A study on the impact of global currency fluctuations with a special focus to Indian Rupee
Upcoming SlideShare
Loading in...5
×
 

A study on the impact of global currency fluctuations with a special focus to Indian Rupee

on

  • 557 views

The paper discusses about the factors influencing and impact of currency fluctuations on global economy. Then we shift our focus to Indian rupees factors which causes the Rupee fluctuations has been ...

The paper discusses about the factors influencing and impact of currency fluctuations on global economy. Then we shift our focus to Indian rupees factors which causes the Rupee fluctuations has been discussed. In the end we discuss about the steps taken by the RBI and the government and what else can be done by investors to lessen the impact of Global currency fluctuations and what can be done to prevent Indian Rupee fluctuation.

Statistics

Views

Total Views
557
Views on SlideShare
557
Embed Views
0

Actions

Likes
0
Downloads
48
Comments
0

0 Embeds 0

No embeds

Accessibility

Upload Details

Uploaded via as Adobe PDF

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Processing…
Post Comment
Edit your comment

A study on the impact of global currency fluctuations with a special focus to Indian Rupee A study on the impact of global currency fluctuations with a special focus to Indian Rupee Document Transcript

  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. Title of the Industry Assignment A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. Key Words FII, CAD, QE, Currency Swap, FCNR, CPI, Repo Rate, Tequila Crisis, ETF, Hedge Executive Summary The paper discusses about the factors influencing and impact of currency fluctuations on global economy. Then we shift our focus to Indian rupees factors which causes the Rupee fluctuations has been discussed. In the end we discuss about the steps taken by the RBI and the government and what else can be done by investors to lessen the impact of Global currency fluctuations and what can be done to prevent Indian Rupee fluctuation. Table of Contents Title of the Industry Assignment ................................................................................................................... 1 Key Words ..................................................................................................................................................... 1 Executive Summary....................................................................................................................................... 1 Table of Contents .......................................................................................................................................... 1 Exhibits .......................................................................................................................................................... 2 Figures ........................................................................................................................................................... 4 Introduction .................................................................................................................................................. 5 Literature Review .......................................................................................................................................... 5 Analytical Interpretation on the topic .......................................................................................................... 7 Suggestions ................................................................................................................................................. 11 Conclusion ................................................................................................................................................... 12 Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. Exhibits Exhibit 1 http://articles.economictimes.indiatimes.com/2013-06-21/news/40119665_1_weak-rupee-us-dollar-operating-margins Exhibit 2 http://www2.blackrock.com/us/individual-investors/insight-education/global-investing/global-investing Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. Exhibit 3 http://blogs.ft.com/beyond-brics/2013/01/14/chart-of-the-week-how-important-is-manufacturing-to-emerging-markets/#axzz2ccpgTM7t Exhibit 4 http://www.eia.gov/countries/cab.cfm?fips=IN Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. Figures Table 1 http://www.resourceinvestor.com/2010/06/09/eurogold-currency-crisis-accelerates Table 2 http://www.moneycontrol.com/stocks/marketstats/fii_dii_activity/ Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. Introduction This study aims to explore the dynamics, factors influencing and impact of fluctuations in the currency. Currency fluctuations are simply the ongoing changes between the relative values of the currency issued by one country when compared to a different currency. These changes are something that occur every day and affect the relative rate of exchange between various currencies on a continual basis. It is these fluctuations that investors in currency exchange deals look to closely in order to generate a profit from their investments. Exchange rates are among the most monitored, analyzed and governmentally manipulated economic measures. Currency fluctuation also impacts the real return of an investor's portfolio, profitability of firms, and growth of specific sectors amongst various other determinants of the economy. Literature Review Exchange rate has fluctuated a lot from 1990-91.Indian rupee had fallen by almost 20% in this fiscal year. Fall in the value of rupee has induced exports to rise ahead of income. Imports have not been significantly affected by depreciating value of rupee, indicating positively sloped demand curve for imports. Results of decomposition model of export earnings and import bills show the pivotal role of change in exchange rate, though the quantitative dimension is relatively more important in imports than exports In mid-1991, India's exchange rate was subjected to a severe adjustment. This event began with a slide in the value of the rupee leading up to mid-1991. The authorities at the Reserve Bank of India slowed the decline in value by expending international reserves. With reserves nearly depleted, however, the exchange rate was devalued sharply on July 1 and July 3 against major foreign currencies. This paper seeks the answers through error correction models and by constructing the equilibrium real exchange rate using a technique developed by Gonzalo and Granger (1995). The evidence indicates that overvaluation as well as current account deficits and investor confidence played significant roles in the sharp exchange rate depreciation. http://www.jstor.org/stable/3872503 The 2006 paper on The Sources of Real Exchange Rate Fluctuations in India finds that the real exchange rate of the Rupee against the US dollar is non-stationary and that real shocks have permanent effects on the exchange rate, thus making exchange rate management at best futile and possibly harmful to the economy. The liberalisation of the financial sector of developing countries has long been advocated by the financial repressionists' as a means of stimulating investment and economic growth (see for example, McKinnon (1973), and Shaw (1973)). Such liberalisations, however, frequently lead to a sharp rise in capital inflows and real exchange rate appreciation. Under a fixed nominal exchange rate policy, the rise Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. in the liberalised domestic interest rate lead to a capital inflow, which through central bank intervention to peg the exchange rate leads to a rise in the money supply and higher aggregate demand. This in turn raises the domestic price level causing a permanent, real exchange rate appreciation. With a floating exchange rate, the net capital inflow is likely to lead directly to a nominal and real exchange rate appreciation. If the nominal appreciation makes domestic products less competitive abroad and demand for them falls in the longer run the domestic price level may fall to restore the real exchange rate to its former level. In this case the real appreciation is only temporary. If, however, the interest rate liberalisation is supported by more general price liberalisation process, as in the transition economies of Central and Eastern Europe, then the higher domestic prices will continue to cause a real appreciation perhaps long after the financial liberalisation is complete. It follows that identifying the sources of exchange rate fluctuations is important if exchange rate stabilisation is to be achieved. Attempts to stabilise exchange rate changes that are due to structural changes in the economy could be futile and potentially damaging to the economy. As a consequence it is important to be able to measure and to be able to distinguish between, the relative importance of permanent and transitory shocks on exchange rates. Recent attempts to distinguish between permanent and transitory shocks on exchange rates have found that for developed countries real shocks are more important than nominal shocks in accounting for real exchange rate fluctuations (see, for example, Lastrapes (1992), and Evans and Lothian (1993)). Similar results have been found for Japan, although for Korea, Taiwan and the Philippines the impact of real shocks on the real exchange rate have been found to be relatively less important (Chen and Wu, 1997). For high inflation countries, however, such as Brazil and Argentina, Hoffmaister and Roldos (2001) find that nominal shocks have potentially relatively larger effects than permanent on real exchange rate movements. In the context of the transition economies, there is also a distinction to be made between high and low inflation countries. For example, Diboolu and Kutan (2001) find that for low-inflation Hungary real shocks predominate whereas for high-inflation Poland, nominal shocks are more important as sources of variation in the real exchange rates. This paper attempts to assess the sources of the real exchange rate appreciation in India since financial liberalisation in the early 1990s, using the long-run, structural VAR approach. India is an interesting case study because in the early 1990s it embarked on a substantial and wide-ranging liberalisation policy, which led to large net capital inflows and the eventual adoption of a floating exchange rate policy in March 1993, after a brief transitional phase of dual exchange rates. These reforms have led to high rates of economic growth and greater trading links with the rest of the world. http://www.jstor.org/stable/29793852 Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. Analytical Interpretation on the topic A weak currency is the sign of a weak economy, and a weak economy leads to a weak nation. – Ross Perot History is filled with numerous examples (Table 1) of what havoc currency fluctuations can cause on an economy: 1. Tequila Crisis of 1994-95: The current-account deficit of Mexico went to a dangerous 7% of GDP and its foreign-exchange reserves dwindled which resulted in the snapping of peso's fixed exchange rate against the dollar. The currency plunged by around 50% within six months. This in turn caused the local-currency value of the government's large dollarlinked debts to swell enormously and sent Mexico into a deep recession. Many banks went bust. Thousands of Mexicans, particularly in the new middle class, defaulted on loans as interest rates rocketed, and had their homes repossessed. In 1995 GDP shrank by 6.2% 2. The Asian crisis of 1997-98 –The devaluation of the Thai baht in July 1997 occurred after the baht came under intense speculative attack, forcing Thailand’s central bank to abandon its peg to the U.S. dollar and float the currency. This triggered a financial collapse that spread like wildfire to the neighboring economies of Indonesia, Malaysia, South Korea and Hong Kong. The currency contagion led to a severe contraction in these economies as bankruptcies soared and stock markets plunged. Similar to Thailand, where there was an over investment in commercial real estate, Korea had an over investment in non-real estate means of production like factories, machinery, overseas acquisitions, etc. When growth was strong, the Korean private sector could maintain high debt loads. However, when growth starts to slow and plateau, it becomes difficult to maintain a high debt load and it's at this stage where problems developed. Korea's central bank which was sitting on $25 billion in dollar reserves believed that they had ample protection against the Asian contagion but evidently, only $9 billion of the supposed $25 billion was actually liquid and available for use as actual reserves. Much of it was already dispersed to smaller Korean banks and tied up to support short-term foreign debt obligations. However, in this case reserves were not available for the upcoming economic crisis. So, when currency speculators attacked the won, the South Korean central bank could not come up with a sufficient answer and speculators were able to devalue. Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. Rupee Fluctuation The depreciating rupee is a burning issue with the industry and media alike clamoring for reforms. Some of the biggest reasons for their concerns are: 1. Firstly the imports will get costlier thereby widening the Current Account Deficit. The costly imports will provide an upward push to the already raging inflation. Fuel, consumer goods will get costlier consequently raising the retail and wholesale inflation. 2. Secondly, the FIIs have started to exit the capital markets big time. The government needs to act before the capital flows slow down or even worse, reverse. India will have to delve into its FOREX reserves to counter the capital outflows which will further put pressure on the rupee. The table 2 in Figures shows that from February 2013 to August 2013 the FII’s were net buyers, but as the news of tapering of QE3 came in June, the FII’s became net sellers in the period (data till 12th July) both in the equity as well as the debt market. 3. Thirdly, Companies with foreign debt will come under increased stress as the rolling over of debts will get costlier. Corporate profit margins may thus fall further. Due to this new foreign companies will shy away from investing in India. On the other hand even if depreciating rupee helps exports, the decrease in the overall demand from foreign markets is not boosting it. According to Prasad Koparkar, Senior Director, CRISIL Research, “Demand growth and competitiveness, rather than currency movements, are more critical to determining growth and profitability. Around 180 listed export-oriented companies reported a marginal 1-2 per cent growth in revenues in dollar terms and 60-bps rise in EBITDA margins in 2012-13, despite a weak currency”. So it is necessary for India to wake up quickly and take some immediate steps to curb the rupee depreciation. The question that follows is why is this happening? The recovery in the US economy had prompted US Fed to begin tapering of the $85-billion per month quantitative easing (QE) that has been on since September 2012. Anticipating this, foreign investors were pulling out their money from India to invest it back in the US, which is resulting in a scarcity of dollars in India. The fear of the US Federal Reserve (Fed) tapering its quantitative easing III (QE) has spread across all asset classes resulting in an appreciating dollar. This leads to another question, Why is Indian Currency (Rupee) so vulnerable to US Federal Reserve QE program? There are 4 main factors responsible for this: 1. Strong correlation with the dollar index. Post-independence India required huge investments in infrastructure. But 200 years of colonial rule had resulted in a capital deficiency which led to India having to depend on external borrowings from IMF and the World Bank. This led to constant devaluation of the Rupee the most prominent milestones on this road being 1966 and 1991. Moreover India is an import oriented economy forcing us to pay in dollars; hence the strong dependence on Dollar. Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. 2. High Ratio of Foreign Institutional Investors Inflows India being a developing economy attracts a lot of Hot Money (short term foreign inflows) as foreign investors expect higher returns on their investments as compared to developed economies. According to Nomura Global Markets Research the ratio of FII to Total Market Cap is 16.4 %. As can be seen, our capital markets are flooded with foreign capital making it susceptible to fluctuations whenever they withdraw capital from our economy. 3. Low domestic savings:-Over the last 20 years there has been a structural decline in equity savings in India. Our savings has dropped by 5% from the last 5 years. In order to promote savings the real interest rate will have to increase which can be done in 2 ways either by increasing the nominal interest rate or lowering the inflation. 4. Weak Balance of Payment Positions India imports more than it exports as a result of which trade balance always shows a deficit which reflects in its Current account deficit (CAD) figures which fell to record 4.8% of GDP for the 2012-13 fiscal. This weak balance of payments leads to ever persistent demand for Dollar which puts depreciatory pressure on Rupee on account of payments for petroleum products, gold, etc. The depreciation of the local currency is a trend that has been seen across all emerging markets. Indonesia, Thailand and Brazil have all been hit with the same bug hence it comes as no surprise that India is also among the affected. Moreover Foreign Institutional Investors (FIIs) have withdrawn from the bond markets of these countries in the past few weeks. A risk-off approach has been seen globally which has led to redemptions from global exchange-traded funds (ETFs). Consequently, the sustained selling by FIIs in the Indian equity market has added to the rupee’s troubles. Every Cloud Has a Silver Lining (Exhibit 1) India has become a more attractive destination amid the sharp depreciation. With the rupee becoming cheap compared to the US dollar, the tourists are pouring into and report says there is 15 % enhance in foreign bookings as equated to previous year. The beach destinations of Goa and Kerala are once again becoming favourite spots and the Government needs to launch focussed advertising and promotion overdrive, to bring in more capital to the country. Again, there are certain people who are revelling on the depreciation phenomenon- the exporters. They would find the dollar value of their exports falling with possible positive effects on demand curve. And those locked into long-term contracts denominated in dollars would witness their rupee revenues and profits soaring up. The exporters of IT and IT-enabled services can take maximum advantage over the situation. Fiscal Steps Taken To Curb Slide • Raising FDI caps like in telecom raised to 100% from 74%, insurance sector raised to 49% from present 26%, subject to Parliament approval, FDI up to 49% in petroleum, refining power exchange, tea plantation and stock exchanges allowed under automatic route, from earlier approval route, Raised FDI in asset reconstruction companies to 100% from 74%; of this up to 49% will be under automatic route, credit information companies to 74% from 49%., FDI up to 100% through automatic route allowed in courier services Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. • Paying for imports in local currency India could save $8.5 billion in foreign exchange spending on crude oil imports in 2013/14 if it relied more on supplies from Iran, which is able to accept payment in rupees • Raising the currency swap arrangement between India and Japan to USD 50 billion from USD 15 billion • The Government has increased the import duty on gold from 4% to 8% in the last six months to discourage gold imports which accounts for significant part of CAD (Current Account Deficit) resulting in decline in Gold imports. The RBI imposed that all gold imports intended for domestic consumption and made through either nominated agencies or directly, would have to be through 100% cash margins Monetary Steps Taken To Curb Slide • New bank licenses: NBFC stocks such as Bajaj Finance, JM Financial etc rally in trade after the new governor, Dr. Raghuram Rajan roughly indicated that new bank licenses are likely to be announced around January 2014. • Interest rate measures: RBI in its recent policy has increased the repo rate by 25 basis point to 7.50% in order to reduce the liquidity in the market. This will increase the yield in the Indian bond market compared to U.S bond market • Currency measures: The RBI announced a fixed-rate swap for FCNR (B) deposits which are dollar-denominated deposits for expat Indians. This is for three years at 3.5%, for over 3-year deposits. • Overseas borrowing limit for banks: The RBI has also increased the current overseas borrowing limit for banks from 50 per cent of the unimpaired Tier I capital to 100 per cent. This can be swapped with the RBI at the bank's option at a concessional rate of 100bp below the prevailing market swap rate. • Issuance of Inflation Indexed Savings Certificates linked to the CPI New Index: To protect savings for households, the RBI is expected to introduce Inflation Indexed Savings Certificates linked to the CPI to retail investors by November 2013. • Asking Oil Companies to buy their dollar requirements from one bank/institution: The Oil companies are the largest dollar buyers in the domestic market with nearly $7 billion purchase per month. They buy Dollar from domestic market by seeking competitive quotes from multiple public, private and foreign institutions thereby adding to the volatility of the market. So RBI has asked these oil companies to buy more of the currency from single public/private banks/institutions and reduce the volatility of the rupee Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. Suggestions We can look at the solutions in 2 ways:1) What investor/business can do to protect himself in case of currency fluctuation 2) In reference to India’s context what can be done in order to avoid Rupee fluctuation In order to protect against currency fluctuations an investor can take the following things:• Global Investing: If you believe that local currency is in a secular decline, invest in strong overseas markets, because your returns will be boosted by the appreciation in the foreign currency. Many major foreign markets have outperformed US stocks in recent years. In the past decade, the United States could be counted among the top 10 performing markets only once (Exhibit 2). Since economic cycles in foreign markets often differ from those driving local markets, investing in foreign securities helps to mitigate risk better than an all-domestic portfolio • MNC’s investing: There are large number of multinational companies, many of which derive a substantial part of their revenues and earnings from foreign countries. For e.g. Even during the recent Rupee Depreciation when most of the markets were falling, the S&P BSE IT Index moved up by 18.86% in the last six months while the S&P BSE Healthcare index has moved up 14% over the last six months. • Hedge currency risk: Adverse currency moves can significantly impact your finances, especially if you have substantial forex exposure. But plenty of choices are available to hedge currency risk, from currency futures and forwards, to currency options and Currency exchange-traded funds such as the CurrencyShares Euro Trust (FXE) can be used to make a direct bet on a rising euro versus the U.S. dollar, while the WisdomTree Brazilian Real (BZF) can be used to bet on the Latin American nation. The simplest approach is just to monitor the changes, and this can be the best option if companies do not think that they are at a particularly high risk from exchange rate fluctuations. Companies can also hedge against the exposure via derivatives. Although this may be the most complicated option, it can be effective in limiting exposure to volatility. If your currency risk is large enough to keep you awake at nights, consider hedging this risk. In order to be make the rupee stable we need to make our economy stronger by focusing on the following three things 1) Increasing domestic consumption 2) Reviving the manufacturing sector 3) Reducing our dependence on other economies for energy Aman Vij IIM Ranchi
  • A study on the impact of Global Currency Fluctuations. A special focus to Indian Rupee. For tackling the 1st problem we can take the help of china model wherein China in order to overcome the impact of fall in exports because of reduced demand from developed economies moved onto increasing the investment on infrastructure which ultimately led to higher domestic demand. We should provide better business starting environment by removing policy paralysis. Other than that our priority should also be to clear the 215 odd projects worth Rs 7 L crore stuck in red tape. This will lead to greater job opportunities which in turn lead to greater incomes and thus greater demand and our consumption will increase. Thus our Indian business houses which goes outside because of better support will stay in India itself and thus we would reduce our dependence on FDI and FII. The share of manufacturing is only 16% in the economy (Exhibit 3). The gap between India’s domestic production and needs of its 1.2 billion population is therefore met by imports. To reduce the dependence on imported goods, India needs to have a sustainable, self-sufficient manufacturing sector. To revive the manufacturing sector, Government of India needs to provide incentives for enhancing the private investment in the sector. The incentives could be in the form of tax breaks on investment, lesser restrictions on opening of a new business, lower interest rate loans. For overcoming the 3rd problem we need to encourage oil companies to invest more on R&D and explore more sources like the underwater reserves, new basins. Inspite of the fact that India has huge coal reserves, we are still importing coal. Also we have a huge gap between our oil production and consumption (Exhibit 4) which is adding to our trade and current account deficit. We should also invest more in renewable sources of energy like solar, wind and hydro. Other than that we should also focus on entering into long term contracts with oil rich countries to reduce the effect of volatile pricing of spot markets. Conclusion Currency moves can have a wide-ranging impact not just on a domestic economy, but also on the global one. Investors can use such moves to their advantage by global investing. Because currency moves can be a potent risk when one has a large forex exposure, it may be best to hedge this risk through the many hedging instruments available. Coming to the Indian Rupee, over and above the steps taken by the RBI and the government, we need to keep the growth story of India intact which has attracted a lot of investors to us so far. India still requires a lot of capital in priority sectors such as infrastructure which has suffered a lot due to policy paralysis. Hence it is imperative for the Indian government to concentrate on bringing structural changes which would could reduce frequent fluctuations in Rupee’s value. Aman Vij IIM Ranchi