Devaluation of indian currency and its implications


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Devaluation of indian currency and its implications

  2. 2. CONTENTS • Introduction • Brief history of Indian rupee • History of devaluation • Exchange rate mechanism • Causes of devaluation of Indian rupee • Implications of devaluation of Indian rupee • Policy options with RBI to control devaluation of rupee • Role of GOI to control rupee devaluation • Conclusion
  3. 3. INTRODUCTION • Devaluation means decreasing the value of nation's currency relative to gold or the currencies of other nations. • In common modern usage, it specifically implies an official lowering of the value of a country's currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign currency. • For example, Rs 25= 1 $. Rs. 30 = 1$ • Devaluation is usually undertaken as a means of correcting a deficit in the balance of payments. • Almost all the countries of the world have devalued their currencies at one time or the other with a view to achieving certain economic objectives • During the great depression of 1930 devaluation was carried by most countries of the world for the correcting their over-valuation
  4. 4. Main objectives of devaluation 1. To encourage exports 2. To Discourage the imports 3. To correct the balance of payment
  5. 5. History of the rupee  India was one of the first issuers of coins (6th Century BC)  The word rūpya is derived from sanskrit which means "a coin of silver“  The silver coin remained in use during the Mayura,Mughal Era, Maratha Era as well as in British India.  Acute shortage of silver during the First Word war, led to the introduction of paper currency  Among the earliest issues of paper rupees include; the Bank of Hindustan (1770– 1832), the General Bank of Bengal and Bihar (1773–75), and the Bengal Bank (1784–91).
  6. 6.  The rupee was subdivided into 16 annas.  Each anna was subdivided into either 4 paisas.  So One rupee was equal to 16 Annas, 64 Paises.  In 1957, decimalization occurred and the rupee was divided into 100 Naye Paise.  After a few years, the initial "Naye" was dropped.  Stainless steel coinage of 10, 25 and 50 paise, was introduced in 1988 and of one rupee in 1992.
  7. 7. Udaya Kumar Dharmalingam, the man who designed the rupee symbol Launched on 8 July 2011
  8. 8. HISTORY OF RUPEE DEVALUATION • • • • • In early controlled exchange rate regime, with respect to USD, the rupee exchange rate was around Rs 4.00 in the 1950s, Rs 5.00 in the 60s, Rs 7.00 in the 70s, and Rs 8.00in the 80s. In the era of 90s, the rupee moved to Rs 20s and Rs 40 in the next decade of 2000. During this period, the Government had declared two major devaluation in the year of 1996 and 1991. The rupee was devalued first in 1966 by 57% from Rs 4.76 to Rs 7.50 against the US dollar. In the year 1991, the rupee was again devalued by 19.5% from Rs 20.5 to Rs 24.5 against the US dollar
  9. 9. The 1966 devaluation was the result of the first major financial crisis the government faced due to: •Continued trade deficits •The Indo-Pakistani War of 1965 •US and other countries friendly towards Pakistan to withdraw foreign aid to India •The drought of 1965/1966 which resulted in a sharp rise in prices. .
  10. 10. 1991 Economic crisis The trade deficit in 1991 was US $9.44 billion The current account deficit was US $9.7 billion  The gulf war led to much higher imports due to rise in oil prices.  Cost pull inflation  Political and economical instability Depleting foreign exchange reserve
  11. 11. 2013 Devaluation India's Currency, The Rupee, Has Plummeted To A Record Low Against The Dollar. (Indian Rupee = American Dollar) * 2013 (Aug 28)
  12. 12. 1947 1966 Exchange rate (INR per USD) 4.79 7.5 1975 1980 1985 8.39 7.86 12.38 1990 17.01 1995 32.42 2000 43.5 Year
  13. 13. 2005 (Jan) 43.47 2006 (Jan) 45.19 2007 (Jan) 2008 (October) 2009 (October) 39.42 48.88 46.37 2010 (January 22) 46.21 2011 (April) 44.17 2011 (September 21) 48.24 2011 (November 17) 55.39
  14. 14. 2012 (June 22) 57.15 2013 (May 15) 54.73 2013 (Aug 28) 68.83 2013 (Dec 6) 61.68
  15. 15. Exchange Rate Mechanism All economies that interact with international economy can be broadly classified into three categories on the basis of exchange rate policy of the country. 1. Fixed Exchange Rate 2. Floating (or free) Exchange Rate 3. Hybrid system
  16. 16. Fixed exchange rate • Economies peg the value of their currency with some other prominent currency like US dollar. • This of exchange rate regime is maintained by generally smaller economies like Nepal and Bhutan (pegged to Indian Rupee) or several African nations.
  17. 17. Floating exchange rate • Exchange rate is determined by demand and supply of the currency. • Economies like US, UK, Japan etc
  18. 18. Hybrid system • Most midsized economy like India practices a mix of both these regimes
  19. 19. Indian rupee and its exchange rate historically
  20. 20. Exchange rate of the Indian rupee
  21. 21. How does government control exchange rate? • control is exercised by actively participating in international currency market through its central bank (Reserve Bank of India or RBI in our case)
  22. 22. Continue………… • Suppose there is huge demand of rupee in India which is driving the value of rupee • . Also, let’s assume that RBI is comfortable only in range of Rs 50 to Rs. 60 per US dollar. • This rapid surge in th e demand of rupee which might be because of a. Indian export is far more than its import, b. foreign investors want to invest in India c. large number of Indians earning abroad are remitting their money back home All these together pushing the exchange rate below Rs. 50 per dollar.
  23. 23. Contd………. • The RBI will then step in the market and will offer Rs.50 for each dollar. • Soon other traders will have to arrive at this rate, if they want to participate • Since RBI has the ability to print currency notes, it can keep the lower limit of exchange rate fixed at this value • When demand for rupee is subsided, RBI will step back and let market determine the exchange rate. • In the process, RBI will have accumulated a pool of dollars; this is called forex reserve or foreign exchange reserve
  24. 24. Contd…….. • Let’s assume that exports have dwindled, imports are on surge, foreign investors are fleeing Indian market and remittances are at all time low. • Now, everyone wants dollar but there is little supply. • This will drive the price of dollar up. It’s about to breach the upper limit of Rs. 60/ USD • RBI will step in again and will put its dollar reserves on sale at the rate of Rs. 60/ USD. This will stop the further depreciation of rupee • Finally, as you can see, in order to be able to stop the currency from appreciating, RBI will have to print money and for preventing its depreciation it needs a reserve of dollar
  25. 25. MAJOR REASONS BEHIND FALL IN THE VALUE OF INDIAN RUPEE • Demand Supply Rule • Dollar gaining strength against the other currencies • Mounting Current Account Deficit • Increased import • Inflation • Corruption and Political Instability • Mounting Demand of Dollar • High Government Deficit • Mounting Trade Deficit: • Outflows of Foreign Capital: • Lower Inflows of Foreign Capital • Oil Prices • Rupee Speculation
  26. 26. A graphical representation of the causes and repercussions of the Rupee downfall
  27. 27. Mounting current account deficit • • • • • • Current account deficit indicates the status on trade between a country and the rest of the world The deficit was registered $74bn during the year in 2011-12 and to $87.8 in 2013 Which was $46bn in the year 2010-11 Gold imports, hefty oils bills and decreasing exports due to global slowdown leads to higher current account deficit The euro zone, one of India's major trading partners is under a severe economic crisis leads to reduced exports Thus India record a CAD of around 4.9%, depleting its forex reserves and depreciating the rupee source: Directorate General of Commercial Intelligence and Statistics
  28. 28. Export -import (US $ million) YEAR EXPORT IMPORT 2005-6 103090.5 149166.0 2006-7 126414.1 185735.2 2007-8 162904.3 251439.2 2008-9 185295.0 303696.3 2009-10 178751.4 288372.9 2010-11 251136.2 369769.1 2011-12 305963.9 489319.5 2012-13 300570.6 491487.2 Source : Directorate General of Commercial Intelligence and Statistics
  29. 29. (US $ million) 600000 500000 400000 300000 EXPORT IMPORT 200000 100000 0 2005-6 2006-7 2007-8 2008-9 2009-10 Source : Directorate General of Commercial Intelligence and Statistics 2010-11 2011-12 2012-13
  30. 30. Inflation • High inflation rate leads to decrease in purchasing power of money • High inflation rate compared to other country will leads to increased import than the export. • A fall in purchasing power due to inflation reduces consumption, hurting industries.
  31. 31. Corruption and Political Instability • A series of corruptions cases are being observed which has reduced confidence among investors. • Lack of firm initiative by government on issues like allowing FDI in retail.
  32. 32. Mounting Demand of Dollar • Due to instability in European markets • Oil, gold and metals are all of a sudden being dumped in favor of the dollar • Shift of FII’ (foreign institutional investors) from the Indian markets
  33. 33. Trade deficit • India imports more than it exports • India's trade deficit in the 201112 fiscal years is seen at USD 185 billion,
  34. 34. Mounting trade deficit year Export Import Trade balance
  35. 35. Outflows of foreign capital • This is burning issue in Indian economy at present. • Due to global uncertainty and various economy crises like Europe sovereign debt problems, • FII withdrew over $4 billion from India in 2011; against an inflow of $1.35 billion in 2010 :
  36. 36. Lower inflows of foreign capital • Further the uncertainty and delay in our commitment to economic reforms, retrospective taxes, and policy paralysis within the government have created a fear in mind set of global investor resulting into decline of foreign investment • RBI figures exhibit that they stood at $62 billion in financial year 2007-08, • Dropped to $28 billion during the year of global crisis 2008-09, • then bounced back to $70.1 billion in 2009-10, • $64.4 billion in 2010-11 • And close to $60 billion during the first 11 months (April-February) of 2011-12
  37. 37. Rupee Speculation • It refers to the flow of funds (or capital) from one country to another in order to earn a short-term profit on interest rate differences and/or anticipated exchange rate shifts. • Once currency traders and speculators realize that India's central bank is unable to manage its exchange rate, and reduce the adverse impact on its currency, they may enter the market in a big way to sell the rupee. • As a result, the rupee may devalue more than it should.
  38. 38. Implications of devaluation • Increased export and less import • Impact on foreign investors • Higher inflation • Increase in cost of borrowing: • Increase in fiscal burden • Increase in the import bill • Impact on importers and prices of goods • On thermal coal imports • On fertilizer imports • On companies and consumers
  39. 39. Increased export and less import • Fall in the value of rupee makes exports cheaper and imports expensive. • The various sectors like petroleum and petroleum products, engineering goods drugs and pharmaceuticals – which have import inputs of as much as 75-77 percent, 19-21 percent and 17-19 percent , respectively (as per report of associated chambers of commerce and industry of India) lead to a strict dent on their income due to fall in the value of rupee.
  40. 40. Impact on foreign investors • When invest foreign in investors Indian stock market, they make a loss if it depreciates and may earn profit if rupee appreciates
  41. 41. Higher inflation High inflation and uncertainty about future inflation discourage investments and savings.  As high inflation raises uncertainty in the economy, it also leads to lower equity values.
  42. 42. Increase in cost of borrowing • Interest rate differentials in domestic and global markets encourage the industry to raise money through foreign markets however a fall in the rupee value would negate the benefits of doing so.
  43. 43. Increase in fiscal burden The central government fiscal burden might increase as the hike in the prices of imported crude oil and fertilizer might warrant for a higher subsidy provision to be made for these commodities.
  44. 44. Impact on Effect On Rupee depreciates Rupee appreciates Importers Imports become costlier and Imports become cheaper and hence importers lose hence importers gain Exporters Realization from exports Fall in export realization to the increase and hence exporters extent of forex difference and gain hence exporters lose Foreign travel Trip becomes costlier Trip becomes cheaper
  45. 45. Increase in the import bill Case A: Import bill valuation using Case B: Import bill valuation using April prevailing exchange rates for the 2011exchange rates for the respective Respective months months Month Month Value of Import(Rs. Crore) Month Month Value of Import(Rs. Crore) April 2011 (Rs 44.4/USD) December 2011 Rs 52.8/USD) Increase in Import Bill 160536.6 April 2011 (Rs(44.4/USD) December 2011 Rs 44.4/USD) Increase in Import Bill 160536.6 226535.0 65999.0 Note: Exchange rate during the April (44.4) and December (52.8) Source: ASSOCHAM’s calculation 190495.8 29959.2
  46. 46. Import bill of crude oil Case A: Import bill valuation using prevailing exchange rates for the Respective months Month Month Value of Import(Rs. Crore) April 2011 57700.0 Case B: Import bill valuation using April 2011exchange rates for the respective months Month Month Value of Import(Rs. Crore) April 2011 57700.00 December 2011 63376.7 December 2011 53294.10 Increase in Import Bill 5676.70 Decrease in Import Bill 4405.90 Note: Exchange rate during the April (44.4) and December (52.8) Source: ASSOCHAM’s calculation
  47. 47. Impact on DAP fertilizer price Commodity Period Price $/mt Exchange Rate Price Rs Commodity Period Price $/mt Exchang e Rate Price Rs Fertilizers (tonnes) April 2011 610 45.0 27450 Fertilizers(t May onnes) 2011 610 45.0 27450 Oct 2011 631 52.7 64241 21 4.3 3658.3 Nov 2011 631 45.0 28395 Difference Difference 21 0.0 945 Source: ASSOCHAM’s calculation
  48. 48. On thermal coal imports Commodity Period Price $/mt Exchange Rate Price Rs Thermal Coal (Tonnes)) April 2011 127.60 45.0 5739.50 Nov 2011 121.90 52.7 6424.10 9.43 8.3 684.60 Difference Source: ASSOCHAM’s calculation
  49. 49. Impact on Common Man  Imported goods:  Fuel price:  Tourism:  Students studying abroad
  50. 50. Impact on infrastructure • Around 15 per cent of the borrowings of infrastructure companies have been in dollar terms • Increased the price of construction equipment and building materials results in enhanced project execution cost. • Increasing costs of inputs like steel and cement are also affecting infrastructure building. • Fresh investments in infrastructure could also get over priced
  51. 51. Impact on Agriculture Sugar : • India, the world’s second-biggest producer of the sweetener. • A softening rupee will be advantage for exporters from India. Wheat: • India is world’s largest producer of wheat. • Fall in the rupee will lift margins for Indian wheat exporters. Rice & Edible oil: • India is the world’s second-biggest rice producer • Fall in the rupee will lift margins for Indian rice exporters.
  52. 52. Contd…………. • India is the world’s top buyer of edible oil. • imported oils like palm and soy have risen in local markets . Pulses: • Despite holding the tag of the world’s biggest producer of lentils, India is also the largest importer of lentils as rising domestic consumption outpaces harvests. Cotton: • Fall in the rupee will lift margins for Indian rice exporters.
  53. 53. Impact on real estate • Real estate sector is a second largest employment generator after agriculture as demands of property declining it not only affect economy. • increases the project cost and time frame followed by the increased in the prices of raw material, transportation, wages and salary of labor, engineers, import of construction equipment etc , outsourced services in form of design consultancy, architects • Higher Inflation rate and weak economic condition make unfavorable climate for investor.
  54. 54. On banking sector  If an Indian company defaults on its dollar debt and goes bankrupt then it will have a contagion effect on all the banks that have lent to that company.  The other adverse affect is that the liabilities on NRE and foreign currency deposits may increase because of the depreciation in rupee.  A positive impact for banks of the currency depreciation this year is that RBI raised interest rate ceilings on Indian banks foreign currency deposits of
  55. 55. Devaluation is good or bad ? • it creates an imbalance on the Balance of Payments especially for import driven economies • country like India which imports majority of essential commodities like Oil, pays much more in terms of the value in INR imports get expensive thereby increasing the CAD. This will further devaluate the currency • This is a welcome change for a company which is into the export of goods or services
  56. 56. Conditions for the success of devaluation 1. More than unity elasticity of demand for exports and imports 2. Sufficient supply of exports 3. Stable international price level 4. Non-competetive devaluation 5. Counter-devaluation measures 6. Spirit of sacrifice by the people
  57. 57. Solution?
  58. 58. What Indian Government Can do, to Bring back Positive Vibrations in Indian Economy? 1 .Allow free flow of foreign investment for the development of infrastructure and manufacturing sector. 2. Restrain / discourage import of non essential and luxury items e.g. auto sector imports.. 3. Restrain /discourage export of agricultural produce and basic minerals e.g. iron ore. 4. Promote aggressively exports of manufactured goods like China 5. Promote migration of skilled personnel / work force from India.. 6. Facilitate the voluntary return of the funds parked outside India.
  59. 59. Contd…… 7. Reduce / cut unnecessarily expenditure of government institutions 8. Government should observe restraint in offering financial aid to other countries. 9.To balance demand & supply 10.Proper implementation of monetary policy and fiscal policy in our country 11.Stability in imports & exports etc.
  60. 60. Policy options with RBI to control devaluation of rupee • Raising Policy rates • Using FOREX Reserves • Easing Capital Controls • Administrative measures
  61. 61. conclusion  Even after taking few measures by government , rupee depreciation has abated but it still remains under pressure.  Both domestic and global conditions are indicating that the downward pressure on Rupee to remain in future.  Thus, RBI should continue its policy mix of controlled intervention in forex markets and administrative measures to curb volatility in Rupee.  Apart from RBI, government should take some measures to bring FDI and create a healthy environment for economic growth.
  62. 62. We invented money and we use it, yet we cannot understand its laws or control its actions. It has a life of its own” -Lionel Trilling