Drop-by-Drop INR Drops


By
S.Siddhu
II MBA
Thiagarajar School of Management
Madurai
 


1. Introduction:

India's currency is one of the worst performing currencies in Asia. Talking about the reasons for the depreciation of rupee a series of activities have led to the current scenario. Since the great depression of 2008, the Indian economy had been continuously slowing down and the dollar value depreciated to 48.44%. The fundamental reason behind such depreciation is that India keeps on importing from the world market. Higher the import of crude oil and gold has increased the Current Account Deficit (CAD) to a larger extend. CAD for the previous fiscal (2012-13) was $87.8 billion.

2. Objective of the article:

The main objective of the article is to:

* identify the major reasons behind the rupee depreciation and the steps taken by the Government/RBI to control the rupee slide

* provide suggestion to control rupee depreciation

3. Scope of the article:

This article deals with the major reasons that causes rupee to depreciate.

4. Graph Interpretation:

Indian Rupee has performed worst in the past three months. When analysed, it is found that there are several reasons that caused the rupee to depreciate. These factors have been discussed in the later part. When analyzing the trend of the rupee movement for the past five years, fig 1, it is found that by the end of August, 2013, the Rupee should have been Rs.55/USD. But in considering the trend for the past three months, fig 2, it is found that by the end of August, 2013, it reached a value of around Rs.64/USD.


                                                     Fig 1.Trend for past 5 years


                                                     Fig 2. Trend for Past 3 months

The factors that caused such a difference are discussed below.

5. Factors affecting the rupee:

a. Gold Import

India accounts to 20% of the global demand for gold the previous fiscal. It is found that about 50% of the gold imports have been used for marriages. P.Chidambaram, the Finance Minister, said the government was looking to contain gold imports at 850 tonnes this fiscal year, after imports of 950 tonnes last fiscal. During the first quarter, the global demand fell to 12 percent to 856.3 tonnes against 974.6 tonnes. But India's demand jumped 71% to 310 tonnes, compared with 181.1 tonnes in the year-ago period despite repeated increases in import and excise duties by the government this year. By the month of May, the government has raised the import tax rates and excise duty. The import duty on gold is raised to 10% from 2%, the third raise in eight months, and on silver the duty was hiked form 6% to 10%. The excise duty was raised to 9% from 7%. Despite these measures taken by the government, the gold import is increasing. By the mid-September, the import of gold duty is further raised by 5% to 15%.

RBI measures to control Gold imports

RBI has implemented new measures to control the CAD. Amongst then, the few are the importer need to ensure that at least 20% of the gold should be available for export. As of now, the importer has to leave behind 20% of the gold in customs bonded warehouses and will be allowed for fresh purchases only if 75% quantity is exported. India has exported only 7% the previous fiscal. Due to tightening regulations form Government and RBI, the gold's are imported in illegal manner. In the first 10 months of 2012-13, the Directorate of Revenue Intelligence seized gold worth Rs.60.17 crore (200kg at the current price of gold) and uncovered 36 instances of smuggling. In the corresponding period in 2011-12, it seized gold worth Rs.7.42 crore and traced 15 cases.

b. Increasing FII outflow:

The second major reason is outflow of Foreign Institutional Investor (FII). By 17th May, S&P rated India as BBB- (negative). This created major loss to the Indian Economy. Foreign institutional outflow in June alone is $7.53 billion, more than double the previous highest single month FII outflow (3.53 billion in October 2008). By July and August, about $3 billion and $2.5 billion overseas investors have pulled out from Indian capital market. Lot of FII money went back to US, resulting in dollar strengthening. This created more demand for dollars resulting in rupee depreciation. As foreign funds have been sellers in the domestic debt and equities market, the country's foreign exchange reserves have come down to cover imports. As the foreign reserve comes down, the demand for the dollar increases resulting in the dollar value appreciation. This ultimately makes the import costlier, accelerating the inflation. The idle ratio for the CAD to foreign reserve is 1:6. India's present CAD is around $70 billion and the forex reserve is $278.8 billion as of august.

c. Reducing FDI inflow

Following this, the inflow of FDI has been reduced to a larger extend. This in turn reduced the income of US dollar and caused more demand to the dollar. India has attracted $22.78 billion in 2012, a decline of 34% from $34.62 billion in 2011.   Foreign investments are important for India, which needs around $1 trillion in the next five years to overhaul its infrastructure sector such as ports, airports and highways to boost growth. But due to decline in foreign investments it puts pressure on the country's balance of payments and caused a huge impact in the value of rupee. The Government is also liberalizing the conditions for FDI so as to attract more investors.

Relaxation on FDI:

The Department of Industrial Policy and Promotion (DIPP) is planning to allow FDI investors to exit after completion of the project or three years, whichever is earlier. The other change under consideration include reducing the minimum capitalization of the eligible construction project is which FDI can come in to $5million against $10 million presently for the wholly owned subsidiaries and from $5million to $2.5 million for joint ventures with Indian partners. The conditions which were imposed on Wal-Mart to enter India have now been withdrawn by the government so that it enters India as soon as possible and bring with it the direly required FDI.

d. Widening Fiscal Deficit:

Fiscal deficit in India is another factor that causes Rupee depreciation. Imports of Crude Oil don't decline despite high prizes because government doesn't pass on it to the end consumers for political. Top international rating agencies like S&P, Fitch have a negative outlook on India. Moody's is the only one that has a 'stable' outlook on its 'Baa3' rating on India.

Moody's has said that the food security bill will weaken the government finances and deteriorate country's macroeconomic situation. "The measure is credit negative for the Indian government because it will raise government spending on food subsidies to about 1.2% of GDP per year from an estimated 0.8%" Moody's said. Thus this will increase the fiscal deficit. Higher fiscal deficit exacerbates the CAD as it increases aggregate demand which necessitates higher imports, resulting in more demand for US dollars and the rupee would depreciate.

Widening current account deficit, Low forex reserves, Growth slowdown, Speculative trend in the currency, trend of other market, Recovery of US market, dependence of foreign money are some of the reasons for Rupee depreciation.

6. Suggestions:

According to author's point of view, apart from the measures already taken, the government should now focus on increasing exports. SEZ's and export houses should be given liberations so that they can sell their product in the market. Loans should be made cheaper for these organizations so that there cost of borrowings reduces enabling them to produce at competitive rates. Power and fuel costs should be reduced for them so that their overall cost of production falls. Further special tax rebates should be given to them. Focusing on FDI is important because FDI will increase the foreign currency flow into the country. To increase the FDI first of all we should attract the foreign investors by improving our economic condition which is interrelated with rupee value.These measures will ensure that the Indian goods become cheaper in the international market which will hence trigger the exports of the Indian products. Further, the smuggling of gold should be checked in the nation as with the increase in import duty the act of smuggling has increased. Custom officials should become stricter with the norms and the various regulations. The government should also look for the substitute products for its imports.

Sources:

1. Economic times (articles between June 2013 to September 2013)
2. Livemint.com (Web based articles between July 2013 to September 2013)
3. Business line (Since May 2013 to September 2013 articles)
 


S.Siddhu
II MBA
Thiagarajar School of Management
Madurai
 

Source: E-mail September 21, 2013

 

           

 

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