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Indian rupee in Crisis


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  • Continued Global uncertainty: Owing to uncertainty prevailing in Europe and slump in international market, investors prefer to stay away from risky investments (flight to security). This has significantly affected the portfolio investment in India. Credit rating agency’s downgrade of India to BBB- with a negative outlook, the last of the investment grade has not helped the cause. Any outward flow of currency or decrease in investment will put a downward pressure on exchange rate. This Global uncertainty has adversely impacted the domestic factors (current and capital account etc.) and caused the depreciation of rupee. Current Account Deficit: While a country like China will be more than happy with a depreciating currency, the same doesn’t apply for India. China exports more than it imports, thus a depreciating currency makes its exports cheaper in the International market, in turn making China more competitive. India on the other hand does not enjoy this luxury, mainly because of increasing demand of oil, which constitutes a major portion of its import basket. The fall of oil price to $90/barrel has helped India to fight the depreciating rupee up to some extent but at the same time Euro zone, one of the major trading partners of India is under severe economic crisis. This has significantly impacted Indian exports because of reduced demand. Thus India continues to see current account deficit of around 4.3%, depleting the forex reserve and thus depreciating INR.Capital Account flows: Deficit countries need capital flows and surplus countries generate capital outflows. India needs dollars to finance its current account deficit. Institutional investors investing in India are directly impacted by the global market uncertainty. In 2008 India had a net outflow of $14billion of FIIs and INR depreciated from 39 level to 52 against dollar. A volatile currency is never good for a foreign investor as it increases the transaction risk. Thus the relation becomes a vicious cycle, thereby further magnifying the volatility. Though RBI has intervened through open market operations to arrest the downfall of INR (managed float) but the reserves of $290billion don’t provide enough room to make a significant impact.Persistent inflation: India has experienced high inflation, above 8%, for almost two years. If inflation becomes a prolonged one, it leads to overall worsening of economic prospects and capital outflows and eventual depreciation of the currency. The Real Effective Exchange Rate (REER) index (6 currencies- Euro, Yen, Pound Sterling, US Dollar, Hongkong Dollar and Renminbi) has fallen by 13.84% during the last one year while the nominal rate has depreciated by 24%. REER index measure includes the level of inflation differences across nations; it reflects a country's competitiveness in international trade. Thus the trend suggests that the country's competitiveness (measured by REER) has not improved as much as the decline in nominal exchange rate points out mainly because of increase in domestic costs. Under normal circumstances inflation is tamed by increasing interest rates, but since India already has high interest rates, it does not leave that option open, as it may lead to further slowdown in growth.Interest Rate Difference: Higher real interest rates generally attract foreign investment but due to slowdown in growth there is increasing pressure on RBI to decrease the policy rates. Under such conditions foreign investors tend to stay away from investing. This further affects the capital account flows of India and puts a depreciating pressure on the currency.Lack of reforms: Key policy reforms like Direct Tax Code (DTC) and Goods and Service Tax (GST) have been in the pipe line for years. A retrospective tax law (GAAR) has already earned a lot of flak from the business community. Attempts are being made to control the subsidy bills but fiscal deficit continues to hover around 5% of GDP. The government announced FDI in retail but had to hold back amidst huge furore from both opposition and allies. This has further made investors sentiment negative over the Indian economy.
  • This exchange rate is used to determine an individual country's currency value relative to the other major currencies in the index, as adjusted for the effects of inflation. All currencies within the said index are the major currencies being traded today: U.S. dollar, Japanese yen, euro, etc.This is also the value that an individual consumer will pay for an imported good at the consumer level. This price will include any tariffs and transactions costs associated with importing the good.Read more: is real exchange rate?Real exchange rate can be defined as the rate that takes into account inflation differential between the countries. Suppose the rupee was trading at Rs 40 to a dollar at the beginning of 2009. Assuming a 10% inflation in the Indian economy and 5% inflation in the US economy for the whole year, then this model says the rupee should depreciate by 5% (10%-5%) to Rs 42 to a dollar, other things being equal.Why is the real exchange rate important?Competitiveness of a country's exports is decided not only by the nominal exchange rate, but also relative price movements in domestic and foreign markets. For instance, even if the nominal exchange of the rupee remains unchanged with respect to, say, the dollar, India's exports to the US will become less competitive if inflation in India is higher than in the US. This means nominal exchange rate will have to be adjusted for effect of inflation.How is nominal exchange rate adjusted for inflation?Central banks use the concept of 'real effective exchange rate', or REER, to adjust nominal effective exchange rate for inflation. Conceptually, the REER is the weighted average of nominal exchange rates adjusted for the price differential between the domestic and foreign countries. The price differential, however, is based on the purchasing power concept. The currencies used are of those countries with which trade is the highest.How does the RBI calculate REER?The RBI calculates REER for India. It calculates the value of the rupee with respect to two indices, one comprising six countries and the other 36 countries with a 2004-05 base. The RBI, however, uses the wholesale price index-based inflation whereas globally consumer price indices are used. One conceptual flaw with this model is that it assumes that the base exchange rate is the correct exchange rate or represents the purchasing power parities accurately, which may not be the case
  • The new indices will use 3-year moving average trade weights in place of the present fixed trade weights, in order to suitably reflect the changing pattern of India’s foreign trade with its major trading partners. The RBI is also revising the thirty six-country REER/NEER series. The new series has been constructed with 1993-94 as the base year as against 1985 as the base year in the existing indices.Currency Signs• RBI has replaced its five-country indices of NEER and REER with new six-currency indices• It is also revising its thirty six-country indices• The new six-currency indices will include USA, Eurozone, UK, Japan, China and Hong Kong SAR• The new indices will also have two new currencies, both Asian — the Chinese renminbi and the Hong Kong dollarThe new series comprises a revised set of currencies for better representation of countries, which have a significant share in India’s foreign trade.The revised set, includes Hong Kong SAR, Denmark, Iran, Kuwait, Qatar, Russia, South Africa, Sweden and UAE. Besides, with the expansion of the Eurozone, the new indices, include all the twelve countries that have euro as common currency.Has the rupee really fallen over the years? The rupee was around 19 against the US dollar in 1991. Now, 20 years later, the rupee is around 53 against the dollar. This means the Indian currency has fallen, or depreciated, by 179 per cent over the years against the dollar.However, the rupee has not fared badly if its value against all major global currencies is taken. The real effective exchange rate (REER) — or the REER Index of the rupee — calculated by the Reserve Bank of India (RBI) based on a basket of 36 global currencies (36-REER) was 94.2 on March 31, 2012. It was around 75.5 in 1991. This means, in real terms, the rupee has remained strong over the years. The 36-REER — with 2004-05 base as 100 — even rose by 4.7 per cent during the fourth quarter of 2011-12. However, for the full year it declined by 3.3 per cent after a rise of 8 per cent in 2010-11, the RBI says.The 6- currency REER Index, which is at 105.5 has showed a rise of 4.2 per cent in the last quarter of 2011-12. It rose 13 per cent in 2010-11 but fell marginally by 2.9 per cent in last fiscal. The central bank has kept the 6-REER Index close to the 100 level to keep the exports competitive amidst huge capital flows and dollar purchases by the RBI.The RBI takes the REER Index — adjusted for relative inflation in India and her trading partners — seriously while formulating its exchange rate policies. The rupee’s value against the dollar alone is not the deciding factor. The rupee-dollar value is not considered as the real measure of export competitiveness as India exports goods and services to several countries — not just the US alone — and the economic indicators, including inflation and currency value in these countries, are different.
  • Using Forex Reserves: RBI can sell forex reserves and buy Indian Rupees leading to demand for rupee. But using forex reserves poses risk also, as using them up in large quantities to prevent depreciation may result in a deterioration of confidence in the economy's ability to meet even its short-term external obligations. And not using reserves to prevent currency depreciation poses the risk that the exchange rate will spiral out of control. Since both outcomes are undesirable, the appropriate policy response is to find a balance. Recent data shows that RBI had indeed intervened by selling forex reserves selectively to support Rupee.Raising Interest Rates: The rationale is to prevent sudden capital outflows and ultimately lead to higher capital inflows. But India’s interest rates are already higher than most countries. This was done to tame inflationary expectations. So further raising interest rates would lead to lower growth levels.c. Make Investments Attractive- Easing Capital Controls: RBI can take steps to increase the supply of foreign currency by expanding market participation to support Rupee. RBI can increase the FII limit on investment in government and corporate debt instruments. It can invite long term FDI debt funds in infrastructure sector. The ceiling for External Commercial Borrowings can be enhanced to allow more ECB borrowings.
  • DOLLAR-WINDOW FOR OIL COMPANIESThe RBI could open a dollar window for oil companies to sell rupees and buy dollars from the central bank. This would reduce volatility in the rupee by enabling oil companies to directly source a large part of their dollar requirement instead of buying large chunks from the market. The RBI could sell the dollars to oil importers at its daily reference rate. However, that could severely strain the country's reserves given the country's large oil import bill.DOLLARS AGAINST OIL BONDSThe RBI could conduct special market operations for oil companies, holding auctions to buy oil bonds and giving the oil companies foreign exchange at market rates. However, dealers say the outstanding amount of oil bonds is too small to lead to significant rise in dollar supply. The RBI opened such a dollar window for oil companies in 2008 and discontinued it in 2009.SOVEREIGN-BACKED NON-RESIDENT INDIAN BONDThe government could issue a sovereign-guaranteed bond through State Bank of India to non-resident Indians at attractive interest rates, similar to the Indian Millennium Deposits issued in 2000, when the bank attracted around $7 billion for a $5 billion issue. However, such a move could increase the country's debt and interest liability.SOVEREIGN OVERSEAS BONDIndia could issue sovereign bonds to raise dollars from overseas investors. However, the RBI is wary of the government issuing bonds directly as it exposes the country to foreign exchange risk during repayment. One option would be to sell a dollar bond repayable in rupees. The Philippines was the first country in Asia to sell dollar bonds abroad to be repaid in its local currency in September 2010.MORAL SUASIONThe RBI can attempt to persuade banks and finance companies to raise funds in dollars abroad and bring them back to India to lend locally. Many banks have an ongoing forex bond issue programme , and the rupee's decline can make it attractive to raise dollars and convert them into rupees even after accounting for the hedging cost given the fall in forward dollar rates.STAGGER IMPORT PAYMENTSThe central bank could issue rules to effect a delay in import payments, which typically are made at the end of every month. The bunched-up outflows put pressure on the rupee, and the RBI could look at asking for staggered payments.
  • Transcript

    • 1.  General Changes  Prior Intimation to RBI for Increase in Threshold Limits by Foreign Institutional Investors (FIIs)  Investments by Foreign Venture Capital Investors (FVCIs)  Investments by Qualified Financial Investors (QFIs)  Import of capital goods/machinery/equipment (including second-hand machinery)- conversion to equity  Transfer of shares where valuation norms are not met  Limit for providing undertaking for transfer of security by PRI to PROI as gift has been raised Changes in Sectoral Caps  Policy on commodity exchange  Non-banking Finance Companies (NBFC) clarification on leasing  Changes in FDI policy in single-brand retail trading and pharmaceuticals sector  Foreign Investment in Pharmaceuticals Sector - Amendment to the Foreign Direct Investment Scheme
    • 2.  Banking - 74% Non-banking financial companies (stock broking, credit cards, financial consulting, etc.) - 100% Insurance - 26% Telecommunications - 74% Private petrol refining - 100% Construction development - 100% Coal & lignite - 74% Trading - 51% Electricity - 100% Pharmaceuticals - 100% Transportation infrastructure - 100 % Tourism - 100% Mining - 74% Advertising - 100% Airports - 74% Films - 100% Domestic airlines - 49% Mass transit - 100% Pollution control - 100% Print media - 26% for newspapers and current events, 100 % for scientific and technical periodicals
    • 3.  Continued Global uncertainty Current Account Deficit Capital Account flows Persistent inflation Interest Rate Difference Lack of reforms
    • 4. Market Situation Economic Factors Factors Affecting INRPolitical Factors Special Factors
    • 5. Demand/Supply FIIs situation of currencyBuying/Selling Floating rate of in Forex Currency Markets
    • 6. Internal Factors External Factors• Industrial Deficit • Export Import• Fiscal Deficit • Loan sanctions by World Bank• GDP & GNP and IMF• Foreign Exchange Reserves • International oil and gold• Inflation Rate prices• Agricultural Rate and • FDI & Portfolio investments production• Different types of policy impacts( EXIM, Credit policy etc.)• Infrastructure
    • 7. Delay in Delay in Political Implementati sanctioningInstability on of Policies budget
    • 8.  Events contributing in appreciation or depreciation of INR e.g.,  Indo –China War (1962)  Indo-Pak War (1965)  Bofors Scandal (1985)  Pokhran Nuclear Test(1998)  Kargil War (1999)  CWG Scam  Anna Hazare Campaign  Recent Credit Rating
    • 9.  IT Sector– The sharp depreciation in rupee is expected to boost software sales and forex gains in coming months. Remittances, travel expenses and dividends could increase outflows, however, they are unlikely to cause an abrasion in the P&L position of these companies Textiles – With easing of cotton and cotton yarn prices and improved export realisations, the textile industry is expected to gain in the current forex environment. Mark-to-market losses on existing hedged positions and suitability of new hedging contracts would be crucial determinants of overall profitability. The man-made fibres segment could face some pressure on account of higher import costs of inputs and marked-to-market losses on expenses. Dollar-denominated expenses could lend some offsetting support to margins Pharmaceuticals – Companies in this industry are net exporters and stand to gains through higher export realisations enhanced by a depreciating rupee. Losses on external commercial borrowings (ECBs) and limited feasibility of conversion on foreign currency convertible bonds (FCCBs) pose a concern to these companies, but are not expected to be huge. Gems and jewellery – With increased investment demand amidst a volatile global economy, prices of gold and other metals, which are inputs to this industry, have witnessed steep rise. Consequently the sectors profitability could be affected. However, the sector is export-oriented and is expected to gain against the rupee depreciation trend. Ferrous metals – Steep rise in prices of coking coal and iron ore aggravated by adverse rupee movements is expected to continue to pressure raw material costs for this industry and allied segments. Rather muted industrial production and investment activity in this industry on account of a tighter monetary regime could further manifest in contraction of supply. Power – Thermal power plants are expected to face some strain on account of higher import costs of ferrous metals and petroleum products, which in turn are expected to remain firm in the near future. Furthermore, some OMCs have restated assets in rupee terms and are likely to face added pressure in coming months Fertilizers – The industry imports about 50% of its raw material requirement. In Q3 FY12, raw material expenses rose sharply by nearly 20% on account of higher input costs against elevated global prices and depreciation in rupee. Potassium chloride is one of the major import items and a decline is already being observed in the same. This trend is likely to continue in the coming months along with a decline in sales.
    • 10.  1966 Economic Crisis-From 1950, India ran continued trade deficits that increased in magnitude in the 1960s. Furthermore, the Government of India had a budget deficit problem and could not borrow money from abroad or from the private corporate sector, due to that sectors negative savings rate. As a result, the government issued bonds to the RBI, which increased the money supply, leading to inflation. In 1966, foreign aid, which had hitherto been a key factor in preventing devaluation of the rupee, was finally cut off and India was told it had to liberalise its restrictions on trade before foreign aid would again materialise. The response was the politically unpopular step of devaluation accompanied by liberalisation. The Indo-Pakistani War of 1965 led the US and other countries friendly towards Pakistan to withdraw foreign aid to India, which necessitated more devaluation. Defence spending in 1965/1966 was 24.06% of total expenditure, the highest it has been in the period from 1965 to 1989 (Foundations, pp 195). Another factor leading to devaluation was the drought of 1965/1966 which resulted in a sharp rise in prices. At the end of 1969, the Indian Rupee was trading at around 13 British. A decade later, by 1979, it was trading at around 6 British pence. Finally by the end of 1989, the Indian Rupee had plunged to an all-time low of 3 British pence. This triggered a wave of irreversible liberalisation reforms away from populist measures.
    • 11.  1991 Economic crisis-In 1991, India still had a fixed exchange system, where the rupee was pegged to the value of a basket of currencies of major trading partners. India started having balance of payments problems since 1985, and by the end of 1990, it found itself in serious economic trouble. The government was close to default and its foreign exchange reserves had dried up to the point that India could barely finance three weeks’ worth of imports. As in 1966, India faced high inflation and large government budget deficits. This led the government to devalue the rupee. At the end of 1999, the Indian Rupee was devalued considerably.
    • 12.  Current Deregulation Of Petroleum Prices. (Earlier Government Used To Give Subsidies, But Not It Decide D To Let The Market Forces Determine The Price) Central Government Intends To Do Away With Various State Sales Taxes And Excise Duties And Combine Them All In A Comprehensive GST (Goods And Services Tax), It Is Not Implemented Yet But Will Be Pretty Soon In Next Year Or Two. The Various CECA And CEPA (Kind of Free Trade Agreements) With Malaysia And Singapore. Allowing Retail Giants Like Wal-mart To Open Shops In India. Supreme Court Monitored Investigation Of Indian Black Money Stashed Abroad. The Nuclear Fuel Supply Agreements With France, America Et Al.
    • 13.  The weighted average of a countrys currency relative to an index or basket of other major currencies adjusted for the effects of inflation. The weights are determined by comparing the relative trade balances, in terms of one countrys currency, with each other country within the index.
    • 14.  The unadjusted weighted average value of a countrys currency relative to all major currencies being traded within an index or pool of currencies. The weights are determined by the importance a home country places on all other currencies traded within the pool, as measured by the balance of trade.
    • 15.  Used as indicators of external competitiveness. NEER is the weighted average of bilateral nominal exchange rates of the home currency in terms of foreign currencies. The Reserve Bank of India (RBI) has replaced its five-country indices of nominal effective exchange rate (NEER) and real effective exchange rate (REER) with new six-currency indices. It is also revising its thirty six- country indices. As against the present practice of having three base years in the case of existing five-country indices, viz, 1991-92, 1993-94 and 2003-04, the last being a moving base updated every year to facilitate comparison with a more recent period, the new six-currency indices will have 1993-94 as fixed base and 2003-04 as a moving base, which will change every year as at present. The new six-currency indices will include USA, Eurozone, UK, Japan, China and Hong Kong SAR. The new indices will also have two new currencies — both Asian — the Chinese renminbi and the Hong Kong dollar. Two currencies in the existing five-country series, viz, French franc and Deutsche mark have been replaced by euro in the new indices.
    • 16.  Exporters: Exporters get their payment in dollar (or other forex currencies ) and convert into Indian Rupees, In the situation of falling rupee they get more Indian rupees . Thus a falling rupee is good for the exporters. Non-resident Indians : NRIs send money to their family regularly. In a falling rupee market, they can send more Indian rupees to their relatives. Hence in a situation of rupee becoming weak, NRIs and their relatives stand to gain. Receivers of fees and remuneration in foreign exchange: People doing online jobs for foreign companies from here and receive payment for that ( example Ad sense revenue) can get more Indian rupee equivalent and they gain when rupee is weak against dollar.
    • 17.  Expensive Importers: Importers face the opposite of exporters. In a falling rupee market, they have to pay more Indian Rupee to pay their imports in dollars. So they stand to lose . Indian tourists, students, Haj pilgrims going abroad: These category of people have to pay more Indian Rupees to fetch dollars to take care of their travel and needs abroad. So they are badly affected in a falling rupee market, which can unsettle their plans. Higher inflation Repayment of Loans
    • 18.  Growth deceleration not accompanied by lower inflation Outlook for growth lowered by almost all including RBI Lower private consumption demand Reserve Bank’s estimates suggest trend growth (non- inflationary) has fallen to 7.5% from 8%. Weak monsoon feeding into food inflation worries Currency depreciation could lead to imported inflation Already high fiscal deficit reduces maneuverability India is an outlier in many respects, particularly with respect to high fiscal deficit and persistent high inflation. Current account deficit at 4.2% in 2011-12 is above comfort levels
    • 19.  Large fiscal deficit and persistent inflation limits fiscal and monetary space for further stimulation. The centre’s gross fiscal deficit (GFD) higher at 5.8 per cent in 2011-12 against 4.9 per cent in 2010-11. Subsidies to GDP ratio – budget proposed cap of 2% Our peers seem to have better fiscal fundamentals than ours Even our inflation is one of the highest among peers Note: Inflation and fiscal deficit are IMF estimates for 2012 Source: IMF
    • 20. The current & evolving economic and financial system is a product of bothdomestic and external factorsSlowdown in India in 2008 was more due to global developmentsCurrent slowdown is combination of global and domestic factorsGlobal developments have considerable direct and indirect influence on oureconomy and financial system through various channels - 7Cs
    • 21.  Using Forex Reserves Raising Interest Rates Make Investments Attractive- Easing Capital Controls
    • 22.  Key policy reforms that should be initiated includes rolling of Goods and Services Tax (GST), Direct Tax Code (DTC), FDI in aviation and retail, Companies Bill and diesel decontrol. Efforts should be made to invite FDI but much more needs to be done especially after the holdback of retail FDI and recent criticisms of policy paralysis. The government took steps recently to loosen rules for portfolio investment in the Indian market, indicating its desire to sustain external inflows. The measure to increase External Commercial Borrowings (ECB) to $10bn will help in borrowing in dollar at a less cost. It may take similar steps to encourage FDI as well, helping sustain external funding. Dollar-window For Oil Companies Dollars against oil bonds Sovereign-backed non-resident indian bond Sovereign overseas bond Moral suasion Stagger import payments
    • 23.  Small Industries Development Bank of India (Amendment) Bill, 2012 The NHAI (Amendment) Bill, 2011 The Microfinance Institutions (Development and Regulation) Bill, 2012 Public Procurement Bill, 2012 Prevention of money laundering (amendment) bill, 2011 The Direct Taxes Code Bill, 2010 The Micro financial Sector (Development and Regulation) bill, 2011
    • 24.  The Indian Rupee has depreciated significantly against the US Dollar marking a new risk for Indian economy. Grim global economic outlook along with high inflation, widening current account deficit and FII outflows have contributed to this fall. RBI has responded with timely interventions by selling dollars intermittently. But in times of global uncertainty, investors prefer USD as a safe haven. To attract investments, RBI can ease capital controls by increasing the FII limit on investment in government and corporate debt instruments and introduce higher ceilings in ECB’s. Government can create a stable political and economic environment. However, a lot depends on the Global economic outlook and the future of Eurozone which will determine the future of INR.
    • 25. Thank You