IMPACT ON INDIAN ECONOMY

This kind of movement leads to high inflation, as India imports around 70% of its crude oil requirement and the government will have to pay more for it in rupee terms. Due to the control on oil prices, the government may not easily pass the increased prices to the consumers. Further, this higher import bill will lead to increase in fiscal deficit for the Govt and will push the inflation, which is already hovering around double-digit mark, which is not good for ordinary people as well. On the other hand, Indian corporate will also have to pay more in rupee terms for procuring their raw materials, despite drop in global commodity prices, only because of a depreciating rupee against dollar. There are many costs and benefits attached to a stronger and a weaker currency. However, while deciding on a policy, the economic and political situation must also be factored in. In light of the current depreciation of the rupee, one must assign a weightage to the various costs and benefits and then decide whether the depreciation is desirable or not. It is most likely that there will be large support for both views.

Why is the Indian Rupee Depreciating?

By Samudranil August 29, 2013

The Indian Rupee has depreciated to an all time low with respect to the US Dollar. On 28th August 2013, the Indian rupee had gone down to 68.825 against the Dollar but the situation was somewhat revived by the Reserve Bank of India that decided to open a special window for helping state owned oil companies Indian Oil Corp Ltd., Bharat Petroleum Corp and Hindustan Petroleum Corp. The beneficiaries will be able to buy dollars through this window till further notice is provided. These companies, together, require about 8.5 billion dollars every month to import oil and it is expected that this will help them meet the requirements. This has had an immediate effect as is evident from the fact that the INR has started at 67 against the USD at the early proceedings in the Interbank Foreign Exchange Market. The question, however, is why this is happening. There are several reasons that can be enumerated in such a scenario: Basic law of economics As per the rudimentary laws of economics if the demand for USD in India exceeds its supply then its worth will go up and that of the INR will come down in that respect. It may be that importers are the major entities who are in need of the dollar for making their payments. Another possibility here could be that the Foreign Institutional Investors are withdrawing their investments in the country and taking them elsewhere. This can create a shortfall in supply of the dollar in India. In fact, of late, the FIIs have been heading to greener pastures like Singapore owing to the greater operational efficiency and lesser bureaucratic problems that have unsettled the Indian business fraternity and hampered its overall economic growth.

This situation can only be addressed by exporters who can bring in dollars in the system. If somehow the FIIs can be wooed back, then this imbalance can also be addressed to a certain extent. Price of crude oil The worth of crude oil has been a major bane for India since it has to bring in the majority of its requirement from outside the country. The demand for oil in India has been going up every year and this has led to the present situation. All over the world, the price of oil is given in dollars. This implies that as and when the demand for oil increases in India or there is an increase in oil prices in the global market, there also arises a need for more dollars to pay the suppliers. This also results in a situation where the worth of the INR decreases significantly in comparison to the dollar. Performance of dollar with respect to other currencies The central banks across Japan and countries in the Eurozone have been bringing out a lot of money and this has meant that both Yen and Euro have lost their value. Compared to this the US Federal Reserve is giving hints that it will end the fiscal stimulus so that the dollar becomes stronger with respect to other currencies such as the Indian Rupee at least for the time being. Till now in 2013, the US dollar index has become stronger by 1.91%. In an interview with the Economic Times, the CO-CIO of Birla SunLife Mutual Fund, Mahesh Patil has stated that the increase in worth of USD is the major reason behind the depreciation of the INR. The Federal Reserves decision to reduce its Quantitative Easing has also contributed to the present situation as every asset class has been affected by the decision. Volatility in the equity market The equity markets in India have been volatile for a certain period of time. This has put the FIIs into a dilemma as to whether they should be investing in India or not. In recent times their investments have touched an unprecedented level and so if they pull out then the inflow will go down as well. As per a report in Business Today, the international investors in India have withdrawn to the tune of INR 44,162 crore during June 2013 and this is a record amount. This has also created a current account deficit (CAD) that is only increasing, thus contributing significantly to the depreciation of the INR. Effects of equity market problems on investors Now if the INR becomes weak then it will affect the investors who are putting their money in India. For the first time ever since 2012 the FIIs have been reduced to net sellers of debt based securities. The main reason behind this is the present state of the INR. The expenses incurred in hedging the unpredictable INR are reducing the yield differential that is the main area of profit for these investors.

India, in fact, is not the only emerging market where the currency has taken a hit. The situation is similar in countries like Indonesia, Brazil and Thailand. The bond markets in several countries like India are also taking a hit as the FIIs are withdrawing en masse. The exchange traded funds are also being redeemed as the global business fraternity is looking to cut down on risks. Poor current account deficit One of the main reasons behind the Indian governments inability to arrest the fall of the national currency is the critical current account deficit. In the 2012-13 fiscal Indias CAD was measured at 4.8 per cent of the GDP. The government has been unable to come up with any new destinations for exporting its products and this has also hampered the growth in this sector. There are other crucial reasons here like the lack of one window for clearance purposes and procedural delays. Even areas where India has traditionally done well on this front have fared badly this time around. Withdrawal of investors Recently ArcelorMittal and Posco decided to pull out from their projects in India. Posco did not go ahead with a steel plant worth INR 30,000 crore that was supposed to be built in Karnataka and ArcelorMittal withdrew from setting up a steel plant in Odisha that was supposed to cost around 52,000 crore. There were lot of delays and problems related to acquiring land for the project. In fact in 2012-13 the Indian companies have spent more outside India compared to FIIs in India. Downgrading of Indian stocks Goldman Sachs, one of the leading banks in the world, has rated Indian stocks as being underweight. It has also asked investors to be careful given the concerns surrounding the recovery of the growth of Indian economy. Condition of import bill Indias import bill has been going up of late and most of this can be attributed to gold. This has also hampered Indias efforts to arrest the slide of the INR . Gold alone takes up more than 10 per cent of Indias import bill in April 2013, 141 tons of gold were imported and it went up to 162 during May. The government took some measures that restricted gold imports to 31 tons during June but once again in the first 25 days in July the imports went up to 45 tons. Contraction of Indian economy The various important sectors of Indian economy such as manufacturing, mining and agriculture have seen poor growth in 2013 and this has made them less appealing propositions for the investors. During June 2013, the aggregate industrial production in India reduced by 2.2 per cent and in July 2013 the RBI predicted that in the present fiscal there would be a growth of 5.5% which was lesser than its previous prediction of 5.7%. Future prospects of INR In spite of all that has been said above it will be foolish to write off the INR completely and say it shall not rise from the mire. Experts are saying that the government needs to take some short and

medium term steps that will help the economy get back on its feet yet again. It is only through continued efforts that the Indian government will be able to retrieve the situation. However, it will take a Herculean effort to help the INR get back to the 55 mark.

Nine steps India can take to prevent rupee slide

Fall in rupee to record lows has raised the prospect of government or RBI taking steps to support the currency, seen vulnerable because of a record high current account deficit. Below are some measures the Reserve Bank of India and government could consider to protect the rupee * Dollar window for oil cos RBI could open a dollar window for oil companies to buy dollars directly from it instead of markets, but it would drain foreign exchange reserves * Dollar for oil bonds RBI could hold auctions to buy bonds from oil companies, providing them dollars or other non-rupee currencies, but the outstanding amount of oil bonds is small as the government has been giving direct cash subsidy to oil companies * Asking exporters to buy Indian rupee RBI could ask exporters to convert part, or their entire, overseas foreign currency earnings in the market immediately, providing near-term relief to the rupee * Curbing net open position limit for banks It could ask banks to limit their net overnight open position limits, making it difficult to short the rupee and prevent speculative trading * Moral persuasion RBI could persuade banks and financial institutions to raise funds in dollars abroad and lend them locally, a measure that has worked in the past when overseas rates were attractive

* Stagger import payments It could issue rules delaying or staggering import payments, which are typically made at the end of every month, although RBI has not taken this step in recent years * Additional fiscal reforms The government could review sectors such as defence, or revive pension and insurance reforms, but passage through parliament could be tough * Govt-backed NRI bond The government could issue a sovereign bond through State Bank of India to nonresident Indians, but such a move could increase external debt and interest liability w * Sovereign overseas bonds Advantages of Rupee Depreciation Beneficial to the Exporters India is majorly involved in exports of handicrafts, gems, jewelry, textiles, readymade garments, industrial machinery, leather products, chemicals and related products. India has been the worlds largest processor of diamonds. The exports make a major contribution in foreign receipts. The companies that are export driven may benefit in terms of better prices for their products and services and be able to increase their profit margins. For example: if the companies were exporting goods at $1= Rs 48 they would receive Rs 4800 for every $100. Whereas, now they would receive Rs 5135 at current rupee price for every dollar i.e. $1= Rs 51.35 Moreover the products of Indian exporters would be more competitive in the foreign market and will have an edge over other Asian countries. Therefore, rupee depreciation should boost the exports.

Good News for NRIs The fall of Indian rupee is benefiting the NRIs remitting money to India. The salaried workforce abroad can send in more money to their loved ones and their families in India at the same dollar amount. Currently the Indian rupee is at a 32 month low of Rs. 51.35 against the US dollar in comparison to Rs. 44.1 per dollar during August 2011. For example: An NRI who remitted $2000 to his family, in august was able to send Rs 88,000. Whereas, considering the current rupee depreciation he can send Rs 1, 02,700 for the same amount of dollars. Thus NRIs can enjoy huge benefits from this current rupee fall.

Benefits to the IT sector The IT sector being a major job creator in the Indian economy may actually benefit from depreciating rupee as it spells good news for the IT sector. For Information Technology companies, services are billed mainly in dollars or in other foreign currencies. Majorly the companies that hedge funds for a short duration are more likely to benefit from the depreciating rupee. Hedging of funds means to allocate certain amount of funds as investments in certain securities that are generally speculative in order to earn higher returns Thus, the companies with short duration hedge funds would benefit. Any depreciation of the rupee would peg up their realizations and increase their profit margins. Benefits to Investors invested in International Funds The impact of currency movements on an international fund depends on the type of fund and its underlying holdings. These funds will be impacted by the movement of individual currencies, trading and the stock prices, rather than the rupees behavior against the dollar alone. However the investors who have invested in funds that have done well despite the market downturn, such as global commodities and gold are more likely to be more beneficial. Like- Birla Sun Life Commodities Equities-Global Precious Metals is up 4.8 per cent.

Benefits to the Hotel Industry Indian Hotels is a dominant player in the luxury and premium business travel space having presence across tier-1 and tier-2 cities, as well as 16 hotels outside the country. It is expected to do well on account of higher room demand, and high average room rates and occupancy rates. Moreover, with a depreciated rupee an increase in tourists from abroad can be expected as they would have to pay less in rupee terms for their dollars, thus resulting in an increased demand in the hospitality sector.

Disadvantages to Indian Economy Inflation graph and Fiscal deficit to scale up: India is suffering from a nearing two digit inflationary pressure. A depreciation rupee will add fuel to this. It leads to high inflation, as India imports around 70 per cent of its crude oil requirement and the government will have to pay more for it in rupee terms. Due to the control on oil prices, the government may not easily pass the increased prices to the consumers. Further, this higher import bill will lead to rise in fiscal deficit for the government and will push the inflation. It (rupee fall) will be definitely blunt the high base impact. We will have to rework the (inflation) numbers, as we had not taken this into account. We had expected December inflation at 8.2%, but now it could be 8.5% because of the rupee fall, said bheek Barua, chief economist at HDFC Bank. Going by a Yes Bank report, every 10% fall in the rupee is likely to lift the inflation rate based on the wholesale price index (WPI) by 40 basis points. Since November 1, the rupee has declined 5.5% against the greenback. The rupee has depreciated by about 11% against the dollar during 2011-12 so far. Indias imports account for about 22% of GDP and depreciation of the rupee raises the risk of imported inflation, the RBI had said in the October report. Rupee depreciation has already started to push up prices in some sectors like automobile, consumer goods, and mobile phones. For instance, makers of consumer durables have raised product prices by up to 10%, as their import

costs have gone up because of the rupeesdepreciation. In the last few m onths, FMCG firms, including Hindustan Unilever, Dabur, GCPL and Emami have increased prices of their various products by 3 to 10 %. As a result, Indian FMCG firms are turning to efficient cost management and local procurement of raw materials to offset increasing pressure on margins due to the weakening of rupee that has spiked input costs. A depreciating rupee makes imports of component, capital goods and raw materials more expensive. As inputs and other equipment that are imported get costlier, margins get reduced to that extent. Companies with a high import component and those with foreign currency borrowings may be marked down in the stock market as the rupee depreciates. The worst affected will be the oil and gas companies and capital goods companies which are net importers. For these companies raw material is in $ terms and sales are in Rupee terms. So, depreciating rupee will have a very adverse impact as this will cause an increase in the cost of raw materials without any corresponding increase in the price of finished products.

A blow to Indian Importers: India import industry will also have to pay more in rupee terms for procuring their raw materials, despite drop in global commodity prices, only because of a depreciating rupee against dollar. Corporate India is a net borrower of dollar and to that extent a depreciating rupee impacts its balance sheet adversely. Companies with foreign debt on their books are badly impacted. With the rupee depreciating against the dollar, these companies will need more rupees to repay their loans in dollar. This will increase their debt burden and lower their profits. Obviously, investors would do better to stay away from companies with high foreign debt. Negative impact on FII flows to Indian market: Rupee depreciation is a huge risk for FIIs who are planning to invest in India. If an FII invest $10000, it can buy stock worth Rs 500000 @ current market price. Consider a scenario where after 1 year, the stock of FII made no loss, no profit and rupee

depreciated to 55 against dollar. On stock sale the FII would get Rs 500000, but while converting to dollars, it ends up in loss. Negative impact on Indian students and travellers abroad: Individually, travelling abroad becomes more expensive as travel cost can go up by around 10 percent compared to last July figures. Students studying abroad too will be hit as more rupees will go out to pay for the courses, stay and other expenses.

Concluding Remarks The fall in the value of currency not only hurts the national pride, but also carries other risks as well. Depreciation of rupee dampens the inflow of foreign capital, rise in the external debt burdens, and also mount Indias oil and fertilizer subsidy bil ls. The most positive impact of depreciation of rupee is the stimulation of merchandise exports and discouraging merchandise imports and thus improving the terms of trade. But, even after significant increase in the exports and sales in this year, Indian companies are reporting huge foreign exchange losses due to the depreciation of Indian rupee. This declines the overall profitability of these companies. As far as imports are concerned, for a country such as India, imports are necessary. India imports many essential goods like crude oil, fertilizers, pharmaceuticals and many capital goods. Thus, the argument that depreciation is good as it discourage Indias import does not make any sense. Further, software or other exports also do not depend on the rupees value only, but most on the quality and reputation of the product. Therefore, while it is not possible to completely eliminate for-ex risks, those companies that adopt prudent hedging strategies will have that extra edge over their peers.