RUPEE DEPRECIATION

PRESENTATION ON

PRESENTED TO:-PROF. PRASAD KSHIRSAGAR

PRESENTED BY:-PRATIK S. AWASAREPOOJA S.PAWARPRIYANKA DABHOLKAROMKAR PIWALKARRAGHAV GUPTASUNEET HEREKAR

BY GROUP NO-8RUPEE DEPRECIATION

ACKNOWLEDGEMENT

We would like to express my special thanks of gratitude to my Prof. Prasad Kshirsagar Sir, who gave us golden opportunity to do this wonderful project on the topic “RUPEE DEPRECIATION”. While studying this project we gained lot of knowledge and information.

Secondly we would also like to thank to our friends who helped to finish this project within the limited time. We have made this project not only for marks but also to increase our knowledge.Thank you one and all.

ROLL NO

CANDIDATE NAME TOPIC NAME:RUPEE DEPRECIATION

SLIDE NO

100 PRIYANKA DABHOLKAR

Introduction,Reason to worry about the rupee depreciation 2 & 3

99 RAGHAV GUPTA Foreign exchange instrument 4 & 5

134 SUNEET S. HEREKAR What is rupee appreciation & depreciation, Forex market role

6 TO 8

138 PRATIK S. AWASARE Inflow foreign assistance : gross & net (milion dollar equivalent) 1966, Two additional factors played a role in the

1966 devaluation, Summary of changes in foreign exchange 1986-92, What went wrong in-1991, Summary of

changes in foreign exchange 2006-12, Conclusion

9 TO19

110 POOJA.S.PAWAR Statistical representation of rupee decline,Historical indian rupee rate

20 & 21

134 OMKAR PIWALKAR CHRONOLOGY OF INDIA’S EXCHANGE RATE POLICIES 22 T0 24

Flow Of Presentation INTRODUCTION REASON TO WORRY ABOUT THE RUPEE DEPRECIATION FOREIGN EXCHANGE INSTRUMENT WHAT IS RUPEE APPRECIATION & DEPRECIATION? FOREX MARKET ROLE INFLOW FOREIGN ASSISTANCE : GROSS & NET (MILION DOLLAR EQUIVALENT) 1966 TWO ADDITIONAL FACTORS PLAYED A ROLE IN THE 1966 DEVALUATION SUMMARY OF CHANGES IN FOREIGN EXCHANGE 1986-92 WHAT WENT WRONG IN-1991 SUMMARY OF CHANGES IN FOREIGN EXCHANGE 2006-12 CONCLUSION STATISTICAL REPRESENTATION OF RUPEE DECLINE HISTORICAL INDIAN RUPEE RATE CHRONOLOGY OF INDIA’S EXCHANGE RATE POLICIES

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INTRODUCTIONSince India’s Independence in 1947, India has faced two major financial crises and two consequent devaluations of the rupee. These crises were in 1966 and 1991

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FOREIGN EXCHANGE INSTRUMENT• FX volume surveys report turnover by instrument.

Instrument types include the following: • Spot transactions are single outright transactions that

involve the exchange of two currencies at a rate agreed to on the date of the contract for value or delivery within typically two business days. Outright forwards involve the exchange of two currencies at a rate agreed to on the date of the contract for value or delivery at some time in the future. This category also includes forward foreign exchange agreement (FXA) transactions, non-deliverable forwards (NDFs) and other forward contracts for differences.

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Continue…

• Currency swaps involve the exchange of fixed or floating interest payments in two different currencies over the lifetime of the contract. Equal principal based on the initial spot rate is typically exchanged at the beginning and close of the contract.

• Currency or foreign exchange options are contracts that give the right to buy or sell a currency with another currency at a specified exchange rate during or at the end of a specified time period.

• Foreign exchange swaps involve the exchange of two currencies on a specific date at a rate agreed to at the time of the conclusion of the contract, and a reverse exchange of the same two currencies on a future date at a rate agreed to at the time of the contract. For measurement purposes, only the long leg of the swap is reported, so that each transaction is recorded only once.5

What is rupee appreciation & depreciation? Exchange rate is the price of foreign currency (USD, Yen, Euro, Pound etc) in

terms of domestic currency (rupee) i.e. amount of domestic currency needed to buy one unit of foreign currency.

Currently price of 1$ = ` 53.74’, which means 1$ can be purchased in exchange of `54’

Exchange rate tells us the value of domestic currency in relation to one unit of foreign currency. 1$ is worth `53.74’.

Rupee prices keep fluctuating all the time. Sometimes we need more rupees to buy one unit of foreign currency and sometimes we need fewer rupees to buy one unit of foreign currency.

This change in rupee price is known as rupee appreciation or depreciation. Rupee appreciation is when value of rupee increases (becomes expensive)

and fewer rupees can buy one unit of foreign currency. This is also known as strengthening of rupee as now INR is worth more than foreign currency.6

Continue.. Rupee depreciation is when rupee value decreases (becomes less expensive) and more rupees

can buy one unit of foreign currency. This is also known as weakening of rupee as now INR worth is less than foreign currency.

If exchange rate changes to 1$ = `55’, we say rupee has depreciated as 1$ can buy more INR. Currency price is always stated in relation to another currency. So when one currency

appreciates the other currency depreciates. Suppose exchange rate changes to 1$ = `50’, we say rupee has appreciated as 1$ can buy fewer

INR. Capital account flows- Current account deficit is funded by capital flows and current account

surplus generate capital outflows (invest in other countries). When there is capital inflows in the country, demand for the currency increases leading to currency appreciation. Capital outflow causes the country’s currency to depreciate as supply of its currency decreases and demand for foreign currency increases7

FOREX MARKET ROLE• The FX market is one of the most important financial markets in the

world. It facilitates trade, investments and risk-sharing across borders.• While good and timely data are available on prices of FX instruments,

the same is not true for trading activity. • The authoritative source on turnover (the Triennial) scores high on

quality but gets lower marks for timeliness. In this article, I show how it is possible to leverage alternative sources on FX activity to obtain a timelier grasp of turnover developments.

• I produce a time series that, despite some caveats, is comparable to the headline number from the Triennial.

• The results show that FX activity continued to grow during the first year of the financial crisis but experienced a sharp drop after the Lehman bankruptcy, from which it recovered only slowly. Moreover, I find that trading activity was about $4.7 trillion per day in October 2011.8

INFLOW FOREIGN ASSISTANCE : GROSS & NET (MILION DOLLAR EQUIVALENT) 1966

ITEM

PL 480/665 185 258 389 458 502 1792 480 414 196 112

WHEAT GRANT & SPECIAL FOOD

ASSISTANCE

7 1 8 16 32 93 61 52 19

TOTAL 192 258 390 466 518 1824 573 475 248 131

AMORTISATION PAYMENT

145 105 124 147 124 645 184 283 104 138

INTEREST PAYMENTS

69 81 100 107 139 496 135 161 82 79

TOTAL DEBT SERVICING

214 186 224 254 263 1141 319 444 186 217

NET AID FLOW 497 747 1015 1266 1359 4884 1187 1142 574 415

NET AID FLOW EXCLUSIVE OF FOOD

305 489 625 800 841 3060 614 667 326 284

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Two additional factors played a role in the 1966 devaluation

• The first was India’s war with Pakistan in late 1965. The US and other countries friendly towards Pakistan, withdrew foreign aid to India, which further necessitated devaluation.

• In addition, the large amount of deficit spending required by any war effort also accelerated inflation and led to a further disparity between Indian and international prices.

• Defense spending in 1965/1966 was 24.06% of total expenditure, the highest it has been in the period from 1965 to 1989 .

• The second factor is the drought of 1965/1966. The sharp rise in prices in this period, which led to devaluation, is often blamed on the drought, but in 1964/1965 there was a record harvest and still, prices rose by 10% . The economic effects of the drought should not be understated, but the data show that the drought was a catalyst for, rather than a direct cause of, devaluation

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Continue…• India’s system of severe restrictions on international trade

began in 1957 when the government experienced a balance of payments crisis.

• This crisis was caused by a current account deficit of over Rs 290 crores which necessitated India lowering its foreign exchange reserves (RBI Bulletin, July 1957, pp 638).

• The large current account deficit was largely a result of the Second Five-Year Plan which mandated higher imports, especially of capital goods.

• Exports in the year 1956-1957 stagnated while imports increased by Rs 325 crores from the previous year.

• Another factor behind the current account deficit was the increase in freight costs due to hostilities in West Asia11

Continue…• Periodically, when import prices reached a premium, the

government would impose import tariffs in order to absorb the gains accruing to foreign exporters as a result of India’s import quotas.

• The second step the government took away from free trade came in 1962 when India began to subsidise exports in an effort to further narrow its consistent current account deficit.

• As import prices rose, the government began to impose tariffs to increase its revenue. Ultimately, in July 1966 India was forced by economic necessity to devalue the rupee and attempt to liberalize the economy to attract foreign aid.

• The drought of 1965/1966 harmed reform efforts as feeding those in drought-affected areas took political precedence over liberalizing the economy

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Continue….• According to T N Srinivasan, the policies of export subsidisation

and import tariffs adopted by the government between 1962 and 1966 were a “de facto” devaluation.

• Since they made imports more expensive and exports cheaper, these policies reduced some of the pressure on India’s balance of payments

• Following the 1966 devaluation, the government initially liberalized its trade restrictions by reducing export subsidization and import tariffs.

• These actions counteracted the devaluation to some extent but even taking these policies into consideration, there was still a net devaluation and, as the trade data above show, the devaluation did stimulate exports

• In the resulting backlash against economic liberalization, quantitative restrictions and export subsidies returned, albeit at lower than pre-1966 levels. 13

SUMMARY OF CHANGES IN FOREIGN EXCHANGE 1986-92YEAR IMPORT EXPORT TRADE BALENCE CHANGE IN IMPORT CHANGE IN EXPORT TRADE BALANCE AS % OF EXPORT

1986-87 201.0 124.5 -76.4 2.2 14.3 61.4

1987-88 222.4 156.7 -65.7 10.7 25.9 41.9

1988-89 282.4 202.3 -80.0 26.9 29.1 39.6

1989-90 354.2 276.8 -77.3 25.4 36.8 27.9

1990-91 431.9 325.5 -106.4 21.9 17.6 32.7

1991-92 478.5 440.4 -38.1 10.8 35.3 8.7

APRIL DEC 1992 474.8 373.3 -101.5 38.7 23.1 27.2

APRIL DEC 1991 342.4 303.3 -39.1 7.9 30.8 12.9

1986-87 15.7 9.7 -6.0 -2.1 9.4 61.4

1987-88 17.2 12.1 -5.1 9.1 24.0 41.9

1988-89 19.5 14.0 -5.5 13.6 15.6 39.6

1989-90 21.3 16.6 -4.6 9.1 19.0 27.9

1990-91 24.1 18.1 -5.9 13.2 9.1 32.7

1991-92 19.4 17.8 -1.6 -19.4 -1.5 8.7

APRIL DEC 1992 16.6 13.1 -3.5 16.5 3.4 27.2

APRIL DEC 1991 14.2 12.6 -1.6 -22.5 -3.7 12.9 14

WHAT WENT WRONG IN-1991• Inflation caused by expansionary monetary and fiscal policy

depressed exports and led to consistent trade deficits. In each case, there was a large adverse shock to the economy that precipitated, but did not directly cause, the financial crisis.

• Additionally, from Independence until 1991, the policy of the Indian government was to follow the Soviet model of foreign trade by viewing exports as a necessary evil whose sole purpose was to earn foreign currency with which to purchase goods from abroad that could not be produced at home.

• As a result, there were inadequate incentives to export and the Indian economy missed out on the gains from comparative advantage.

• 1991 represented a fundamental paradigm shift in Indian economic policy and the government moved toward a freer trade stance.15

Continue…• By borrowing from the Reserve Bank of India and,

therefore, essentially printing money, the government could finance its extravagant spending through an inflation tax.

• Additionally, the large amounts of foreign aid that flowed into India clearly did not encourage fiscal or economic responsibility on the part of the government.

• In 1966, the lack of foreign aid to India from developed countries could not persuade India to liberalize and in fact further encouraged economic isolation. In 1991, on the other hand, there was a political will on the part of the government to pursue economic liberalization independent of the threats of aid reduction.

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Continue..• It is easy in retrospect to fault the government’s policies for

leading to these two major financial crises, but it is more difficult to convincingly state what the government should have done differently that would have averted the crises.

• One relatively non-controversial target for criticism is the tendency of the Indian government since Independence towards large budget deficits.

• Basic macroeconomic theory tells us that the current account deficit is roughly equal to the sum of government and private borrowing.

• Given the fact that the household saving rate in India is quite high, most of the blame for India’s balance of payments problems must rest with the government for its inability to control its own spending17

SUMMARY OF CHANGES IN FOREIGN EXCHANGE 2006-12SL

NO. YEAR FOREIGN EXCHANGE

RESERVE AT END OF FINANCIAL YEAR

TOTAL INCREASE/ DECREASE IN RESERVES

INCREASE/DECREASE IN RESERVES ON BOP

BASIS

INCREASE/DECREASE IN

RESERVES DUE TO VALUATION

EFFECT

1 2 3 4 5 6

2 2006-07 199.2 +47.6 +36.6[76.9%]

+11.0[23.1%]

3 2007-08 309.7 +110.5 +92.2[83.4%]

+18.3[16.6%]

4 2008-09 252.0 -57.7 -20.1[34.8%]

-37.6[65.2]

5 2009-10 279.1 +27.1 +13.4[49.4%]

+13.7[50.6%]

6 2010-11 304.8 +25.7 +13.1[51.0%]

+12.6[49.0%]

7 2011-12 311.5 +6.7 +5.7[85.1%]

+1.0[14.9%]

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Conclusion• These two financial episodes in India’s modern

history show that engaging in inflationary economic policies in conjunction with a fixed exchange rate regime is a destructive policy.

• If India had followed a floating exchange rate system instead, the rupee would have been automatically devalued by the market and India would not have faced such financial crises.

• A fixed exchange rate system can only be viable in the long run when there is no significant long- run inflation19

STATISTICAL REPRESENTATION OF RUPEE DECLINE

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Chronology of India’s exchange rate policies • 1947 (When India became member of IMF): Rupee

tied to pound, Re 1 = 1 s, 6 d, rate of 28 October, 1945 • 18 September, 1949: Pound devalued; India

maintained par with pound • 6 June, 1966: Rupee is devalued, Rs 4.76 = $1, after devaluation, Rs 7.50 = $1 (57.5%)

• 18 November, 1967: UK devalued pound, India did not devalue • August 1971: Rupee pegged to gold/dollar, international financial crisis

• 18 December, 1971: Dollar is devalued • 20 December, 1971: Rupee is pegged to pound

sterling again22

Continue…• 1971-1979: The Rupee is overvalued due to India’s policy of import substitution • 23 June, 1972: UK floats pound, India maintains fixed exchange rate with pound • 1975: India links rupee with basket of currencies of major trading partners.

Although the basket is periodically altered, the link is maintained until the 1991 devaluation.

• July 1991: Rupee devalued by 18-19 %• March 1992: Dual exchange rate, LERMS, Liberalized Exchange Rate Management

System• March 1993: Unified exchange rate: $1 = Rs 31.37• 1993/1994: Rupee is made freely convertible for trading, but not for investment

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