rupee value has a major role to play. There are two ways to look at this situation in terms of import bills or current account deficit. First is the perspective which says that this fall of rupee will result in an increase in CAD, the other being that of a favourable situation in Balance of Payments, thus better position on CAD front. In the first situation, the fall of rupee will lead to rise in import prices and important commodities like petroleum products will become expensive. At the same time, this rise in prices of petroleum products will certainly lead to inflationary situation in the economy. This situation is more common and is based on the assumption that the rise in prices will overpower the quantum of imports and exports, as with depreciation of the rupee, comes a rise in exports and fall in imports. So in the first situation, with rise in prices overpowering effect of favourable increase in (X-M), i.e., (exports less imports), fall in rupee will lead to increase in current account deficit. Now, imagine a situation where the quantum of exports increase and imports decrease overpowers the rise in prices. This would lead to a favourable situation for CAD in India and inflation rates may not rise.

Depreciation of the Rupee may lead to an inflationary trend in the country, given the rise in oil prices. India imports crude oil with payments being made in terms of dollar. A weakening of Rupee against Dollar implies that India would have to pay more for importing oil. This may prompt oil companies to hike the prices of petrol and diesel. Costlier transport fuel will knock up prices of most goods and lead to inflation. Also, the industries which are dependent on imported goods as raw material will witness a surge in their input cost and they would most likely pass on the increased cost to the customers by hiking prices.

Most of our external borrowings are dollar denominated. An eroding Rupee would make the payment of interest and repayment of maturities in near future costlier. Although India has a large forex reserve of $402 billion, with which it can sustain and survive any major crisis for nearly a period of 9 months, continuous selling of Rupee for Dollar would lead to tightening of liquidity. This would indeed contribute to inflation. Higher debt servicing expenses may lead to fiscal deficit and add on to the twin balance sheet problem.

Having discussed all the possible implications, it must be brought forth that the fall of Rupee is not a crisis, it is not the true explanation of its name either. The situation is strengthening US Dollar with respect to every other currency except for the Japanese Yen, as implied above. We feel like there is no need to buy the panic and the political pandemonium created on the grounds of the assumption that Rupee falling below 70 is worst for our economy. In fact, as we have a look on the Balance of Payments situation of the country, the situation can prove to be a better situation than we expect. Due to a prospective rise in exports and complementary dip in imports, the situation is expected to have a good impact on Balance of Payments and more importantly on Balance of Trade, if it overpowers the rise in import prices. Apprehensions of inflation are no danger either, given the statistical relationship that a 5% fall in Rupee contributes merely a 0.2% increase to inflation. Moreover, with the establishment of the Monetary Policy Committee, the inflation is well within the limits suggested by the Institution. The situation is shouting for ‘Make in India’. This is certainly the best situation to use ‘Make in India’ as investing in India has become cheaper due to the depreciation of Indian Currency with respect to US Dollars and at the same time, Rupee is not going through a crisis situation as well.

The market saw a boost too with Government coming up with a Committee in action. One of the important decisions is to look after mandatory hedging for infrastructure loans, which relates to external commercial borrowings and hence, the value of the currency. Moreover, the restrictions imposed on FPIs are going to be modified as decided by the committee, which will remove the limit of 20% FPI, set by RBI in April this year. The new limit is 50%. But one of the most significant steps which the Government Committee has decided is to do away with withholding tax on Masala Bonds, the Rupee denominated bonds, which might increase the demand for such bonds in future. With these steps, market sentiments have come into action to turn the Rupee arrow green after weeks of fever, which shows how market sentiments play an important part in deciding the value of a currency.

Prima facie, the current scenario may seem to be a phase of tumult or crisis to many, but it might prove to be a blessing in disguise, given the prospective opportunities available to the investors as well as the economy to boost up, if handled with the best of practicality.

Currency weakness is a factor of dollar strength rather than anything else. But, I would say that investors should look at countries with large current account deficits as well as high level of debt,” is what Raghuram Rajan said in an interaction with CNBC. In fact, several economists are of the view that this depreciation was long overdue and Rupee is still overvalued! So what is important here is not subscribing to political ideologies and panic in this situation.

By Sakshi Agarwal and Aman Srivastava


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