Exchange Rate Slide What Impact Is It Having

I. Falling Rupee and Its Impact Since the current round of global uncertainties started after the downgrading of USA and the increasing threat perception of a Greek default, the rupee has been depreciating. Earlier as well, the rupee has been unsettled whenever the global economy showed signs of trouble as in 2008. A look at the pattern of rupee in comparison to the four major currencies shows that since April 2011, there has been a depreciation trend that is much more visible. (Fig 1) Fig 1 Exchange Rates

Such wild fluctuations in the rupee exchange rate within a short span of time are unsettling and leaving its imprint on the rest of the economy. The depreciating rupee will add further pressure on the overall domestic inflation and since India is structurally an import intensive country, as reflected in the high and persistent current account deficits month after month, the domestic costs will rise on account of rupee depreciation. The rupee depreciation will particularly hit the industrial sector and put higher pressure on their costs as items like oil, imported coal, metals and minerals, imported industrial intermediate products all are getting affected. On the basis of ASSOCHAMs interactions with market players, there could be two possible scenarios: Scenario 1: If the global recovery does not take place and the pattern of flow of funds away from the Indian economy continues as it has done in the recent months the exchange rate could well reach the levels of 53.8 in January 2012 and 55.1 in March 2012. Scenario 2: If global economies are able to recover and the funds start to flow again into the Indian markets then the exchange rate would settle for somewhere around Rs 49.50.This would also be the new normal level of exchange rate.
US Dollar Jan Feb Mar 45.4 45.4 45.0 44.4 Pound Sterling 71.5 73.3 72.7 72.7

Euro 60.5 62.1 63.0 64.3

Yen 55.0 55.1 55.0 53.3

Apr May
2011

45.0 44.8 44.4 45.5 47.6 49.3 52.7 53.1 53.8 54.5 55.1

73.4 72.7 71.7 74.4 75.2 77.6 81.4 81.8 82.1 83.4 85.8

64.3 64.5 63.2 65.4 65.5 67.7 69.9 70.3 71.8 72.5 73.7

55.4 55.7 56.0 59.0 62.0 64.2 67.3 69.2 70.5 72.6 74.4

Jun Jul Aug Sep Oct Nov

Dec Jan 2012 Feb Mar

A. Impact on Oil Imports Oil imports consume he largest part of the forex reserves. A depreciating rupee is bound to offset the decrease in the international prices of commodities such as oil. As can be seen from the figure below although the oil price per barrel has fallen however the depreciating rupee has not given any respite to the importer as they actually have to shell out more money in order to
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purchase the same quantity of oil. Take for instance crude oil imports. Brent crude oil price was $118.46 per barrel on April 2011 when exchange rate for the rupee was Rs 44.4 to a dollar. On November, oil price had gone down to $109.03 per barrel and exchange rate was Rs 52.7 to a dollar. Thus, because of the rupee depreciation not much benefit can be derived out of the lower oil price. Instead, the increase in price of importing oil between April and Novemebr is to the tune of Rs. 489.8 per barrel. (Fig 2) Fig 2 Oil price and Exchange Rate

Source: RBI

B. Impact on Debt A depreciating rupee is not only impacting the import bill it has also severly affected the cost of borrowings for the corporate sector. As was reported recently1 Indian companies have borrowed close to $29 billion in foreign currencies, through ECBs (External Commercial Borrowing) and FCCBs (Foreign Currency Convertible Bonds), since the beginning of this year, The corporates had been increasingly tapping overseas loans, mostly in the US dollar, till a few months ago to save costs arising out of higher interest rates and liquidity constraints within the country, but the subsequent fall in the rupee value has negated the benefits. The report suggested that a sharp fall of about 17 per cent in the value of rupee from near Rs 44-level against the US dollar at the start of 2011 to below Rs 51-level currently has made the cost of repaying these foreign loans costlier by a similar margin.
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For instance an Indian company would now need to pay an amount of about Rs 5,134 crore (based on current rupee value of Rs 51.34 per US dollar) towards the principal amount to a bondholder of $1 billion, while a similar loan amount would have been worth about Rs 4,400 crore at the beginning of 2010. The falling value of rupee may make the foreign loans availed by the Indian companies this year costlier by an estimated over Rs 25,000 crore (about $five billion), if the current currency valuations persist. External Debt Scenario As per the latest data made available by RBI, Indias external debt, as at the end-June 2011, was placed at US$ 317.0 billion recording an increase of US$ 10.5 billion or 3.4 per cent over the end-March 2011 level primarily on account of increase in commercial borrowings, short-term trade credits and NRI deposits. The external commercial borrowings and short term trade credits accounted for 70 per cent of the rise in total external debt over the quarter broadly reflecting the surge in imports. NRI deposits and multilateral borrowings accounted for about 20 per cent of the increase in total external debt (Figure 3).These are certain payments for which funds need to be kept at hand always. Fig 3 External Debt Outstanding US $ Billion

Source: RBI Monthly Bulletin November 2011, Indias External Debt:Trend, Policy Changes and Cross-country Comparison*

Government (Sovereign) external debt stood at US$ 78.7 billion as at end-June 2011 as against US$ 67.1 billion as at end-March 2010. The share of Government external debt in the total external debt at 24.8 per cent at end-June 2011 declined marginally over end - March 2011 (25.5 per cent). On the other hand, the share of non-Government debt in total external debt rose during the quarter to 75.2 per cent from 74.5 per cent (Figure 4).Therefore what this could mean is that maybe Indian corporates might have gone in for cheaper loans from foreign avenues which now would have become expensive owing to the depreciating rupee. Fig 4 Government and Non-Government External Debt in percentage

Source: RBI Monthly Bulletin November 2011, Indias External Debt:Trend, Policy Changes and Cross-country Comparison*

Another key element to be noticed in the external debt picture of India is the exposure of debt in terms of various currencies. The data suggests that the US Dollar denominated debt continued to be the largest with a share of 54.2 per cent in the total external debt as at end-June 2011. The share of Indian rupee in the total external debt stock accounted for 19.2 per cent as at end-June 2011 followed by Japanese Yen (11.1 per cent), the share of Euro accounted for3.7 per cent as at end-June 2011 (Figure 5).Now here again the depreciation of rupee is bound to increase the interest payments as indicated earlier that since April until November 2011 there has been an 16.54 per cent depreciation.

Fig 5 Currency Composition of External Debt in percentages

Source: RBI Monthly Bulletin November 2011, Indias External Debt:Trend, Policy Changes and Cross-country Comparison*

As indicated in the table below (Table 1) unlike the case is with China where they have foreign reserves to the tune of 3 trillion dollars the foreign reserves in Indias case were just about equivalent to the external debt at the end of June 2011 period. Table 1: Indias External Debt and the ratio of Foreign Reserves to the Total External Debt

2007-08 2008-09 2009-10 2010-11PR end-June 2011P

External Debts (US $ Billion) 224.4 224.5 261 306.5 316.9

Ratio of foreign Exchange reserve to total External Debts 138 112.2 106.9 99.5 99.6

Source: RBI Monthly Bulletin November 2011, Indias External Debt:Trend, Policy Changes and Cross-country Comparison*

I. Effect of a Depreciating Rupee Finally to somewhat understand the effect of depreciating currency on the external debt figures Table 2 has been tabulated taking an assumption that figures for various heads as given in the end of June 2011 period were the same for November 2011 and shows what shall be the effect on each parameter due to the depreciating rupee. Therefore we can see that the depreciating rupee has had the serious effects upon the external debt figures of the nation. Impact of a depreciating rupee: Total external debt has increased by Rs. 2186.8 billion for the period June 2011 to November 2011. The currency composition for major currencies has also had an impact due to this depreciation. The debt in U.S dollars has increased by Rs. 1185.2 billion, that in Japanese Yen has increased by Rs. 242.7 billion. In terms of the three major components of external debt the changes in External Commercial Borrowings, NRI Deposits and Short term Debts have been Rs. 643.2, 365.0 and 472.5 Billion respectively.

Table 2: Effect of Depreciating Rupee on the External Debt Composition of India (in Rupees Billion) Total External Debt
Government Debt Non-Government Debt Total External Debt End June-2011 End Nov-2011 Change 3525.7 4068.7 543.0 10672.5 12316.2 1643.8 14198.2 16384.9 2186.8

Currency Composition of Debt

US Dollar SDR Indian Rupee Japanese Yen Euro Pound Sterling 7695.4 1348.8 -------1576.0 525.3 241.4 8880.6 1556.6 -------1818.7 606.2 278.5 1185.2 207.7 --------242.7 80.9 37.2 8

Others Sum of Currency Composition of Debt

85.2 14198.2

98.3 16384.9

13.1 2186.8

Components of External Debt

External Commercial Borrowings NRI Deposits Short-Term Debt Key Components of External Debt
June Exchange Rate taken as 44.4 November Exchange Rate taken as 51.7

4176.3 2369.8 3067.6 9613.7

4819.5 2734.8 3540.1 11094.4

643.2 365.0 472.5 1480.7

II. Why is the Rupee Falling Moving on, let us try and understand as to how the crises in the U.S. and European region might also be leading to this heavy depreciation in rupee. We shall try and do so by looking at the trends in Net FIIs. In the light of uncertainty and fall in global stock market, foreign institutional investors are supposed to be pulling out their money from various EMEs (Emerging Market Economies) and taking them back to their home countries in order to sustain themselves. As can be seen from the figures below since April barring the month of September we can see that whenever there has been a fall in the Net FIIs the exchange rate has depreciated considerably. (Fig 6) Fig 6 Net FII and Exchange Rate

Source: SEBI

Table:3 Trends in FII and Exchange Flow

Net FII
Apr May Jun Jul Aug Sep
7196.1 -4276.0 4883.3 10652.9 -7902.5 -1865.7

Exchange Rate
44.4

45.0 44.8 44.4 45.5 47.6

Source: SEBI

Key Observation BSE Index Bse Index Apr 19,463.11 May 19,224.05 Jun 18,527.12 Jul 18,974.96 Aug 18,352.23 Sep 16,963.67 Oct 16,255.97 Nov 15,822.28
Source: SEBI

Indian financial market index (BSE index) indicates a declining trend from April 2011 to November 2011. The falling index is partially an indication that FIIs are selling out, this would further increase the pressure on rupees.

III. Comparative Exchange Rate movements in EMEs To understand whether this phenomenon of depreciating rupee is a standalone case for India the study has tries to look at the currency trends of six other nations vis--vis the U.S dollar. The countries considered were China, Brazil, South Africa, India, Mexico and Russia. The trend seems to suggest that almost all the nations have seen their currencies depreciating since May 2011 barring China which has shown currency appreciation in the given period. (Fig 7) As suggested by the trend lines amongst the nations considered South Africa has seen the highest level of currency depreciation, followed by India. (Table 4) Thus there is reason to believe that the crisis prevalent in the west is affecting almost all major economies worldwide.

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Fig 7 Comparative Exchange Rate movements in EMEs vis--vis U.S Dollar

Appreciated by 2.67 per cent

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Apr May Jun Jul Aug Sep Oct Nov

Brazil Real 1.59 1.61 1.59 1.56 1.60 1.74 1.77 1.78

Table 4: Exchange rates of Nations vis--vis U.S Dollar Mexican South Africa Russian China Indian Peso Rand Ruble Yuan Rupees 11.72 6.73 28.06 6.53 44.4 11.66 6.86 27.92 6.50 45.0 11.81 6.79 27.98 6.48 44.8 11.67 6.79 27.91 6.46 44.4 12.24 7.09 28.81 6.41 45.5 13.04 7.56 30.73 6.39 47.6 13.45 7.97 31.25 6.37 49.3 13.67 8.19 30.83 6.36 51.7

Source: http://www.exchangerate.com/past_rates_entry.html

IV. Should RBI Intervene ? The persistent decline in rupee is a cause of concern. Also there have been of lately suggestions made that, some intervention from the Reserve Bank could become a critical stabilising factor. Indeed, Reserve Bank had earlier intervened at times when the rupee was appreciating to protect the interests of Indian exports. So, the demand is why not when the rupee is depreciating. However looking at all the above factors the magnitude of external debt, the currency composition of the debt as well as the continuous depreciation of the rupee makes one wonder

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whether the RBI should put extra burden on its existing foreign reserves on order to check this exchange rate fluctuation. V. Suggestions What the authorities can do, other than direct intervention

Oil import demand could be staggered and purchases co-ordinated so that at no point there is undue bundling of imports.

The government can take initiatives which encourage and increase the flow of foreign investments into India. Three recent steps taken by the government be it the pension fund FDI limit or the increase in the investment limit investors in government security and corporate bonds are the steps in the right direction.

The government can make investments attractive and invites long term FDI debt funds in infrastructure sector.

Government can consider temporary import compression. FDI in the aviation industry, retail can also attract foreign investors.

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