The impact of rising rupee on financial management of Indian MNCs


Dr. M. Srinivasa Rao
Prof. D.S. Prasad
ICFAI Business School


In 1999, Goldman Sachs (BRIC Report) predicted that India's GDP at current prices will overtake that of  France and Italy by 2020 and that Germany, UK and Russia by 2025,  By 2035, India is expected to be of 3rd largest economy in the world behind US and China overtaking Japan. Goldman Sachs had made these predictions based on India's expected growth rate of 5.3 to 6.1% in various periods in the past, at present India is registering more than 9% growth rate. Jim O'Neal, head of the Global Economics Team at Goldman Sachs, had said on the BBC, "In thirty years, India's workforce could be as big as that of the United States and China combined." He also added that "India could overtake Britain and be the world's fifth largest economy within a decade as the country's growth accelerates."

Presently  India is the third largest economy in the world as measured by Purchasing Power Parity (PPP) and twelfth largest in the world as measured in USD exchange-rate terms, with a GDP of US $1.0 trillion. Amongst the major economies of the world, India is the second fastest growing economy with a GDP growth of 9.4% for fiscal year 2006-2007. The main reason for this is its diverse economy which encompasses agriculture, handicrafts, textile, manufacturing and a multitude of services.

However, the BRIC (Brazil, Russia, India, China) report ignored the effect of rapid decline in Purchasing Power Parity ratios of economies as they approach maturity, resulting in PPP that eventually tend toward 1.0 (as compared to nearly 5.0 for India and China in this current year i.e. the value of 1 US$ in India and China after conversion into local currency at currency exchange rates was 5 times of that in the US due to their cheaper currencies). This decline is attributed to the following,

  • Inflation
  • Appreciation of the local currency

Normally, currencies appreciate when the economies are doing well and the rise in their value is a cause for celebration. The high value of the Deutsche Mark when Germany was the trendsetter for the world economy in the 1960s and the 1970s, the high value of yen in the 1980s when Japan seemed set to take over the world and the dollar's high value in the late 1990s when the US economy brooked no competition were sources of immense pride for their respective countries.

The Indian journey from 1990s to the mid 2000s:

The Indian rupee (INR) has appreciated by nearly 10% since late 2006, posing an acute dilemma for Indian policymakers. In some ways, the present strength of the currency, this is now hovering just above the symbolic Rs. 40: US $1 exchange rate is an enviable position. It suggests that the country's attractiveness to foreign investors is increasing and signals optimism about the future of Indian economy in general. However, the concerns of export intensive corporations, who have a crucial role of India's economic resurgence, and whose goods become more and more expensive for overseas buyers need to be examined critically and addressed in a timely and effective manner.

The recent strengthening of the rupee is a dramatic departure from the  past trends. The currency depreciated steadily for a decade after being floated in 1993, dropping from an average annual rate of Rs. 31.37: US $1 in the 1993-94 fiscal year (April-March) to Rs. 48.40: US $1 in 2002-03 (an average annual depreciation of nearly 5%). Between 2003-04 and 2005-06, however, the rupee appreciated against the dollar by 3% an on average a year—although there was considerable two-way movement of the rupee from month to month. The trend of steady month-on-month appreciation began in September 2006 and has been continuous since then.

Although the Indian rupee-US dollar exchange rate has a significant impact on the Indian economy and business sector, the rupee has also appreciated against other currencies as well. In January-July 2007, the rupee's value in terms of Pounds, Euros and Yen rose by 8%, 6.9% and 11.2%, respectively. According to the Reserve Bank of India (RBI) during 2005-06, 86% of Indian exports and 89% of imports were invoiced in US dollars. The Euro was a distant second, with shares of 8% in exports and 7% in imports.

Why the Indian rupee appreciated?

The main reason for the INR's appreciation since late 2006 has been a flood of foreign-exchange inflows, especially US dollars. The surge of capital and other inflows into India has taken a variety of forms, ranging from FDIs to remittances sent home by Indian expatriates. In each case, the flow seems unlikely to slacken. The main impact of these various types of flows is examined below:

  • Foreign Direct Investment (FDI) - India's outstanding economic growth has created a large domestic market that offers promising opportunities for foreign companies. Moreover, the country's rising competitiveness in many sectors has made it an attractive export base. These factors have boosted FDI inflows into the country. For example, in 2006-07, FDI amounted to around US $16bn, almost three times the previous year's figure. More than half of these inflows arrived in the final four months of the fiscal year (December 2006-March 2007).
  • External Commercial Borrowings (ECBs) - Indian companies have borrowed enormous amounts of money overseas to finance investments and acquisitions at home and abroad. India's balance-of-payments (BoP) data reveal that inflows through ECBs amounted to an enoromous US $12.1bn during April-December 2006, a year-on-year jump of 33%. The flood of borrowed money is likely to grow in 2007. In the first three months of the year, Indian companies have notified the RBI of their plans to raise nearly US $10bn in overseas debt markets.
  • Foreign portfolio inflows - India's booming stock market embodies the confidence of investors in the country's corporate sector. Foreign portfolio inflows have played a key role in fuelling this boom. Between 2003-04 and 2006-07, the net annual inflow of funds by Foreign Institutional Investors (FIIs) averaged US $8.1bn. Trends during the first five months of 2007 indicate that this flood is continuing, with net FII inflows amounting to US $4.6 billion. Another major source of portfolio capital inflows has been overseas equity issues of Indian companies via Global Depositary Receipts (GDRs) and American Depositary Receipts (ADRs). Inflows from GDRs and ADRs amounted to US $3.8bn in 2006-07, a year-on-year increase of 48%.
  • Investments and remittances - Indians settled in other countries have also been a major source of capital inflows, with many non-resident Indians (NRIs) investing large amounts in special bank accounts. While NRIs' emotional connection to their country of origin is part of the explanation for this, the attractive interest rates offered on such deposits has also provided a powerful incentive. In 2006-07, NRI deposits amounted to US $3.8bn, a 35% increase over the previous year; the outstanding value of NRI deposits as of end-March 2007 was US $39.5bn. Another large source of foreign-exchange inflows has been remittances from the huge number of Indians working overseas temporarily. Such remittances amounted to a colossal US $19.6bn in April-December 2006, a 15% year-on-year increase.

The Export Scenario:

Buoyant export growth has also built up India's foreign-exchange holdings. IT and Business Process Outsourcing (BPO) exports have expanded at robust pace, with exports of software services reaching US $21.8bn in April-December 2006 (a year-on-year increase of 31%). However, the rupee's appreciation is alarming exporters, as it makes their products more expensive in overseas markets and erodes their international competitiveness.

The RBI's deputy governor, Mr. Rakesh Mohan has recently referred to the effects of the rupee's appreciation as a case of 'Dutch disease'. The term refers to episodes where large inflows of foreign exchange, usually as a result of the discovery of natural resources or massive foreign investment, have lead to appreciation of the currency, undermining a country's traditional export industries. ('Dutch disease' was originally referred to as the adverse impact of the discovery of natural-gas deposits in the Netherlands on that country's manufacturing exports.)

Trade Policies:

Indian policymakers face a difficult dilemma. On the one hand, the rupee's appreciation has benefited the economy by making imports cheaper. This is no small benefit since containing inflation has been high on the policy agenda during the past year, as the annual inflation rate (as measured by the point-to-point change in wholesale prices) rose to 6.1% in January 2007, compared to 4.2% a year ago. The inflation rate has subsequently moderated. This may offer the RBI some comfort in it's battle against inflation, but the bank's new, stricter inflation target (4.5-5% in 2007-08, down from 5-5.5% in 2006-07) suggests that there will be one more increase in interest rates by the end of 2007.

On the other hand, for both economic and political reasons, policymakers cannot afford to ignore the problems of exporters. Although exports account for a relatively small share of the economy, India's rapid export growth in recent years has been an important catalyst of economic growth. Given the limited extent to which the RBI can intervene in the foreign-exchange market in the face of large and sustained capital inflows, policymakers can only stem rupee appreciation substantially by easing limits on domestic firms' overseas investments or restricting inflows, for instance, through further controls on ECBs. The RBI has already taken tentative steps in this direction, especially recent ECB guidelines for Indian firms to borrow in foreign currency and eliminating the exemption from ECB limits previously enjoyed by real-estate firms.

In confronting this dilemma, government policymakers are undoubtedly hoping that there will be no need for a major intervention. However, the problem is unlikely to disappear soon. The Economist Intelligence Unit forecasts an average annual exchange rate of Rs. 41.3: US $1 in 2007 (a 13.5% real appreciation year on year) and Rs. 40: US $1 in 2008 (6%).

Let us now look at the pros and cons of a rising rupee.

Advantages of the rising rupee:

  • Foreign debt service: Appreciation of the rupee helps in easing the pressure, related to foreign debt servicing (interest payments on debt raised in foreign currency), on India and Indian companies.With Indian companies taking advantage of the United States soft interest rate regime and raising foreign currency loans, known as external commercial borrowings (ECBs), this is a welcome phenomenon from the point of view of their interest commitments on the loans raised. This will help them avoid taking a bigger hit on their bottom-line, which is beneficial for its shareholders.
  • Outbound tourists/student bonanza: The appreciating rupee is a big positive for tourists traveling or wanting to travel abroad. Considering that the rupee has appreciated by over 10% against the US dollar since mid-2002, traveling to the US is now cheaper by a similar quantum in rupee terms.The same applies to students who are still in the process of finalizing their study plans abroad. For example, a student's enrollment for a $1,000 course abroad would now cost only Rs.44,000 instead of the earlier Rs 49,000!
  • Government reserves: Considering that the government has been selling its stake aggressively in major public sector units in the recent past, and with a substantial chunk of this being subscribed by FIIs, the latter will have to invest more dollars to pick up a stake in the company being divested, thus aiding the governments build up of reserves.

Disadvantages of the rising rupee:

  • Exporters' disadvantage: The exporters are at a disadvantage owing to the currency appreciation as this renders their produce expensive in the international markets as compared to other competing nations whose currencies haven't appreciated on a similar scale. This tends to take away a part of the advantage from Indian companies, which they enjoy due to their cost competitiveness. However, it must be noted that despite the sharp currency appreciation in recent times, Indian exports have continued to grow. This is vindicated from the fact that while in the month of February 2004, India's exports were higher by 35% over the same month previous year, in the first 11 months of the current fiscal, Indian exports have been higher by 15% year-on-year.
  • Dollar denominated earnings hurt: The strengthening rupee has an adverse impact on various companies/sectors, which derive a substantial portion of their revenues from the US markets (or in dollar denominations). Software and BPO are typical examples of the sectors  adversely impacted by the appreciation of rupee.

How will rupee appreciation impact Indian Multinationals?

Even though the INR fluctuates a lot, but it is still up 7% making it the best performing currency against the USD in 2007. A month back it touched a nine-year high. Rupee appreciation will be negative for overall earnings, says a recent Merrill Lynch research report. According to the report, the companies that will be impacted negatively by the rupee appreciating include global commodity stocks like Reliance, Hindalco, Tata Steel and software companies like Satyam, Infy etc. And the gainers will be Jet Airways, Reliance Communicationsand auto companies like Tata Motors, Maruti, Hero Hondaetc.

The Losers:

Global commodity companies price their products off landed costs. With a decrease in landed costs, profits for these companies will be hit. As an example, Reliance's 70% of revenues come from exports which again would be hit by the rising rupee  thereby eroding their profitability.

The rising rupee and the fluctuating dollar have affected the Indian IT industry adversely. It has dented profits and at the same time, many foreign clients with a dollar budget are finding it too expensive to use Indian service providers. That is, software companies are also going to lose on the back of the appreciating rupee as their exports are priced in foreign currency.

Infosys, CFO, V Balakrishnan, said that in the fourth quarter of the fiscal year 2006-07, they have seen an impact of 100 bps on their operating margins because of the movement of the rupee. "But that was more than offset by the increased non-operating income that we have seen because the effective yield in the last quarter has increased from 7% to 10%."  He said that in this quarter the rupee appreciated by around 1.8% and for every 1% change in the rupee dollar rate the company have an impact of 50 bps.

The management of MindTree, a global consulting house, predict that the rupee appreciation will be the key hurdle for their future performance. Patni Computers has seen rupee appreciation impacting their margins by 0.3% in the last quarter.

The Gainers:

On the other hand, sectors that are likely to gain from the currency gaining are auto, engineering and aviation companies.

The biggest gainers in the auto sector are Hero Honda, Maruti, Tata Motors and Ashok Leyland as the imported price of their raw materials will cost less.  Engineering companies like Suzlon also gain on raw material cost savings.

Jet Airways is the other gainer on its aviation fuel costs for its domestic routes. Though its international revenues will get hurt, there will be more savings on account of  fuel, lease rentals, interest and depreciation. Deccan Aviation management has said that rupee appreciation is having a favorable impact on the lease side.

Companies with foreign currency loans or Foreign Currency Convertible Bonds (FCCBs) like Reliance Communications, Bharat Forge, Sun Pharma and Ranbaxy are also likely to gain due to rupee appreciation. Allianz Global feels that a sharp rupee appreciation will have a drag effect particularly on banks.

Present scenario:

The current impact of rupee appreciation is best demonstrated by what it has done to our textile exports, a highly employment-intensive sector, driven by small and medium enterprises (SMEs). From a healthy export growth rate  of 21% in 2005-06, it has plummeted to a mere 4.6% during the 11 months of 2006-07.

CRISIL, a leading credit rating agency has come out with a report (CRISIL Budget Impact Analysis) on textile impact analysis and is of the view that the package for exporters in the form of enhanced DEPB (Duty Entitlement Pass Book) and drawback rates will marginally offset the impact of rupee appreciation and benefit the exporters. The textiles industry is severely affected by the rise of the rupee against the dollar, since currencies of most of our competitor countries have either remained stable or have depreciated against the dollar during this period. Chinese Yuan has appreciated by around 4%, Indonesian Rupiah by around 2.7%, Bangladeshi Taka has remained almost stable and Pakistani Rupee has depreciated by 0.69%. There is an intense competition in the export market. Small and medium exporters are unable to pass on their costs in terms of currency appreciation to buyers. The consequent lowering of export proceeds erodes the top line and profit margins of exporters. Therefore, players would be required to find additional ways to overcome the additional loss through operational efficiencies and moving up the value chain to maintain their existing margins.

Looking Ahead:

However certain sections of the economy have welcomed the rupee appreciation. This is because of the following key reasons:

  • Firstly, the IT industry which is strongly lobbying against the appreciation of the INR should realize that its phenomenal growth during the last decade is partly because of INR depreciation too. INR depreciated by almost 100% against the USD from a level of 25 in 1992 to 48 in 2003. Further, Indian economy needs development of infrastructure which warrants huge investments. A big chunk of the said investments must come from overseas. The host country's currency, viz., INR, must appreciate to instill confidence into overseas investors. 
  • Secondly INR appreciation is welcomed by those companies with overseas borrowings. Significant levels of foreign currency – denominated, especially USD-denominated loans generate forex gains because of reduced interest payout occasioned by the rising INR. Companies like Ranbaxy and L&T have been able to generate forex gains in the last quarter because they have substantial exposure to ECBs.
  • Thirdly, major Indian stock indices are able to scale new peaks because of recent appreciation in the INR. It has been proved beyond any doubt that there is a very strong correlation between our stock indices and the parity value of the rupee vis-à-vis major currencies like the USD. Analysts point out that during the last year Sensex and INR exhibited a correlation of approximately 80% as against the 30-40% exhibited in the last three years. FII's who have heavily invested in India are reluctant to sell off mainly because of the appreciating INR.
  • Lastly and most importantly, INR appreciation has helped control inflation.( It touches a 5 year low at 3.32%) 

Government standpoint:

The government is working on schemes to offset impact of appreciating rupee. The proposed scheme refunding  local taxes and levies to labour-intensive industries with little import content, to offset the impact of the appreciating rupee, which was at a nine-year high. "The rupee appreciation is a cause of concern for exporters and manufacturing firms. We are looking at framing a scheme for labour-intensive industries with no or very little import content to refund the local taxes and levies," Minister of Commerce and Industries Kamal Nath said on the sidelines of the 3rd India-GCC Industrial Forum. "The rupee rise is a concern and the Ministry of Commerce is in discussions with the RBI... the rise is also connected with international factors like fall in the dollar."


It can be inferred that the issue of INR appreciation will play a major role if India has to become a superpower nation by 2020. We have seen that as the Indian stock market is booming in the past few months, the rupee is becoming stronger as compared to the US dollar. This implies as the abiding faith of foreign investors in robustness of the Indian economy and the inflows are rising at exponential rates. But the exports are taking a hit because of this phenomenon. This is the dilemma which the policy makers have to address.

Though the strengthening of the rupee will benefit certain industries, others might face the brunt. But the gain will be to the entire Indian economy. The basic foundation for any country to become an economic superpower is to have a strong infrastructure. This need for huge investments, are being met through FDIs & FIIs. Similar developments in other key areas would truly help India to reach the position of the 3rd largest economy of the world behind US and China by 2035.

Dr. M. Srinivasa Rao
Prof. D.S. Prasad
ICFAI Business School

Source: E-mail October 3, 2007


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