1. RBI has to climb the highest mountain to
control Rupee Devaluation.
2013-15
Ajeet Torgalkar, Raghavendra Muttagi, Nithin M.
SIBM-Banglore
2013-15
2. Abstract
India is facing a crisis of sorts with the value Rupee depreciating rapidly and the entire
focus is now on the RBI to handle this crisis. How and what will the RBI do to control
the decline and bring the rupee back on track. Is this an easy task?
Introduction
An introduction to the valuation of rupee must invariably begin by its current position.
The current scenario is such that the focus of the media has shifted from politics to
economics, as our daily headlines are filled with the slide of rupee in the international
market. In the past two decades the rupee value has fluctuated from Rs.27 to Rs.61.60
per dollar. The fall in rupee value has been significant in the past four months with
rupee falling from 53.37 to 64.30 as against the US Dollar. The onus of controlling this
slide is on the government of India and RBI.
This article mainly focuses on the steps taken by the RBI in controlling the fall in rupee
value, the future prospects of value of rupee and additional steps which if taken will
help in appreciating the value of rupee.
Valuation of currency and its implications
With globalisation and increased global trade, it became imperative for evaluating the
cost of goods and services that a country intends to export or import. It is in this regard
that the valuation of a currency began. The methods involved in evaluating a currency
have changed over the years. In the pre World War I era the methodology used was the
“Gold standard” where in the value of currency was based on the sum total of bullion
held by the treasuries. The ‘Great depression’ changed the scenario and Gustav Cassel’s
‘purchasing power parity (PPP) was introduced which put the inflation rates into focus
and governments used the ‘elasticity approach’ in policy making. Then came the
Bretton Woods agreement (1944) which pegged the value of one dollar to 35 Oz of
gold. However during 1969 – 73 the US could no longer finance its trade deficits and as
a result the fixed exchange rate concept could no longer be continued with. The current
currency evaluation depends on various factors such as demand and supply of a
currency in the market.
Devaluation of a currency is the decrease in the value of a country’s currency with
respect to other currencies of the world. There are basically two types of devaluation –
Planned type and Market driven type. Planned type is deliberately done by a country to
improve its current trading position. Market driven devaluation occurs when country’s
currency has already depreciated through trading the foreign exchange markets. It is a
formal recognition by the government of the country. The implication of currency
3. devaluation includes increased cost of imported goods, increase in fuel prices, increased
cost of studying abroad etc.
The reasons for Devaluation of Rupee.
Import of Gold and Crude Oil: The ever increasing demand for gold in India
results in increased import of gold, which in turn increases the current account
deficit (CAD) and weighs heavily on currency. In a similar manner the demand
for crude oil as a developing country cannot be ignored, resulting in an increased
buying of US dollar and thereby decreasing the value of rupee. (see table no. 3)
Strength of the Dollar: The US dollar is gaining in strength and its index is
currently on a three year high at 84.30. It is further expected to grow on the basis
of an optimistic US economy and thereby increasing the hopes of Quantitative
Easing (QE) tapering.
Equity Market: The Foreign Institutional Investors (FII) who play a major role
in the improvement of our economy are currently exiting from the market and
are also selling their index futures.
Slowdown in Global economy: The global economic slowdown has reduced the
demand for Indian goods and services. This has resulted in a decrease in exports
and increase in imports and hence increasing the CAD. (see table no.3)
Recession in Euro zone: recession in euro is one of the reasons of rupee fall.
People are selling euro and buying dollars.
US dollar reserve: India has only $277 Billion reserve, slow down from $294
Billion(see table no.2)
Table No.1 Rupee Against major currencies
0
20
40
60
80
100
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012
2013
US dollar
UK Pound
Euro
4. Table No.2 Forex Reserves
Table no.3- CAD in Us $ Billion
Steps taken by RBI to control Rupee devaluation
Curbed trading in rupee forwards and once cancelled, forward contracts couldn’t
be bought back.
Restricted bank’s borrowing through Liquid Adjustment Facility(LAF) to the
tune of 1% of total deposits or Rs 75,000cr.
Raised interest rate of Marginal Standing Facility(MSF) by 100bp to 10.25% as
against 9.25% currently.(see table no.4)
Increase of import duty on gold from 8% to 10%.
Increased policy rate by 25 bps, with intention of luring foreign investors to
invest in India. (see table no.4)
It made mandatory for banks to invest in government securities to tune 33% of
their total deposits.
RBI seems to be selling forex reserves to support Indian rupee.
Annual Limit under Liberalised Remittance scheme cut from $2,00,000 to
$75,000 per individual.
Companies will need to restrict their overseas investment to 100% of their
networth. Further investment will need RBI nod, earlier limit was 400%.
200
250
300
350
2009 2010 2011 2012 2013
Forex Reserve in $ Billion
Forex Reserve in $
Billion
2004 2005 2006 2007 2008 2009 2010 2011 2012
India CAD in US$Billion 48.97 -12.95 -26.40 -12.11 -37.51 -26.63 -51.78 -41.40 -80.15
-100.00
-50.00
0.00
50.00
100.00
CAD in US$Billion
5. Table no.4 Policy rate
Suggestions for further control
Relaxations of FDI in many sectors – Government should allow 100 percent FDI
in many sectors.
Use forex reserve to curb rupee devaluation (for short term).
Launch new financial instruments to attract FDI - High interest rates will attract
enough foreign capital.
Try to control Gold Import.
Try to minimise CAD - The government should declare a war on the current
account deficit. This can be done by improving the quality and quantity of our
Exports.
Should set the Rupee at a very high value relative to the U.S. dollar, and later it
will increase on domestic interest rates to maintain a positive influx of foreign
capitals to local currency bond markets, financing Indian expenditures.
Try to develop alternatives to replace oil and also should invest in alternative
energy production (Long term).
Aug. 24 Jul. 26 Aug. 2 Aug. 9 Aug. 16 Aug. 23
2012 2013
Policy Repo Rate 8.00 7.25 7.25 7.25 7.25 7.25
Reverse Repo Rate 7.00 6.25 6.25 6.25 6.25 6.25
MarginalStanding Facility
(MSF) Rate
9.00 10.25 10.25 10.25 10.25 10.25
0.00
2.00
4.00
6.00
8.00
10.00
12.00in%
Policy rates
6. Conclusion:
While the RBI is doing all it can to control the slide in rupee value, a lot needs to be
done as these steps are proving to be inadequate. It needs to learn from other central
banks and international banks and try to improvise on its policies. Furthermore it should
try to anticipate such scenarios in future and keep measures in place to counter them. It
should work in close coordination with the government and other banks and a
concentrated effort should be made to control the slide. The Government of India
should frame policies that will be beneficial in both short term and long term and
improve the overall outlook of our economy.
