Guidelines

This is an individual assignment It is compulsory for EVERYONE. Please write the answers in a separate word document and send it at finance.club@sdmimd.ac.in on or before 19th July 2013. There is no word limit. The top two assignments will be awarded by the management.

History AND DOWNFALL of Indian rupee

Since we were under British rule our rupee was pegged to pounds. At the time of independence it was at par with US Dollar. From 1927 to 1966, it was 13 rupees = 1 pound. This was maintained until 1966, when the rupee was devalued and pegged to the U.S. dollar at a rate of 7.5 rupees = 1 dollar. This value kept degrading and the story goes like this Something strange is happening in India's external economic relations. The rupee has found itself a new low level in relation to the US dollar and the British pound, and seems likely to depreciate even further. 2 years ago, the Indian rupee stood at a then strong Rs 44.5 to the dollar. At that level, the rupee had appreciated by more than 13 per cent vis-a-vis the dollar over the preceding 13 months.

But between August of 2011 and the middle of December the value of the rupee fell to Rs 54 to the dollar, or depreciated by as much as 21 per cent. Between December and early March in the year 2012, the currency regained some of its earlier strength to touch Rs 49 to the dollar. But it has once again lost value and currently is above Rs 52 to the dollar, and possibly heading to its December low. At present it is at its lowest-58.52 This raises the question as to why the rupee is showing signs of growing weakness. Open doors to foreign financial investors are known to generate currency instabilities and crises in most developing economies. While India has side-stepped crises of this kind after 1990, it has periodically faced difficulties in managing the rupee in the face of such flows. Devaluation during the high inflation period of 1970s In the year of 1966 during the prime minister-ship of Mrs. Indira Gandhi, inflation was increasing at unpredicted rate. This was also a time when India was under the immense pressure from the US to devaluate to the rupee to safe guard the aid received by India from the US. This led to the rupee being devaluated to 1 USD = 7 INR. The then members of parliament, Mr. Krishanamachari & Mr. Kamraj opposed the weak Rupee policy but Mrs. Gandhi did not relent, being mindful of the countrys dependence on aid from the US. The strong dollar period of 1980s After 1970, USD grew stronger against the rupee under the incompetence of Indian Politics coupled with robust economic growth in the US. The exchange rate in 1970 was 1 USD = 7.47 INR which rose to1USD=8.48 INR in 1975, after the political uncertainty following the assassination of Mrs. Gandhi in 1984. The next round of weakness in the rupee came in the wake of BOFORS SCAM which toppled Rajiv Gandhis government plunging the rupee to new lows of 1 USD= 12.36 INR in the year 1985. In the year 1990 it rose to 1 USD= 17.5 INR. Devaluation after the economic liberalization of 1991 The economic liberalization under the prime minister ship of Narsimha Rao brought with a sharp devaluation of rupee. At that time the Indian forex reserve dropped to multi year lows and a point came when India had only enough forex to be able to pay for 3 months of import bills. To fill in this gap India borrowed large amounts from the international monetary funds with a obligation to devalue the rupee. The rupee hit new lows with 1 USD= 24.58 INR by the early 1990s. The low rupee policy came as a boom for importers including the information technology industry, which was in its infancy at that time.

Foreign capital inflows This seems to be true in the recent period as well, but in a rather peculiar way. Among the main forms of foreign capital inflows that can influence the availability of foreign exchange in the country are gross inflows of direct investment, which are considered to be of the long-term kind, and portfolio flows, which are considered to be more short-term and purely financial in nature. If we consider the sum of both direct and portfolio investment inflows into India, RBI figures suggest that they stood at $62 billion in financial year 2007/08, collapsed to $28 billion during the year of global crisis 2008/09, and then bounced back to $70.1 billion in 2009/10, $64.4 billion in 2010/11 and close to $60 billion during the first 11 months (April-February) of 2011/12. This points to a puzzle. If aggregate investment flows are seen as influencing the value of the rupee, the depreciation of the rupee in crisis year 2008/09, from less than Rs 40 to the dollar to Rs 52 to the dollar, is explained well by the figures, which point to a significant decline in the volume of capital inflows into the country during that period. The subsequent appreciation of the currency to a level of about Rs 44 to the dollar by late 2010 is also in keeping with the increased foreign exchange inflow that the revival of foreign investment resulted in. What is not so easily explained is the subsequent depreciation of the rupee, including the current decline in the currency.

Speculative flows What is interesting, however, is the observed strong relationship between movements in shortterm, and therefore more speculative, portfolio flows. Portfolio inflows stood at $27 billion in financial year 2007/08, a negative $14 billion during the year of global crisis 2008/09, implying an outflow in that year, and then rose to $32.4 billion in 2009/10 and $31.5 billion in 2010/11. However, these short-term flows fell again to $18 billion during the first 11 months (AprilFebruary) of 2011/12. Thus, if at all foreign investment flows can explain the fall in the rupee in recent months, it is only one component of such flows that could be held responsible: short-term financial flows. One implication of this relationship between movements in speculative foreign capital and the depreciation of the rupee could be that changes in the value of the currency are being driven by speculative factors.

Whenever the Reserve Bank of India intervenes in the market to buy or sell dollars to counter the influence of such speculative forces, the rupee displays some stability. When it does not, the rupee tends to fluctuate sharply, being overwhelmed by speculation. Consider, for example, the appreciation of the rupee that occurred when India experienced a sharp increase in capital inflows over the year before March 2011. The surge was explained largely by developments in the developed capitalist countries, where financial investors had access to the cheap liquidity that developed country governments had pumped into the system in response to the financial crisis. India was chosen as one of the favored investment destinations by those investors. Like many other developing country markets, India became a victim of the dollar carry trade, in which international players borrowed in dollar markets, where liquidity was ample and interest 8rates low, and invested in equity, debt and real-estate in developing country markets, where profit rates were high, in order to make huge profits from the differential between the cost of debt and the return on investment.

Sensex-rupee link The result of such speculative activity was that the rupee's appreciation was also associated with a boom in stock markets driven largely by foreign institutional investment. As a result of speculative investments in the market, the Bombay Sensex stock market index, which had lost much value during the global crisis, rose once again to touch the 18,000 level. The reason was clear. Net portfolio investment inflow into India had revived. Speculation had pushed up both the Sensex and the rupee. Scanning the relationship between the level of the Sensex and the rupee's value over the last five years, we do find a noticeable relationship, with the rupee ruling high when the Sensex is high and settling at lower levels when the Sensex is down. What is interesting, however, is that since early 2009, the gap between the level of the Sensex and the value of the rupee has widened, suggesting that factors other than the mere size of capital flows are affecting the rupee. One possible reason for this enhanced volatility in the rupee relative to the Sensex, which it earlier tracked, could be enhanced speculation in the currency market. To recall, India first permitted trading in currency futures (starting with Rupee-USD futures) on August 29, 2008. Subsequently, trading in currency options was also permitted.

It being an instrument settled at a future date whose value is linked to the exchange rate, the perceptions of participants in the futures market influence the spot price or the market exchange rate as well. Participants include not just those who want to hedge their foreign currency exposures, but speculators who place bets based on their expectations of future trends. Their presence provides the necessary liquidity for the market to work. Import growth However, the depreciation of the rupee has not resulted in any slowdown in import growth, despite the resulting increase in the prices of imports. India's exports in 2011-12 rose to $303.7 billion or by 21 per cent, helped no doubt by the cheaper rupee. But simultaneously, imports rose by a much higher 32 per cent to $488.6 billion, driven substantially by imports of petroleum and gold. As a result, India's trade deficit rose to a huge $185 billion in 2011-12, up from $130 billion in the previous year. The demand for gold is also driven to a significant degree by speculative instincts, since rich Indians are looking for alternatives to stocks as investments. So the widening trade deficit is also partly the result of speculation: domestically for gold and internationally for oil. When the trade deficit widens so sharply, speculative investors would expect that the rupee would have to fall to curtail imports and push exports, so as to help reduce the deficit. This could have triggered speculation based on expectations of the rupee's decline. Instability of this kind is, by no means, good for the economy. While a weak rupee may be good for exporters because it lowers the value in dollars of India's exports, it also renders imports more expensive and contributes to inflation. This effect has not been fully felt as yet because one set of imports whose cost can contribute to generalized inflation is oil and petroleum products. Oil prices International oil prices have risen sharply in recent months because of the political uncertainties in West Asia, especially the stand-off between an aggressive US and Iran. That price increase has not yet impacted the Indian people because the election season that concluded only recently forced the government to hold back on increasing the domestic prices of petrol and diesel. But with this round of elections over, there are powerful forces within the government pushing for an adjustment of domestic oil prices to bring them on a par with international prices. If that is done, the increase would be substantial.

Rupee prices would have to be increased not only to take account of the increase in the dollar price of oil, but also the depreciation of the rupee relative to the dollar. The hike would be substantial. Thus there is a real threat of an aggravation of inflation from its already high level. A discredited Standard and Poor's rating system and capability should not be taken too seriously. Hence the Finance Minister may be correct in saying there is no cause for panic because of its downgrade of India. Unfortunately, investors do pay attention to ratings, including speculative investors. Having exposed itself excessively to such investors, India's government does have reason to fear further downgrades and further volatility.

Objective of this project To make students understand the reasons for the downfall of Indian Rupee and the factors affecting it.

TASK FOR THE STUDENTS.. Find out the fault in the fiscal and monetary policy which affected the downfall of rupee the most. Other relevant factors which affect the Indian rupee. Propose some measures to tackle this situation and what changes can be done in the policies affecting the downfall.