Why the rupee is falling against the dollarThese are extraordinary times. Analysts have described the events ofthe last few days as the worst financial crisis ever to have hit theworld. Imprudent financial decisions, fed by greed and bad luck, haveseen global financial markets collapse. The bankruptcy, sale,restructuring and merger of some of the worlds largest financialinstitutions has caused cataclysmic disruptions in the internationalstocks and money markets.In such a scenario, how could India have escaped unhurt? The globalcrises saw Indian stock markets crash, but as soon as the UnitedStates funneled in $700 billion into the American economy to revivedying markets, India too saw some stability. However, the forexmarket was a totally different ball game.Even as the dollar strengthened, the Indian rupee began to fallalarmingly. The Indian currency has fallen to the lowest level in almosttwo years. At a low of 46.99 to the dollar this year that it hit onSeptember 16, the rupee lost almost 18 per cent against the UScurrency!To put things in perspective, the rupee was trading at about 39.40 tothe dollar in January this year.So why is the rupee falling against the dollar, when the global financialcrisis should impact the United States the most?There are several reasons. Analysts say these are the reasons forthe fall of the rupee. . .
The Reasons For The Fall Of The RupeeThe main reasons behind the fall of the rupee are an increaseddemand for dollars due to a spurt in crude oil prices and the flight offoreign funds from the Indian market. Demand for rupees,simultaneously, has dipped because capital inflows are down. The American sub-prime crisis that shook the global financialmarkets has seen unprecedented bailouts and infusion of dollars intothe US economy. This infusion has been at a cost of many anemerging market, from where funds have been pulled out to ploughback into America. India has been one of the worst hit countries onthis count, as foreign funds took flight, thereby making dollars scarce.The sudden and colossal demand for the US greenback has seen itstrengthen, while the rupees exchange rate has depreciateddramatically during the same period. Indias stock market regulator, the Securities and Exchange Boardof India, has said that foreign investors sold more Indian shares thanthey bought. Global funds are said to have sold Indian shares to the tune of over$9 billion more than they have bought this year. As demand for dollarsfrom importers increased and the US Treasury poured in almost $700billion into the US economy to bail out drowning financial giants, theIndian market saw an outflow of a huge amount of dollars leading to aspurt in the dollar price against the rupee. The growing Indian trade deficit and the large fiscal deficit are alsocontributing to the fall of the rupee. The higher price of imported goods, especially oil that is now rulingat over $107 per barrel, has also led to an increase in domesticinflation and a fall in the value of the Indian currency. High inflationand a strong growth in the Indian economy have already forced theRBI to raise interest rates. The demand-supply balance and the fundamentals are against therupee India has seen a large amount of outflows from its financialmarkets. India is a heavy importer of oil and the current spurt in crudeoil prices has impacted the rupee too. Also, the decline in the value of the rupee has coincided with RBIdiscontinuing its direct sales of dollars to oil firms in early July.
One more reason for the fall of the rupee, as propounded by someeconomists, is the overseas non-deliverable forward (NDF) market thatis not sanctioned by the Reserve Bank of India.An NDF is a non-deliverable forward contract where financialinstitutions buy forward dollars (that is, they book dollars now fordelivery at a predetermined future date) in the Indian market and atthe same time sell a similar amount of dollars in an overseas market --or vice-versa -- so that on the delivery date they make a profit or loss,which is the difference between both the rates.What happens if the rupee keeps on falling? As the rupee falls, foreign investors will want bigger returns fortheir money to compensate for the higher risk. This means that theIndian government, companies and individuals will have to pay morefor the money they borrow: in other words, higher interest rates. A major problem with a falling rupee is that it will increase theIndian governments burden of repaying and servicing foreign debt. Another problem is that it might discourage foreign institutionalinvestment from pouring funds into the Indian markets. Indian companies which could borrow from the overseas markets atcheaper rates to finance their import and export needs will be badlyaffected.How can India control the value of the rupee in theinternational market?The Reserve Bank of India can sell dollars in the open market to bringdown the value of the US greenback, albeit slightly.Normally, the RBI uses its Monetary Policy to defend the rupees value.Short-term interest rates changes do impact the value of the rupeeagainst other currencies. But, the RBI has mostly used the policy tostabilise internal conditions, like steps to control rising inflation.However, if the Indian stock markets boom -- like they did in the lastcouple of years -- more and more global funds would begin to invest inIndia thereby strengthening the rupee as the demand for the dollar inthe local markets drops.
What has the RBI done?The Reserve Bank of India is closely monitoring the developments inthe global as well as domestic financial markets and stands ready totake such pre-emptive action as may be necessary to contain excessvolatility in the domestic financial markets.In order to alleviate these transient pressures which are related largelyto external developments, the RBI has decided to take the followingmeasures:(a) Forex MarketIn the light of current developments in the foreign exchange markets,as on some previous occasions, the Reserve Bank will continue to sellforeign exchange (US dollar) through agent banks to augment supplyin the domestic foreign exchange market or intervene directly to meetany demand-supply gaps. The Reserve Bank would either sell theforeign exchange directly or advise the bank concerned to buy it in themarket. All the transactions by the Reserve Bank will be at theprevailing market rates and as per market practice.(b) Interest Rates on FCNR (B) DepositsCurrently, the interest rate ceiling on FCNR (B) deposits of allmaturities has been fixed at Libor/Euribor/Swap rates for thecorresponding maturities minus 75 basis points for the respectiveforeign currencies. In view of the prevailing market conditions, it hasbeen decided: to increase, with immediate effect, the interest rate ceiling on FCNR(B) deposits by 50 basis points, i.e., to Libor/Euribor/Swap rates minus25 basis points. to increase, with immediate effect, the interest rate ceiling onNR(E)RA deposits by 50 basis points, i.e., to Libor/Euribor/Swap ratesplus 50 basis points.
But why do currency values fluctuate?There are many participants in any foreign exchange market. Theseentities -- like banks, corporations, brokers, even individuals -- buyand sell currencies everyday.Here too the universal economic law of demand and supply isapplicable: when there are more buyers for a currency than sellers, itsexchange rate rises. Similarly, when there are more sellers of aparticular currency than buyers, its exchange rate in the globalmarkets will fall. This does not mean people no longer want money; itonly means that people prefer to keep their wealth in some other formor another currency. Is there any hope for the rupee?The Indian currency, however, has in the last two trading sessionsrisen sharply against the dollar under the hope that foreign investorswill soon buy into the Indian stock markets.With risk aversion among foreign investors declining, the Indian rupeeis likely to strengthen. A temporary aberration?Commerce Minister Kamal Nath has termed the Indian rupees fallagainst the dollar as a temporary aberration, but said that the lowervalue of the rupee will help boost export growth.But even as foreign funds withdrew money from the Indian marketsand the oil prices kept going up, Indias huge foreign currencyreserves -- pegged at $289 billion that is enough to cover for almost ayears worth of imports -- have helped a lot, for even if FIIs take awayfunds India will not face a solvency crisis like it did in the early 1990s.