Reasons for Dollar Value Rising:
Stimulus Withdrawal to
the US
Economy:
The stimulus
withdrawal to the U.S.
economy strengthening — reaching some important signposts such as a fall in the
unemployment rate, by specific dates. The Federal Reserve is acting from a
position of perceived strength. With the Fed announcing a reversal, there has
been a reverse flow. Investors, mostly the foreign institutional investors, are
moving back to the U.S.
by dumping Indian stocks. The Indian currency
fell a day after the US Federal Reserve Chairman Ben Bernanke confirmed that
the Fed could begin rolling back its Quantitative Easing (QE) programme later
this year. QE is an unconventional monetary policy aimed to stimulate the
national economy. This is achieved by buying financial assets from commercial banks
and other private institutions to widen the country’s monetary base, thereby
increasing money supply in the economy. Through QE, long-term interest rates
remain low, resulting in higher borrowing and spending that boosts the economy.
But since the US economy is
gradually recovering, the US Fed, which is similar to our Reserve Bank of India, is
considering normalizing back to a standard monetary policy. The Fed move
naturally means end of cheaper money, thereby raising the dollar’s ‘value’
against the Indian rupee. With the US economy strengthening, foreign
investment has begun to take flight from the Indian stock and the debt markets.
The strong demand for the dollar vis-à-vis the rupee has seen the rupee fall.
Apart from this India’s
high current account deficit makes the rupee very shaky. Thus global economic
movements have a more significant impact on it. Nations that have a high
current account deficit, like India
does, see their currency getting depreciated as against the dollar. This is
what has happened to the Indian rupee.
Dollar is in Demand (Foreign Funds
Outflow): “Exchange Rate is nothing but the price
of a Currency in the International Market. If the demand for the dollar is
higher than its supply, the Rupee should depreciate. If it is the other way
round, it should appreciate”. Due to the above said reason, there is
increase in demand for dollar for imports like oil and falling gold prices lead to a surge in gold
imports, resulting in an increase in demand for dollars. It is the major
concern of Indian economy now. Because of the global uncertainty and various
economy crises like Euro currency value depreciation problem etc led to search
for the safe heaven among the investors. They are quickly pulling out the money
from Indian market and investing in any other safe investments like Gold or US
dollar.
Euro Crisis:
Many European
countries like Greece
are facing debt crisis and selling gold reserves with their Central Banks that
is why dollar is becoming strong.
Interest rate
differential:
There was a huge
interest rate differential between India and US. In India, there
are high interest rates. Economist
Surjit Bhalla believes that there is a need to cut interest rates for
investments. But, RBI Governor defended high interest rates and hinted that
other factors were responsible for the growth slowdown.
Collapse of
International Trade:
If we observe in terms
of international trade, commodity prices are crashing at international level.
Importers are trying to accumulate dollars (for example, oil companies in India are
accumulating dollars for future imports. They are not reducing the oil prices
to the extent they have increased, though oil prices per barrel (159 liters)
has fallen in the international market, as they have to pay in terms of
dollars. Exporters have a very few orders from outside countries, so there is
no matter of converting dollar into rupee thereby decreasing demand for rupee.
Foreign Investments
A currency will tend to become more valuable when its demand is higher than
supply. A currency will tend to become less valuable when its demand is less
than supply. It is the basic theory. When our economy is doing well and market
is performing better than other countries, overseas investors would invest
heavily in our market. It is clear that when more investors coming to India, the
demand for the currency will be very high. Our rupee value will be increased
against dollar. In the same way, when they are pulling out of market, demand
for the rupee will be decreased and value is depreciated.
Inflation
As a general rule, a country with a consistently lower inflation rate
exhibits a rising currency value, as its purchasing power increases relative to
other currencies. RBI believes that the
UPA Government is doing little to fight inflation, leaving all the work to RBI.
Interest Rates
A higher interest rates offer good returns compare to other countries. It
will result in the foreign capital come into the country. Lower interest rates
decrease the currency value. Note that interest rates have the close relation
with inflation rates. The currency value would not be affected only based on
the interest; it is impacted based on the other conditions like inflation or
economic situation.
Current Account Deficits
Basically current account of a country presents the status on the
trade (Exports and Imports) of a country between other trading partners.
Deficit in the current account (more imports and fewer exports) is not good for
a country because the country needs to buy more foreign currency to fulfill its
need inside the country. A country needs to manage its deficit within control;
otherwise it will lead to a economic problem. More demand for the foreign
currency would reduce the value of that country’s currency. Current account deficit
has grown to near 1991 crisis levels.
Government Deficit is High
The government finances are in a bad shape and the combined central and
state government deficit has stubbornly stayed around 10 per cent of GDP. It is
high deficit and investors lost faith in the local economy. RBI Governor said the Government needed to "cut
spending" to reduce the deficit. But, still no sufficient measures are
taken to reduce the fiscal deficit.
Political Uncertainty and Corruption
This is one of the major factors for any country to stabilize the economy.
In India,
last one year we are seeing the series of corruptions and there is no good news
from the ruling party (Congress) about the economic reforms, which took
attention from global media. India
needs political change to gain confidence among the investors.
Rating Agencies:
On 18-06-2012, Rating
Agency Fitch downgraded India's
sovereign debt rating to BBB - (Better Business Bureau). This is an investment
rating. India's
rating is at present negative i.e. not favourable for investment. It cited an
"awkward combination of slow growth and elevated inflation as well as
structural challenges surrounding (India's) investment climate in the
form of corruption and inadequate economic reforms" to downgrade its
outlook. A week earlier, rating agency Standard & Poor's also put India's rating at BBB and said India would be
the first BRIC country to lose investment grade rating. Internationally, India finds itself in the same category as Azerbaijan, Colombia
and Iceland-hardly role model economies-and in a lower category than Italy, Ireland
and Spain,
all three of which are at the heart of the ongoing crisis in the Euro zone.
Foreign Investors:
Foreign investors take
these ratings seriously and a drying up of inflows will further weaken the
rupee.
Domestic Investors:
It has also become
more expensive for both the Government and corporates to borrow overseas; they
have to offer higher interest rates to compensate for the perceived higher
risk. Corporates are already reeling from a high interest rate regime in India. Even
prime borrowers-leading corporates like Tatas and Reliance have to pay an
interest rate of around 14-15 per cent.
Political Will:
In India Political
will is lacking for concrete economic policies. The Government needs to look
inward to end its policy paralysis. The signs are not encouraging. The Congress
remains a divided house on what its economic policy should be. The confusion in the ruling
party is evident from the differences between Anand Sharma and Jairam Ramesh
regarding the petroleum subsidies. Mr. Jairam Ramesh said that petroleum
subsidies must be cut down, a key element of reducing the fiscal deficit. But,
Anand Sharma responded rejecting Ramesh's suggestion for subsidy
reduction by saying that "We are a country of a large number of
unempowered people and weaker sections who need subsidy. People who make an
uninformed comments... should do some homework before taking a political
position."
Several state finance
ministers were opposed at Prime Minister Singh's decision to give a $10 billion
(Rs 55,000 crore) grant to an IMF bailout fund to stabilise crisis-stricken
Euro zone countries, especially when India is going through a deep
financial crisis. The Government should desist from such boastful expenditures.
Communication Gap
between the Government and RBI:
The breakdown in
communication between the officials of North Block (Ministry of
Finance) and Mint Street (RBI) did not help. Mr. Subbarao was annoyed by the fact that
the ministry was trying to order the RBI around with little respect for its
autonomy. The distrust grew over time.
Weak economic fundamentals:
The weak economy and no signs of a quick fix solution are weighing on the
rupee. The UPA government is unlikely to deliver far reaching reforms to
generate heavy capital inflows, as it did last September to stave off the loss
of India's
investment grade credit rating, experts say.
Consequences of fall
in Rupee Value:
Widening trade deficit:
Rising deficit is bad
for India
as it exposes the economy to the risk of sudden stop and reversal of capital
flows. In case of an event shock, for example if the U.S. Fed withdraws its
bond buying programme, there might be sudden outward flow of money, leaving India
scrambling for dollars. The slowdown in the Indian economy has made the current
situation even more volatile because the government is unable to generate heavy
capital inflow. India's
current account deficit was equivalent to a record 6.7 per cent of gross
domestic product in December.
Weakness in domestic
equities:
Foreign
institutional investors have been selling index futures in the last week. This
is a hedging move as FIIs expect stocks (cash segment) to fall in the near
term, traders said. FIIs have been a key support for markets (and the rupee)
after buying over $15.38 billion (Rs 90,000 crore) worth of shares this
year (2013) as of last week.
Rising import bill:
Oil and gold imports
account for 35 per cent and 11 per cent of India's trade bill respectively.
Traders say there has been continuous demand for the dollars from oil
importers, the biggest buyers of dollars in the domestic currency market,
pushing the rupee lower.
Fuel prices:
Fuel prices go up,
causing prices of transported goods to spiral. Crude oil accounts for a
major share of India's
import bill. Import of crude oil will cost more. The state-owned oil marketing
companies were already running on a deficit. The government backed them by
announcing partial deregulation of diesel prices, while petrol prices are
already market-driven. The additional burden of importing crude oil will be
transferred to the consumers by the oil companies. Diesel and petrol prices are
likely to go up.
This will also trigger a chain reaction that would result in a higher burden on
the common man in all walks of life. Higher fuel prices would increase
transportation charges, which would not only impact the office travel costs but
also impact the price of the goods that are transported. Apart from crude oil,
fertilizers and medicines are also imported in substantial volumes. The
increased cost of importing fertilizers would also push the prices of food
commodities higher. Medical care would also get costlier. On the other hand,
India Inc will also have to pay more in rupee terms for procuring their raw
materials, despite drop in global commodity prices, only because of a
depreciating rupee against dollar. Already, oil companies cited the fall in the
rupee value to the dollar to increase petrol prices recently. For oil marketing
companies with every fall in the rupee, the under-recovery on account of
petroleum products goes up by Rs 9,500 crore per year on the price-controlled items.
In the short-run, the
depreciation of the rupee increases the cost of imports and import substitutes.
Among others, it means, the cost of petroleum products would be higher but
since it is invariably not passed on to domestic consumers, the level of
subsidies and with it the size of the fiscal deficit will go up. The threat of
imported inflation will increase as inflation expectations harden.
Inflation:
When a currency loses its value it creates many problems for the economy. It
leads to high inflation, as India
imports around 70 per cent of its crude oil requirement and the government will
have to pay more for it in rupee terms. Further, this higher import bill will
lead to rise in fiscal deficit for the government and will push the inflation,
which is already hovering around the double-digit mark.
Companies borrowed in
foreign exchange:
Companies, which have
borrowed in foreign exchange through external commercial borrowings (ECBs) but
not hedged the foreign exchange risks, will suffer enormously. Many banks will
have to declare such loans as non-performing assets. Consequently, they will
lend less to the productive sectors.
Foreign Education:
Foreign education will
get more expensive. The US, UK,
Australia and Europe are among popular destinations for Indian students
for higher studies. The rupee has lost its value against all major currencies
of the world. This means students will have to pay more in Indian rupees to
fund their education now than they did earlier. Both current students and students
with existing education loans should reassess their loan requirements.
Electronic, Electrical
items, Vehicles:
Electronic, electrical
items, vehicles may get costlier with a flurry of electronic gadgets
ranging from mobile phones, laptops and TVs available in the market, the
manufacturers are forced to set a competitive price. The rupee depreciation
would make the imports costlier, impacting the production cost of the
manufacturers. Manufacturers would also look at hiking the price of these
gadgets to match their profit margins. Car manufacturers also face a similar
situation of increased operational costs. Car manufactures would also revise
their prices upwards. Home appliance companies such as LG and Blue Star have
already announced a hike in the prices of air conditioners and other
items. Computer companies such as Lenovo and HP are also set to hike prices to
offset the impact of a declining rupee.
Foreign Currency Debt:
Just like oil, all
products and commodities are more expensive to import now. Corporates, who have
foreign currency loans on their books, also take a view that despite a
depreciating rupee, keeping the benign interest rates in developed markets
would be lot better to hold on to foreign currency debt as one gets 0-2 per
cent interest on dollar debt compared with 12-14 per cent on rupee debt.
Foreign Travel:
Individually,
traveling abroad becomes more expensive as travel cost can go up by at least 10
per cent. Students studying abroad too will be hit as more rupee will go out to
pay for the courses and stay.
Stock Markets:
Depreciation of rupee
also affects the money flow in the Indian stock markets. FIIs, the main
investors in the Indian equity markets, also start withdrawing their
investments from the markets fearing loss of value. In terms of portfolio
stocks in oil and gas, infrastructure, fertilizer or tyre business, returns
will take a hit as the shares of these companies will fall when the rupee falls
as they procure their raw materials from abroad. On the other hand stocks of
Information Technology (IT) companies and export-oriented units should do
better.
Doubts
about General Anti Avoidance Rules (GAAR):
GAAR is a new chapter introduced in the Finance Bill 2012. FIIs are so
concerned about this. Broadly speaking, GAAR provisions will disallow a tax
benefit if it is proved that you entered into an arrangement with the intent of
avoiding tax. FIIs registered in Mauritius
have a tax advantage when compared with ordinary retail investors in India. While no
one pays long term capital gains – residents have to pay 15% short term capital
gains. However, FIIs registered in Mauritius don’t have to pay those short term
capital gains because they enjoy tax benefits under the DTAA (Double Taxation
Avoidance Agreement) India has with Mauritius. Now, if the tax department says
that a FII has registered in Mauritius
solely to benefit from this DTAA and the FII is unable to prove otherwise –
they will be liable to pay short term capital gains on their investments as
well.
Exchange Rate:
The exchange rate
depends on the market forces - demand and supply of INR (Indian Rupee) and
foreign currencies, and that relationship is shown in the current account and
capital account of the country.
The current account is
the account that shows the imports and exports of goods and services and the
capital account is the account that shows the money invested by foreigners in India, and
money invested by Indians outside the country. As far as I know, India has never had a trade surplus, which means
it has never exported more than it imported and the deficit that occurs as a
result of this has been met by investments by foreigners in the form of FDI and
FII inflows in India.
But recently, even those have slowed down putting pressure on the currency.
Current Account
Deficit:
The current account deficit as
measured by the difference between exports and imports of goods and services is
worst condition . The trade deficit in last fiscal was $184.9 bn. and this
is as high as 9.9% of GDP. On the import side, higher oil prices, and gold
imports are causing a lot more outflow than previous years, these two alone
contributed to 43% of Indian imports. Exports have been slowing down too
and in fact March of 2012 actually saw a drop in exports from a comparable
period a year ago.
Capital Account
Deficit:
On the capital account, FDI has been in
the news for all the wrong reasons. Even historically, India has attracted
lower FDI when compared wit other emerging economies and the lack of
reforms and the inability to make any progress on issues like FDI in multi -
brand retail means that India has been below its potential in attracting
FDI from the world. FII investments have dried up due to the global flight to
safety because of the resurfacing Euro concerns, but even before that, after
the GAAR announcement in the budget, the FII volume had reduced quite a
bit in the Indian market. Investments also depend on the general economic
environment and that hasn’t been good in the past few years leading to an
environment which does not inspire confidence in investors (both global and
domestic) to put money in the market.
Positive Side of fall of Rupee:
The sharp depreciation
in the rupee is bad for the economy at large, but major corporates are likely
to actually benefit from it. Thus, while a small minority sees the plunge in the
rupee value as being good for the economy — it will encourage exports — many
others do not think so. But one positive outcome is that the government will be
put on guard against short-term measures.
Positive for Corporates earnings:
To be sure, more than half the earnings of
companies that constitute the benchmark Sensex come from globally aligned
sectors, which benefit from dollar appreciation on account of exports or having
subsidiaries in developed countries. The depreciating rupee will be
positive for the Indian IT sector that generate more than 80-90 per cent of
their $70 billion revenue from the overseas markets and this kind of
appreciation in foreign currency will enhance their actual realisation of
revenue in dollar terms. Every one per cent change in rupee-dollar has a 40
basis points impact on the margins on the net profit numbers of IT services
companies like TCS, Infosys, HCL to mention a few. However, IDBI Bank chairman
R M Malla was of the viewed that “exporters gain only in the short term and
after that overseas buyers seek price adjustment.”
Solutions to stop fall of Rupee:
Selling dollars by RBI:
RBI is always trying to protect rupee by selling
off dollars but still has been unable to hold rupee from falling at a rapid
pace. Due to rise in dollar, gold prices have slashed down. The last resort of
controlling rupee fall is issuing bonds by Reserve Bank of India. To
prevent further downfall of Indian rupee, RBI is considering selling dollars
directly to oil marketing firms.
Short Term Measures:
We
can take short term measures to stop the fall but if they are not backed by
long term efforts to correct the underlying problems, nothing will change and
we will have to deal with the same situation 8 or 12 months down the line. RBI
allowing banks to set their own interest rates on NRE deposits (NRE
means the amount kept in rupees can be converted and repatriated back into
foreign currency, on the other hand NRO deposits means, the amount is kept
in rupees and cannot be converted or repatriated back into foreign
currency) and making these NRE deposits tax free is a good example of a
short term measure. That would have surely helped bring in foreign exchange at
the time, but since January 2013, the Rupee has already lost 9% against the
Dollar so whatever gains an NRI will make on the interest have already been
nullified by the loss in the value of Rupee, and any similar measure is not
going to be as attractive a second time action. By looking at these
factors, some of them are within India’s control and some are not.
India can’t do anything to influence oil prices, or do anything about the Euro
problems but it can certainly take steps to simplify labor laws, get clearances
fast, build infrastructure to get foreign investments and other such things.
These things need to be done anyway to help improve the standard of living of
the people in the country; the volatile Rupee fall just gives a sense of
urgency to carry them out.
Other solutions:
Maintaining favorable
balance of trade
Containing Inflation
To strive for higher
Economic Growth Rate
Solving Unemployment
Problem
Accelerate Economic
Reforms
Contain Public debt
Contain Fiscal Deficit
Conducive Interest
Rates for robust economic growth
Creation of confidence
among FIIs
To conclude, the Prime
Minister Mr. Man Mohan Singh should take strong measures to increase exports
and reduce imports and re impose confidence in the economy and investor
interest, FIIs so that FDI could return. To get these done, the Government
needs a strong political will power.