Why Rupee is Weakening
Depreciating rupee has spooked the markets and led to widespread speculation. The rupee has collapsed, the stock market is falling - has India moved from a breakout nation to a breakdown nation in just a few months? The currency’s poor performance began earlier this year. Since late April, the cumulative decline has been 8.7 percent, with a 4.2 percent fall in May alone. And since May,The Indian rupee has declined by nearly 16% against the US and is now Asia's worst performing currency so far this year.
India, however, is not the only country suffering from a weakening currency. Other emerging markets like Brazil, Indonesia, Russia, Turkey and South Africa are also witnessing a huge currency volatility because of fears that US may end its quantitative easing by year-end.
Can we really leave the rupee to market pricing? We don’t have a choice but to live with market pricing. Nifty and the rupee are a thermometer. They are reporting that the patient has a fever.
Factors Involved:
Domestic: Various factors are involved in the steady decline of the rupee which impact on the rupee value vis a vis dollar in a cumulative, synergetic way. There are domestic and global reasons. Among domestic reasons are high current account deficit and growth concerns.
Worsening Current Account deficit
High Current Account Deficit (CAD) is the main reason that has continuously impeded all efforts of government in arrest the fall of rupee. Current Account Deficit occurs when a country's total imports of goods, services and transfers is greater than the country's total export of goods, services and transfers. This situation makes a country a net debtor to the rest of the world. India posted a record current account deficit of 4.8 percent of gross domestic product (GDP) in the year ending March. Government’s failure to explore new destinations has led to poor growth of exports. In the absence of a single window clearance system, and process delays, exports have failed to register good growth. Even traditional export areas have failed to show resilience making Indian produce globally less competitive
Rising import bill (arising out of gold and oil) is also a major factor that has curtailed government’s effort to tackle the fall of rupee. Oil imports account for 35 per cent of trade . Traders say there has been continuous demand for the greenback from oil importers, the biggest buyers of dollars in the domestic currency market, pushing the rupee lower. Similarly, falling gold prices have offset the government's and the central bank's moves to reduce gold imports, which increases current account deficit and weighs on the currency. Gold contributes to over 10/11 percent of the total import bill. During the first quarter, global demand for gold fell 12 percent to 856.3 tonnes against 974.6 tonnes in the corresponding period last year. But in India consumer demand jumped 71 percent 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. Gold imports were 141 tonnes in April and rose to 162 tonnes in May. The govt. Could reduce it to 31 tonnes in June but the reduction could not be held for the month of July.
Insufficient Foreign Direct Investment(FDI) inflows
The government has failed to tap major FDI inflow in the country. Instead, India has witnessed withdrawal of major projects by global giants Inordinate delays, land acquisition problems, government clearance delays, lack of promptness have all contributed to the withdrawal of major companies. Last year Indian companies spent more overseas than Foreign Investors in India. To prop up the rupee in the near-term, markets would need assurances that India can attract foreign flows in an increasingly difficult global environment. .
Foreign Institutional Investment(FII) outflows
Overseas investors have pulled out nearly Rs 18,500 crore (about USD 3 billion) from the Indian capital markets in July. Foreign investors have sold a net $11.6 billion of Indian debt and equities since late May. In their highest monthly outflow, overseas investors pulled out a record Rs 44,162 crore (over USD 7.5 billion) in the month of June. Outflows of FIIs have put a continuous pressure on rupee not allowing it to come out of the slump
Poor economic growth in the manufacturing, agricultural and mining sector has dented investor sentiment and they have become wary of investing in India. Reflecting a persistent slowdown, industrial production in June contracted by 2.2 percent.
Instead, traders fear this would impose capital restrictions that could adversely impact company profits and could also scare off foreign investors at a time when the expected tapering of US monetary stimulus is already creating uncertainty in emerging markets
Global: On the global front, the recovery in the US economy is expected to prompt the central bank there to end the loose monetary policy by the year end. At the global level, investors have been worried that the Federal Reserve will end its government bond-buying program. The implication is that if this happens, then the foreign funds that have been moving to emerging markets looking for better returns will return to the United States once bond yields there firm up. This would mean that there will be fewer flows to these developing countries, including India, which would pressure the balance of payments and in turn the domestic currency. . Anticipating this, foreign investors are pulling out their money from India to invest it back in the US, which is resulting in a scarcity of dollars in India. US recovery is also boosting the dollar strength.
This explains to a large extent an apparent paradox in the global currency market, where the dollar has been weakening against the euro, yet has strengthened against the currencies of most emerging markets that have been recipients of fund flows. Brazil’s currency has depreciated 7 percent in May, while the Mexican peso has fallen 4.9 percent, the South Korean won by 2 percent and the Russian ruble by 3.5 percent
The problem is that when fear sets in the foreign exchange market, it often reinforces the fundamentals. The threat of a further decline in the currency causes importers to rush in to buy dollars while exporters will hold back their dollars for conversion, thus exacerbating the demand-supply gap.
Rising import bill (arising out of gold and oil) is also a major factor that has curtailed government’s effort to tackle the fall of rupee. Oil imports account for 35 per cent of trade . Traders say there has been continuous demand for the greenback from oil importers, the biggest buyers of dollars in the domestic currency market, pushing the rupee lower. Similarly, falling gold prices have offset the government's and the central bank's moves to reduce gold imports, which increases current account deficit and weighs on the currency. Gold contributes to over 10/11 percent of the total import bill. During the first quarter, global demand for gold fell 12 percent to 856.3 tonnes against 974.6 tonnes in the corresponding period last year. But in India consumer demand jumped 71 percent 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. Gold imports were 141 tonnes in April and rose to 162 tonnes in May. The govt. Could reduce it to 31 tonnes in June but the reduction could not be held for the month of July.
Insufficient Foreign Direct Investment(FDI) inflows
The government has failed to tap major FDI inflow in the country. Instead, India has witnessed withdrawal of major projects by global giants Inordinate delays, land acquisition problems, government clearance delays, lack of promptness have all contributed to the withdrawal of major companies. Last year Indian companies spent more overseas than Foreign Investors in India. To prop up the rupee in the near-term, markets would need assurances that India can attract foreign flows in an increasingly difficult global environment. .
Foreign Institutional Investment(FII) outflows
Overseas investors have pulled out nearly Rs 18,500 crore (about USD 3 billion) from the Indian capital markets in July. Foreign investors have sold a net $11.6 billion of Indian debt and equities since late May. In their highest monthly outflow, overseas investors pulled out a record Rs 44,162 crore (over USD 7.5 billion) in the month of June. Outflows of FIIs have put a continuous pressure on rupee not allowing it to come out of the slump
Poor economic growth in the manufacturing, agricultural and mining sector has dented investor sentiment and they have become wary of investing in India. Reflecting a persistent slowdown, industrial production in June contracted by 2.2 percent.
Instead, traders fear this would impose capital restrictions that could adversely impact company profits and could also scare off foreign investors at a time when the expected tapering of US monetary stimulus is already creating uncertainty in emerging markets
Global: On the global front, the recovery in the US economy is expected to prompt the central bank there to end the loose monetary policy by the year end. At the global level, investors have been worried that the Federal Reserve will end its government bond-buying program. The implication is that if this happens, then the foreign funds that have been moving to emerging markets looking for better returns will return to the United States once bond yields there firm up. This would mean that there will be fewer flows to these developing countries, including India, which would pressure the balance of payments and in turn the domestic currency. . Anticipating this, foreign investors are pulling out their money from India to invest it back in the US, which is resulting in a scarcity of dollars in India. US recovery is also boosting the dollar strength.
This explains to a large extent an apparent paradox in the global currency market, where the dollar has been weakening against the euro, yet has strengthened against the currencies of most emerging markets that have been recipients of fund flows. Brazil’s currency has depreciated 7 percent in May, while the Mexican peso has fallen 4.9 percent, the South Korean won by 2 percent and the Russian ruble by 3.5 percent
The problem is that when fear sets in the foreign exchange market, it often reinforces the fundamentals. The threat of a further decline in the currency causes importers to rush in to buy dollars while exporters will hold back their dollars for conversion, thus exacerbating the demand-supply gap.
Action Taken to Stem the Fall
All that the govt. has done in stemming the tide down of rupee is in the field of fund outflow. Reserve Bank of India(RBI) last week had laid down restriction on Indian firms investing abroad. Simultaneously it also clamped down on outward remittances by resident Indians. but these actions have triggered talks of return of capital control regime.
Action Needed
There is a debate whether it is a good idea to use the forex reserves to prop up the rupee. Some experts say it’s a bad idea for two reasons. First, India’s reserves are not too large. The resources available to global speculators are vastly larger than those available to the RBI. Second, reserves are not net wealth that we can use as we please. They are the assets that balance the liability that is the Indian rupee, that is issued by the RBI. Selling one dollar means sucking Rs 64 out of the economy. Selling $10 billion means sucking Rs 0.64 trillion out of the economy.
In fact, a medium to short-term approach towards growth has to be adopted by the government.
We should undertake economic reforms so as to make the patient better. This requires reducing subsidies, reducing the fiscal deficit, enacting new laws that reform the government, and achieve better performance on core public goods such as the judiciary and law and order. much faster go on building infrastructure
The long-term strategy consists of two parts: First, we should engage in fiscal prudence, so as to boost domestic savings and thus narrow the current account deficit. Second, we should build sound frameworks for capital flows. It is truly painful to build and run a business in India. We must change that.
In fact, a medium to short-term approach towards growth has to be adopted by the government.
We should undertake economic reforms so as to make the patient better. This requires reducing subsidies, reducing the fiscal deficit, enacting new laws that reform the government, and achieve better performance on core public goods such as the judiciary and law and order. much faster go on building infrastructure
The long-term strategy consists of two parts: First, we should engage in fiscal prudence, so as to boost domestic savings and thus narrow the current account deficit. Second, we should build sound frameworks for capital flows. It is truly painful to build and run a business in India. We must change that.
Rupee depreciation does have its advantages since it makes Indian goods cheaper overseas and therefore more attractive to consumers, which benefits exporters. But these days, exporters may not actually see significant gains as the global economy is still stagnant and the price advantage on exported goods may not materialize any time soon given their relative inelasticity. In fact, some importers of Indian goods are asking exporters to lower their prices on account of this price advantage. But given that India’s foreign currency assets have at best been stable at around $ 260 billion, there are limits on such intervention.
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