This presentation explains the recent depreciation of rupee against dollar, in the backdrop of European Debt Crisis and India's domestic woes. It also reflects on the possible solutions to this dramatic fall and its impact on us.
The Situation Rupee has continued its downfall over the course of the previous year. As on May 22nd, 2012, it plunged to a a low of Rs. 55.70 against the $.
Blame it on a global trend Recently, Dollar has gained in value against a lot of major currencies, namely, the Euro (A year back one dollar was worth €0.71, now it’s worth €0.78.), the Swiss Franc (A year back one dollar was worth 0.88 Swiss francs, now it is worth 0.93), the Brazilian Real (It was worth around 1.63 real a year back. It is now worth over 2 real.) and the INR (It touched a low of Rs. 55.91 and is expected to touch Rs. 60) However, the Dollar has also lost against the Japanese Yen (A dollar was worth around 82 Japanese yen around a year back. Now it’s worth around 79.5 yen.)
Blame it on a global trend (contd.) In the face of European economic crisis, large institutional investors have moved out of the Euro and into the Dollar. In spite of the fact that the debt of the US government ($14.6 trillion) is almost equal to its GDP ($15 trillion), the world at large is considering the dollar to be a safe haven and moving money into it by buying US treasury bonds. The conclusion is that not all countries have lost value against the Dollar, and those that have lost value have lost it in varying degrees. There are other individual issues at play as well when it comes to currencies losing value against the dollar.
High current account deficit: When a country’s imports of goods are more than its exports, it means that is paying more than it is making in terms of the currency in which it is trading. (paying more dollars than we are making) This difference has to be purchased from the market where the basic principles of demand and supply determine the price of the currency. It means that the foreign exchange market has an excess supply of rupees and a shortfall of dollars. This leads to the rupee losing value against the dollar. This is what we are witnessing currently. The situation has been similar over the last few years. In fact, in 2011-12, India ran a trade deficit of $185 billion
Why are our imports more than ourexports? Our nation has an unquenchable thirst for gold and oil. Since we dont have much of either, we have to import these. Oil is sold in dollars. Hence, when India needs to buy oil it needs to pay dollars. But with the rupee constantly losing value against the dollar, it means that Indian companies have to pay more per barrel of oil in rupees. It is actually a cycle, where falling rupee leads to higher oil bill that in turn leads to increased subsidy burden on the government, leading to higher fiscal deficit that leads to a higher trade deficit leading to a depreciating rupee.
Why are our imports more than ourexports? (contd.) The government of India does not pass on a major part of the increase in the price of oil to the end consumer and hence subsidises the prices of diesel, LPG, kerosene, etc. This means that the oil companies have to sell these products at a loss to the consumer. The government in turn compensates these companies for the loss. This leads to the expenditure of the government going up and hence it incurs a higher fiscal deficit.
Indias Fiscal Deficit vs. Earnings 900000 Grows 36% 800000 700000 600000 Grows 312% 500000 Fiscal Deficit (Rs. crores) Income Earned (Rs. crores) 400000 300000 200000 100000 0 2007-08 2011-12
High Fiscal Account Deficit Where does the government get money to pay for the imports? By running a high fiscal deficit. The huge increase has happened due to the subsidy on food, fertilizer and petroleum. Every year, in the budget, the finance minister estimates the amount of subsidy the government will have to bear. But instead of providing for the expenses, the expenses are underestimated in favor of a populist budget. In 2011-12, the fiscal deficit had been estimated at 4.6% of the GDP as against the actual of 5.9%.
High Cost of Subsidies Generally, all the three subsidies of food, fertiliser and petroleum are underestimated, but the estimates on the oil subsidies are way off the mark. For the year 2011-2012, oil subsidies were assumed to be at Rs 23,640crore. They came in at Rs 68,481 crore. In 2010-2011, he had estimated the oil subsidies to be at Rs 3,108 crore. They finally came in 20 times higher at Rs 62,301 crore. In 2009-2010, the estimate was Rs 3,109 crore. The real bill came in nearly eight times higher at Rs 25,257 crore (direct subsidies plus oil bonds issued to the oil companies).
Solution (Short Term) Stop subsidies on oil products and pass the burden to the consumer. If these products are priced correctly, their consumption is likely to come down as well in the near future, given that their prices will go up. Lower consumption is likely to lead to lower imports and thus a lower trade deficit. A lower trade deficit would also mean that the fall of the rupee against the dollar may stop. This, in turn, would mean a lower price for the oil we import in rupee terms and that in turn helps overall economic growth. But of course, it’s easier said than done.
Solution (Long term) An obvious solution to the high deficit is increasing the earnings (tax collections). But with a populist government, corruption and several corporate lobbies, that is a different story altogether.
Is this trend benefiting anyone? Theoretically, a falling rupee should benefit anyone who is earning in Dollars. For example, $100 billion Indian IT/BPO industry earns revenue in Dollars/foreign currency, so their margins should improve. However, with most companies hedging their earnings well in advance, the current fluctuation may not make huge difference. In fact it hampers the planning process for managing volatility.