PROJECT REPORT ON ( Rupee depreciation and impact on inflation )

M. Com PART I SEMESTER II

Submitted by ( Akash Shah ) ROLL NO. ( 117 )

Under the guidance of Prof . S. Pawar Submitted to UNIVERSITY OF MUMBAI In partial fulfillment of the required for the award of degree Master of Commerce Business Management

GURU NANAK KHALSA COLLEGE OF ARTS, COMMERCE & SCIENCE

Nathalal Parekh Marg, Matunga (E), Mumbai 400 019 2013-14

CERTIFICATE

This is to certify that the project titled Rupee depreciation and impact on inflation is true and satisfactory work done by Akash Shah, M. Com Part I, Semester II, Roll no. 117 . The project report is submitted to the University of Mumbai in partial fulfillment of the requirements of the award of the degree of M. Com Part I, for the academic year 2013-14.

__________________________ Signature of the Project Guide

____________________________ Signature of the External Examiner

__________________________ Signature of the Co-ordinator

_____________________________ Signature of the Principal

ACKNOWLEDGEMENT

At the outset, I am thankful to the University of Mumbai for offering the project in the syllabus. I would like to thank the Principal Dr (Mr) Ajit Singh. of the College for giving me the opportunity for pursuing M. Com Part I Semester I programme from the esteemed College. I would like to thank our M. Com programme Co-ordinator, Prof. Sameer Velankar for providing us the necessary help and support in carrying out our project work.0 I would like to thank my project guide, Prof . S. Pawar in giving me the valuable guidance and suggestions in completion of my project work. It would not have been possible for me to complete the task without their help and guidance. I must mention my hearty gratitude towards other faculties, my family, and friends who supported me to go ahead with the project.

I hereby acknowledge all those who directly or indirectly helped me to draft the project report.

EXECUTIVE SUMMARY

The fall of rupee has been a regular event since last three months and recently the rupee hit an exchange rate of 61.80 against the USD which is its lowest value ever.The fall started last year with fluctuation between INR 45 to 55 per dollar and in the first quarter of FY2013, the rupee has fallen by more than 12%. Through this paper, we have tried to analyze various causes that have led to this unfavourable situation and the impact of a depreciating rupee and future course of actions that could revive the foreign reserves. Effort has been made to give reasons and analyze the complete event in depth.

DECLARATION

I (Akash Shah) of GURU NANAK KHALSA COLLEGE OF ARTS, COMMERCE & SCIENCE pursuing M. Com Part I specialization in Business Management hereby declare that I have completed the project on (Rupee depreciation and impact on inflation ) in the academic year 2013-14 for the Semester - I programme.

The information submitted is true and original to the best of my knowledge.

Signature of the Student,

Introduction

Depreciation in rupee has become a big worry for the Indian Government and breaking news for the news channels these days. Rupee has declined to its peak level in the month of July, 2013 and is expected to continue in coming days. What is exchange rate or conversion rate: Each country has its own currency and when we convert currency of one country with that of another country, it is called conversion rate or exchange rate between the two countries. For example- 1USD= INR60 which means if we convert 1 USD in INR we will get Rs.60. The conversion rate fluctuates on timely basis based on various factors such as demand and supply of each currency, inflation rate in country, interest rate prevailing in the country etc. What is currency Appreciation and Depreciation?: Appreciation in any currency means when we exchange that currency with another currency, we will get more foreign currency or we need to pay less home country currency. On the other hand depreciation in a currency means when we exchange that currency with another currency, we will get less foreign currency or we need to pay more home country currency. For example: Few months back, 1 USD= INR 45 which means for each 1$, we need to pay INR 45.While in current situation, 1USD= INR 60 which means for each 1$, we need to shell out INR 60. Thus we need to pay more INR compared to previous situation. Thus in this case, rupee has depreciated and USD has appreciated.

Causes of Rupees Depreciation The rupee depreciation can be attributed to both external and internal reasons that are happening now. The external reasons are because of the policy changes by the US government and also the state of the global economy. Tapering of Quantitative Easing by US Fed Quantitative easing was undertaken by the US federal Bank in order to stabilize the US economy and kick start the growth of the US economy. In order to do that, the US federal bank lowered the interest rates in the US system and reduced the interest rate to historical low of .25%. After this as they could not reduce the interest rates further, in order to inject further liquidity in the system, the US started buying bonds from the open market and injecting around USD 85 billion each month and increased the liquidity in the US system. Because of this reason, yields on the US bonds were very less and the institutional investors tried to invest the funds with them in places where they could get more yields than they would be getting while being invested in US. They invested huge amounts in the emerging markets like India, Brazil and other Asian countries. It is expected that the quantitative easing by the US federal bank would be stopped once the unemployment reaches below 6.5% with the inflation rates anchored at 2%. Its expected that this situation could be attained in April 2014, 8

and there is a signal of tapering of bond purchases by the US federal government by the end of this year. With the revival of the US economy shown by the unemployment rates and housing price stats, it is expected that the quantitative easing would be tapered and finally withdrawn in the near future. If the quantitative easing is withdrawn, the yields in the US treasury bonds would rise. If the yields in the Treasury bond rise, then the spread between the G-secs and treasury bonds would be very less and India will lose its attractiveness as an investment destination for FIIs. Indias stock market and debt market has received huge amount of investments from the FIIs in 2012. FIIs have started pulling out their investment in the country and they have withdrawn a staggering 10.5 billion USD in the months of June and July alone leading to selling of rupees and buying of Dollars which has contributed to the depreciation of the Indian Rupee to a major extent. Global Economy and Recession The USA (11.9% of exports) and Europe (19% of exports) have always been major markets of Indian exports. Anything which affects this growth of economy, will affect the Indian economy as well as the Indian currency. With the slowdown in this economy, the demand for Indian exports has come down leading to the widening of the CAD (Current Account Deficit) of India. A widened CAD always is accompanied by the depreciation in the Indian Rupee. 9

Strengthening of the USD in regards to other Currency The probable exit of Greece from euro zone is looming large and adding to that the other countries like Ireland, Portugal, Spain and Italy are in recession and they have huge debts in the European central banks, and so the exit of Greece may cause the Euro central bank to stomach huge losses. In order to save the banks, huge amount of Euro is needed and the two biggest economies Germany and France are also in trouble, these two countries bear most of the bonds of the Euro banks and the collapse of these banks would greatly affect the economies of Germany, France and Italy. This crisis has led to the instability in th e Euros and the USD dollar is becoming the most stable currency. All the investors would try to make the investments in USD increasing the demand for USD which has further lead to the appreciation of USD in terms of Indian Rupee.

High Volatility of Indian Currency The high volatility of the Indian currency has led to the increase in costs of hedging the Indian rupee. This increase in the cost of hedging has further lowered the returns got by the FIIs in India. Since the returns are lowered, the FIIs have started to pull out their investment in India and as explained earlier they have pulled around 10.5 billion USD in the past two months itself leading

to the excess supply of Indian rupees and also demand of the USD has increased leading to the depreciation of the Indian rupee.

Current Account Deficit and Trade Deficit The depreciation of Indian rupee has had a huge impact on the Imports of India. India is more of an importer rather than an exporter. India Imports 80% of the total oil needs and with the increase in global crude oil prices, there is a huge impact on the imports. If we talk in absolute terms, every 10 dollar increase in the price of an oil barrel increases the Indian current account deficit by roughly $6.5 billion dollars. The current account deficit has widened to a range of 4.8 percent of the GDP, even though in the fourth quarter it moderated to 3.6% of GDP, still the current account deficit is high while the trade deficit is even larger at around 7 per cent of GDP. Further, recent trends indicate a significant worsening of both trade and current accounts. Both exports and imports actually declined in 2012-13 compared with the previous year, but even so the trade deficit still increased by nearly 4 per cent, or more than $7 billion. In April 2013, exports were 2 per cent higher than in April 2012but imports were 11 per cent higher and non-oil imports were 15 per cent more. So the trade deficit increased by more than 26 per cent in April 2013 compared with the previous year. 11

Crude oil represents 30.1% of the total Indian imports in dollar value. However, an interesting point to note is that Gold & Silver represent 10.1% of the import basket. This fetish for Gold & Silver is unique to India and has created a serious problem for the RBI governor on the current account deficit front. Economists talk about the J curve coming into play when imports will eventually become expensive and thus their demand of the goods will come down. But in case of India, the oil goods are highly subsidized. This has led to the inelastic demand of the oil products in India, and thus even with the increase in crude oil prices in the world market, the Indian demand for the oil has not come down thus increasing our CAD, In the case of Gold and silver imports, the recent decrease in the Gold prices in the world market has increased the demand for gold in Indian market further widening the current account deficit in our country. This has become a vicious circle with higher CAD leading to depreciation of rupee and a weaker rupee further widening our CAD. The weaker rupee can be assumed to be beneficial to the exporters as they would be more price competitive in the global market. But due to imports, the cost of raw materials for most of the exporters have gone up thus stripping them of their advantage got with the depreciation of rupee. Thus the advantage is lost and they are not able to sell their goods at lower prices. In the current scenario of high recession, its very difficult for the exporters to increase their exports, thus the depreciation of the Indian rupee has not helped us much.

Government Policies Policy paralysis and non-implementation of the proposed policies is been cited as one of the major reasons for the depreciation of rupee. Even though the bill regarding the multi brand retail has been passed, it has failed to create any meaningful investment in the multi brand retail has occurred because of many of the clauses in the bill and the uncertainty involving the implementation of the bill in different states of the country. The GAAR, which are aimed at reducing tax avoidance by introducing rules and also the implementation of GAAR retrospectively has created enough furor and has also dissuaded foreign investors from investing in India which has dried up the investments into our country reducing the demand for the rupee. Some of the policies like Direct tax code, Goods and service tax has been in the pipeline for implementation for a long time but havent been implemented still which has cre ated negative sentiment about the business environment of India and thus dissuading the foreign investors from investing in India. Implementation of GST is expected to boost the business environment in India and will help increase the level of foreign investments which in turn will support the rupee. Till now, the government has just managed to take a few small steps like increasing the limit for foreign institutional investments in government securities and increasing import duty on Gold to support the plummeting rupee.

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On the other hand, RBI has taken steps such as tightening the norms for rupee forward contracts, raising interest rates on non-resident deposits and announcing relaxations in external commercial borrowings to support the rupee.

Fiscal Deficit Indias fiscal deficit stands at 5.6% of the GDP or 2.63 trillion rupees and in order to finance this expense, the government has to issue bonds from the public and this causes the decreases in the money available in the market which can be used for the purpose of investment thus slowing down the economy. This also increases the cost of borrowing for the corporates since the government demand for money is inelastic to the rise in interest rates and so naturally the interest rates would rise. With the increased cost of capital, the corporates would be reluctant to borrow and invest in new projects leading to stalling of economy and stalling of employment generation in the country. The increased fiscal deficit may also lead to downgrading of the Indian business environment reducing the inflow of the money and also increasing the cost of capital for the companies. So in order to overcome this, the government has to reduce the subsidies or increase the taxes and both will affect the economy. Increasing the tax will reduce the disposable income in the hands of the common man thus slowing down the economy. the increased fiscal deficit has put a huge pressure on the government to reduce its spending on items such as petrol and fertilizer d 14

subsidies. But due to the populist measures taken by the government and the pressures of coalition politics, it has been unable to reduce this spending. In fact, the government has increased the outlay for public expenditure in some areas. The implementation of the food security bill will also increase our fiscal deficit. With the elections nearing, the government would not be willing to reduce the subsidies in near future.

Persistent Inflation In the past 2 years, India has experienced huge inflation and has remained above 8%. The prolonged inflation will lead to overall worsening of the economy and causes the currency outflows to happen thus depreciating the currency. REER index measure includes the level of inflation differences across nations; it reflects a country's competitiveness in international trade. The Real Effective Exchange Rate (REER) index has come down by 13.84% during the last year while the nominal rate has depreciated by 24%. The trend shows that the country's competitiveness has not improved as much as the decline in nominal exchange rate. This mainly points out to the fact that there is an increase in domestic costs. Generally the increased inflation can be overcome by raising the interest rates but in India, since the interest rates were already high, it couldnt be raised further thus leading to higher inflation in the country. Because of this, the countries companies have become less competitive and even the gains made

by the depreciation of rupee for the exporters doesnt impact much by way of increasing the exports.

Impact of depreciation on the Indian Economy The weakening of the Indian Rupee has had a variety of influences on the Indian Economy. The most critical among them are: Rise in Inflation India is a net importer of goods and services. According to a recent press release by the Economic division of the Department of Commerce (Ministry of Commerce and Industry, 2013), Indias net imports were $ 11244.45 million in June, 2013 alone. As the currency depreciates more INR would be needed to purchase 1 USD and this will increase the input prices of raw materials in various sectors of the economy and the high weightage of close to 35% that global commodities have been given in the wholesale inflation basket will place an upward pressure on the Wholesale price index (WPI). In sectors such as petroleum and natural gas, electronic gadgets, fertilizers and organic chemicals where India is heavily dependent on imports, increased costs for the companies will be passed on to the customers in the form of an increase in the prices of products.The prices of petrol and diesel have already been increased as crude oil is the largest item in the list of Indias imports and due to depreciation, the cost of importing oil has increased. Very recently, Panasonic India declared that they 16

had factored a level of 62 for USD/INR and would increase prices of their products if the rupee depreciated further. (Das, 2013)

Investment Climate With the fall of the Indian rupee, the return that foreign investors get from their investments in India will reduce. Due to this, Foreign Institutional investors (FIIs) will take out their money from India and invest it elsewhere due to concerns of a falling rupee. In the month of June alone, FIIs pulled out more than $7 billion from the equity and debt markets in India which led to increase in yield of government securities.This is because their returns in dollar terms would reduce as they would need more rupees to get the same amount of dollars as the rupee continues to fall. Reduction in capital inflows has occurred due to the rupees depreciation and the RBIs tightening of the monetary policy has encouraged companies to delay investment and expansion plans. For companies that have taken debt in foreign currency, i.e. External Commercial borrowings (ECBs), depreciation of the rupee would have an adverse impact on their Income statements. To repay this debt in foreign currency, the company would now need more rupees than before to repay debt if we consider that repayment is in monthly instalments. Recently, Adani Enterprises posted a huge loss in the first quarter of 2013 due to the rupees volatility. The fact that they had to import coal due to shortage of coal supply in India also led to increased cost of raw material. (Press Trusst of India, 2013).

Possibility of Interest rate rise In order to control the fall of the rupee, the RBI has tried to tighten the monetary policy and reduce liquidity in the Indian financial system. By doing this, the RBI hoped that demand for INR would go up vis--vis the USD and rupee would appreciate. But the sale of government bonds, increase in Cash Reserve Ratio (CRR) did not achieve the purpose. The next possible move is to increase the Repo Rate. If this happens, bank would have to pay a higher interest on their borrowings from RBI and this higher interest will also be passed on to customers in the form of increased interest rates. This situation is in stark contrast to the beginning of the first quarter of FY2014 when interest rates were expected to fall and this change can be attributed to the depreciation of the Indian rupee. Interest rate hike would enable inflow of capital from foreign countries and strengthen the rupee. But it would also mean that borrowers would have to pay higher interest on their loans and this would deter new investments in projects. Foreign education and foreign travel Depreciation has also had an impact on those who want to pursue foreign education or travel abroad. They would now need more rupees to purchase foreign currency to meet their needs abroad.

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Current Account Deficit (CAD) Depreciation of the Indian rupee will favour exporters in India. However, considering the imbalance of imports and exports in India, this advantage is nullified. Hence the Current Account Deficit (CAD) will continue to widen.

Who benefits from rupees depreciation? The major benefactor of the rupees depreciation has been the IT industry. Because the industry majorly earns revenues in dollars, the rupee value of the earnings has substantially increased and IT companies have posted handsome profits in the 1st quarter of FY2014. Another industry that benefits is the tourism industry. Depreciation of the rupee means more INR per unit of foreign currency and tourists can gain more value for their currency in India. Also NRIs who remit earnings to India stand to gain due to fall in the rupees value.

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Impact on sectors1. IT IT sector in India exports their services to lot of clients located abroad. So for every 1 percent decrease in the value of rupee PAT of these companies increases approximately by 0.5 to 1%. 2. Pharmaceuticals India houses many global pharmaceutical majors. For this sector 60 and 80 per cent of revenues come from exports. Hence this increases their revenues and ultimately profits by significant amount. 3. Metals Finished steel and metal are exported from India. So these companies earn in the form of dollars giving rise to their revenues. 4. FMCG The goods such as oils and other raw materials required in soap and toothpaste manufacturing are imported. So these companies lose a part of their revenues due to additional accost incurred due to rupee decline. 5. Power Import of coal from Australia required for thermal power plants adds up to the cost of power generation. So this sector gets affected negatively due to rupee decline. 6. Auto Engines and other chassis components are mostly imported by auto companies. This import adds to final cost of manufacturing in two, three and four wheelers. So this sector gets negatively affected by rupee decline. 7. Telecom Telecom majors like BhartiAirtel and Reliance have huge foreign debt. Due to rupee depreciation the value of this debt increases as this debt is reported in terms of dollars in turn affecting sector as a whole. 19

8. Capital goods In this sector also companies have huge foreign debt. Again adding additional costs to their balance sheets.

Impact on NRIs1. A WindfallA US-based NRI who pays Rs 40,000 equal monthly installment, or EMI, on a home loan. On August 1, 2011, his monthly outgo was $908. On January 9, 2012, it was $758, a saving of $150 or Rs 7,909. The same applies if he sends money home. A $1,000 fetched him Rs 44,000 on August 1, but on January 9, 2012, it got him more than Rs 52,000. 2. The Reverse ImpactThe trend is not entirely in favour of people based abroad. If you repatriate your rupee investments to the country where you stay, you stand to lose. For instance, your mutual fund investments worth Rs 1,00,000 converted into US dollars would have got $1,896 on January 9, 2012, as against $2,270 in August 1, 2011. Rupee depreciation has eroded the value of NRI investments in India by nearly 20 per cent in dollar terms. 3. Reasons for Investing in IndiaTo increase dollar inflows and check the decline in the rupee, the RBI recently deregulated the interest rates offered by banks on non-resident external (NRE) and non-resident ordinary rupee (NRO) accounts. An NRE account is a rupee account from which money can be fully repatriated, that is, sent back to the country of your residence. An NRO account is also a rupee account, but one can repatriate only up to $1 million every year from this account. Foreign currency non-rupee account is the same as the NRE account except that the deposits are in foreign currencies. 20

4. Taxation on NRI DepositsThough interest earned on NRE and FCNR accounts is tax-free in India, the tax rate for interest income from NRO accounts is 30 per cent. However, NRIs living in countries with which India has a Double Taxation Avoidance Agreement (DTAA) can avail of lower tax rates. The increase in NRI deposit rates, the 20 per cent rupee depreciation against the dollar and tax benefits under DTA agreements are a once-in-a-lifetime investment opportunity for NRIs. We have illustrated the gains in the table Making Hay. Fixed deposits are not the only option for NRIs in India. The equity markets have fallen close 20 per cent since the beginning of 2011 and many large and mid-cap stocks are trading 30-50 per cent below their year-ago prices. The net asset values of equity mutual funds are also much lower than last year, making it a good time to invest in Indian equities.

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10 reasons to worry about the rupee depreciation-

The over 13% depreciation of the rupee from the beginning of April has the markets jittery and the government worried, and rightly so. ET explains why the sharp decline of the Indian currency against the US dollar is cause for concern.

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Impact on Indian EquitiesThe sharp depreciation of rupee has not only rattled Dalal Street but has hit India-focused foreign funds and exchange traded funds (ETFs), which are promoted by global funds based out of the US, Europe and other developed markets. Feeling the heat, leading global funds such as Fidelity, HSBC, JP Morgan, Wisdom-Tree, Franklin and others have sold Indian equities worth $1.4 billion during the quarter as they faced redemption pressure from overseas clients, according to data compiled by Morningstar, an independent investment research firm. Some of the India-dedicated funds have plunged up to 16% during the April-June quarter (Q2, CY13), while the MSCI India index slipped 5.7% and the BSE Sensex gained 3%. The rupee, which fell nearly 10%, has thrown the Indian capital markets in disarray. Apart from the rupee, foreign investors are particularly concerned about the widening current account deficit, which many expect to hover around 4.5% in FY14 due to the sharp fall in the currency along with a slowdown in exports and rise in the import bill.

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REASONS FOR THE FALL OF RUPEE

Analysing the prime reasons for the drastic fall in the rupee
1. Falling foreign investment inflows 2. Strengthening of the dollar 3. Rising fiscal deficit 4. Untameable inflation

1. Trade Deficit and Capital Account DeficitSince India imports more goods (in value terms) than it exports, it results in a huge imbalance in trade called a trade deficit. In the financial year ending March 2012, the deficit zoomed to $185bn compared with the original estimate of $160bn.Additionally; India's export performance may prove to be a dampener this year. Experts suggest that although exports for India grew 21% in 2011-12, it may not manage to witness a growth rate of even 10-15% in 201224

It is important for India to reduce it trade deficits as that means more foreign currency comes into the country than what is paid for imports. This strengthens the local currency. Furthermore the two additional risks of rising trade deficits are: 1. Sudden Stop 2. Reversal of Capital Flow The slowdown in the Indian economy has made the current situation even more volatile because the government is unable to generate heavy capital inflow. India's current account deficit was equivalent to a record 6.7 per cent of gross domestic product in December. In 2011-12, this deficit was more than $74bn, a huge jump from less than $46bn a year ago. In 2012-13, it may be even higher at $77bn.It hit a record high 4.8 per cent of gross domestic product in fiscal year 2013. This deficit was being financed by foreign money for last many years, but as the U.S. economy gathers momentum, there is increasing likelihood that the Federal Reserve will taper its bond buying programme The result is that India's foreign exchange reserves have dropped from a peak of $320bn in September 2011 to $290bn now. Another reason for the strain on rupee is Oil and gold imports. They account for 35 per cent and 11 per cent of India's trade bill respectively. We import 80 per cent of our crude requirements and so dollars will anyhow go out of the country irrespective of whatever arrangement the RBI makes. 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. Infact, high oil prices inflated the import bill and resulted in further widening of the current account deficit, which accelerated the rupee fall. 2. Low Capital Inflows as compared to outflowIf trade deficits are so high and so much money is going out of the country, sufficient money needs to flow in through investments to compensate for the outflow.One major reason for this has been the falling of the credit rating of 25

India Inc and policy paralysis of the government. In 2011-12, India received foreign direct investment of more than $30bn, in addition to a net inflow of $18bn from foreign institutional investors in stocks and bonds. Uncertainty about India's commitment to economic reforms, retrospective taxes, and policy paralysis within the government have forced foreigners to either postpone their investment decisions, or take money out of Indian stock markets. The corruption sagas unleashed in the 2G and the Coalgate scam hasnt done Indias image abroad any good. In fact in the 2G scam telecom licenses have been cancelled and the message that was sent to the foreign investors was that India as a country can go back on policy decisions. This is something that no big investor who is willing to put a lot of money at stake, likes to hear. As a result, India still has a huge current account deficit but is not getting the constant inflow of dollars. The United Nations Conference on Trade and Development (UNCTAD) recently pointed out that the foreign direct investment in India fell by 29% to $26 billion in 2012. The fear of Fed pulling the plug the bonds has triggered a selloff by foreign institutional investors (FIIs), who have pumped almost $14 billion into India so far this year and $22.2 billion last year. Business Today reported today that overseas investors pulled out a record Rs 44,162 crore (over $7.5 billion) from the Indian capital market in June 2013. A weaker rupee further erodes the returns earned by the foreign investors in the Indian market. Certain economy boasting actions were taken by the government. It had allowed foreign investors to invest upto 51% in multi-brand retailing. However, not a single global retailing company has filed an application with the Foreign Investment Promotion Board (FIPB), which looks at FDI proposals. Also, weakness in domestic equities is another reason as foreign institutional investors have been selling index futures

3. Increasing demand for Dollar versus Rupee leading to strengthening of DollarThe demand for American dollars is more than that of the Indian rupee leading to the rupee rapidly losing value against the dollar. The dollar is expected to 26

strengthen more as Federal Reserve will taper asset purchases. The dollar has been rising since fear of the Federal Reserve tapering its quantitative easing (QE) has hit all asset classes. The currencies of all emerging markets, such as Indonesia, Thailand, Brazil and India have depreciated. The falling investments and government policy paralysis are the main reasons. An additional reason for this is that in 2004, the central bank(i.e. RBI) had approved nearly $220 billion worth of external commercial borrowings and foreign currency convertible bonds (FCCB), at the rate of a little over $2 billion a month. Nearly two-thirds of this amount was approved in the past five years. Much of this ECB will come up for repayment this financial year, putting further pressure on the rupee. Additionally due to low interest rates outside, many companies raised foreign loans and will need dollars to repay the amount. The trouble is that if a lot of companies decide to prepay loans then it will add to the demand for the dollar and thus put further pressure on the rupee. Another aspect that increases demand for dollars is increase in coal imports. Indian coal imports shot up by 43% to 16.77 million tonnes in May 2013, in comparison to the same period last year. Importing coal again means a greater demand for dollars. Similiarly, the massive import for gold also has the same impact. Indias love for gold has been one reason behind significant demand for the dollar. Gold is bought and sold internationally in dollars. India produces very little gold of its own and hence has to import almost all the gold that is consumed in the country. When gold is imported into the country, it needs to be paid for in dollars, thus pushing up the demand for dollars.Same way, we import crude oil from countries like Saudi Arabia, Iraq, Venezuela etc. and these countries dont accept the Indian Rupee for payments, they want us to pay them in an internationally accepted currency like the USD or Euro. So, conclusively, more people try to hedge currency risk by selling rupees and buying dollars.This demand-supply gap between the dollar and the rupee leads to devaluation as well. 4. Slow Growth and High InflationAfter annual economic growth of nearly 9% in 2009-10 and 2010-11, the country grew at 6.5% in 2011-12. Coupled with high inflation due to high food and fuel prices, the rate of inflation rose to 11% as the government is unable to 27

curb its fiscal deficit. High crude oil prices and weak currency make for case high inflation. The depreciating rupee is also building up a case of imported inflation as increased cost of imported commodities and goods goes higher In this scenario, most foreigners as well as Indians tend to take money abroad, or keep it away from India.

This further leads to Global investors hesitating about investing in India which puts more selling pressure on the rupee.

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STEPS TAKEN BY THE RESERVE BANK OF INDIA

Normally, RBI has two options on the table when it is faced with the problem of a declining currency. One is to increase the policy rate thereby attracting foreign inflows thus decreasing the demand for the US dollar. The other option is to squeeze the rupee liquidity thus artificially increasing the rupee demand. RBI opted for the latter option and implemented the following of measures to this end. With rupee loses its value by about 12% since the end of April 2013, RBI and market regulator SEBI got together and announced a set of measures on June 10 to address rupee volatility. These measures were aimed at making it costly to take speculative positions in the market towards a dip in the rupee value and grouping large buyers of dollars into a single window to ease pressure on the market. As part of these measures, RBI barred banks from trading in rupee currency futures and options except on behalf of their clients in order to ease the rupee volatility. It also directed oil companies who happen to be the largest domestic buyers of dollars in order to finance the oil imports to trade only with a single bank thus easing the visible pressure on the market. In addition, SEBI also tightened the exposure norms for currency derivatives thus limiting the speculation in the market which was considered a reason for the declining rupee value. RBI followed up with another set of measures on July 15. RBI restricted the borrowing limit thorugh Liquidity Adjustment Facility (LAF) to 1% of total deposits or Rs 75000 crore. This would limit the liquidity of rupee in the domestic market and deter banks from borrowing excess funds. RBI also increased the Marginal Standing Facility (MSF) interest rate by 100 basis points to 10.25%. This was implement keeping in view the banks which were bearish on the rupee and bought dollars from the forward markets and 29

borrowed from call markets expecting the dollar to rise. Increase in MSF rate would make it costlier to borrow short-term money and reduce speculation thus easing the pressure on rupee. The third announcement was to conduct Open Market (Sales) Operation to the tune of Rs 12,000 crore on July 18. This was again a measure to soak excess rupee liquidity in the market leading to a fall in the bond prices and rise in yields. Higher yields would then attract foreign investment which had eroded since April. However, RBI was able to sell only Rs 2,500 crore worth of government securities in this auction. On July 22, RBI made it mandatory for all nominated banks to reserve 20% of their gold imports for exports. A day later, it directed the banks to draw only 50% of their total deposits in overnight borrowings and made it mandatory to maintain a 99% average CRR daily. In spite of all the above measures, RBI was unable to arrest the downward slide of rupee forcing it to announce on August 8 that it will sell government bonds worth Rs 22,000 crore every Monday starting August 12 to check forex volatility in the market. The bonds were essentially Government of India Cash Management Bills. It was revealed on August 12 that RBI had sold $2.2 billion from its foreign reserves as well as $900 million in the forward market in an attempt to decrease the dollar demand.

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STEPS TAKEN BY THE GOVERNMENT

To arrest the rupee depreciation, Indian Government has taken certain measures which have been explained below: 1. Liberalizing FDI LimitsOne of the major reasons of the rupee depreciation is the huge Current Account Deficit. The CAD for fiscal year 2012-13 had been $ 88 Billion. Hence one of the major steps the government has taken to reduce CAD is to allow more foreign investment. To allow more foreign investment, government has eased FDI caps in 13 sectors of the indian economy. In Telecom sector, 100 % FDI is now allowed. Similarly in Defence, the FDI cap has been raised from 26% to 49% applicable to state of art technology transfer. In four sectors of Gas refineries, Commodity exchange, power trading and stock exchanges, FDI has been allowed via the automatic route. The break up per sector has been mentioned below

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2. Curbing Imports of Precious MetalsOne of the major reasons for the increasing Current Account Deficit can be attributed to high imports of precious metals. Gold imports in year 2011-12 had been $ 40 Billion. Gold is the second largest contributor in the import bill after petroleum. Hence to curb the import of gold, government has increased the customs duty on Gold, platinum and silver to 10%. The Government has also increased the import Tariff of Gold to 459$ per 10 Gms and $ 737 for silver kg imports. However, due to restriction on the imports of Gold, smuggling of Gold has been on rise. 3. Increasing Interest SubventionIn order to reduce CAD, along with reducing imports, the government Is also looking at measures to increase the exports. To achieve this, the government has increased the rate of Subvention from 2% to 3% which will benefit exporters and small and medium enterprise owners. 4. Issuing Quasi Sovereign BondsThe Government in order to increase the inflows to reduce the CAD, has also planned to issue Quasi Sovereign bonds. These bonds would be issued by state owned financial companies. However, there are differing opinions on issuing quasi sovereign bonds,

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Conclusion RBI should take steps to curtail the free fall of rupee because of the impacts it has on the Indian economy. The RBI should concentrate on the monetary policies and the government should lay down policies such that the investment climate is improved in the country. The major reason of policy paralysis should be overcome with slew of measures helping in kick starting the economy and also bringing in investments. Some of the measures like increasing the FDI limit in different sectors should be increased. This would increase the investment in the country and help in overcoming the huge Current account deficit that India has now. As a short term measure, RBI is trying to increase the interest rates which will also bring the investments into the country so that the spread between the investment in the USD and the Indian rupee remains the same. This will ensure that the foreign investors will keep invested in the country. The other thing it can do is to sell the FOREX reserves it has with it so that the demand for rupee could increase. RBI can take steps to increase the supply of foreign currency by expanding market participation to support Rupee. RBI should increase the FII limit for investment in corporate debt bonds and government debt bonds. It can invite long term FDI debt funds in infrastructure sector. The present ceiling on the ECB can also be increased. 33

Another important measure taken by RBI is to temper the speculation led volatility by curbing the trade in rupee forwards and this will also lead to stabilizing the Indian rupee. These are short term measures. As a group, the depreciation of rupee is not good for the economy to grow and we feel that in long term, the rupee will stabilize against other currencies only if the investment climate is improved in the country and also the fiscal deficit and current account deficit is reduced, which will help a long way in helping in Indian economy to grow as strong currency is one of the major needs for growth.

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Bibliography
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