IFM Project v1(Yen, Pound and USD)

8/4/2019 IFM Project v1(Yen, Pound and USD)

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Trends of Exchange Ratesof Indian Rupee vis--vis

Yen, Pound, US Dollar &Euro

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The Indian Currency Regime

Since 1993, Indias currency regime is said to be a managed float, a market determined

exchange rate in the sense that there is a currency market and the exchange rate is not visibly

administratively determined. However, RBI actively trades on the market, with the stated goal

of containing volatility, and influencing the exchange rate.

The INR is not pegged to any particular foreign currency at a specific exchange rate. The RBI

intervenes in the currency markets to maintain low volatility in exchange rates and remove

excess liquidity from the economy. Also, there is absence of full capital account convertibility.

There are quantitative restrictions of various kinds on the FX exposures allowed to different

kinds of transactors, which give RBI additional levers of control. Sometimes SBI engages in

currency trading at the behest of RBI.

From 1975 to 1992, the rupee exchange rate was officially determined by the Reserve Bank of

India and was based on a weighted basket of currencies of Indias major trading partners. India

experienced a balance of payments crisis in 1991. It was due to a combination of internal

weaknesses along problems of the external sector. Within the economy, the main causes were

excessive regulation of private industry and trade by the government, a weak financial system

and high fiscal deficits. In the external sector, the primary contributing factors was an

overvalued exchange rate. The government undertook a comprehensive plan to deal with the

crisis, among which, one was to devalue the exchange rate and transform the system from a

discretionary, basket pegged system, to a market determined, unified exchange rate, following

a short intermediate period of dual rates. In July 1991, the Rupee was devalued by 18%.

Since August 1994, the rupee is convertible on the current account and the process of

integration of the Indian financial market with the rest of the world is underway. Capital

account convertibility is allowed for foreigners, foreign based corporates and non-resident

Indians. Several types of exchange controls have been dismantled and the Indian rupee is no

longer pegged. The Reserve Bank of India (RBI) however, continues to follow a policy of dirty

or managed floating. The aim of the managed float of the Rupee is to foster international

competitiveness and to limit daily market volatility. The Bank has used exchange market

intervention, monetary policy and administrative measures for this. The regime can beinterpreted to be more flexible during normal market conditions and managed when chaos

prevails. In the former case, intervention may be viewed as passive, while in the latter case,

active. The objective behind passive intervention could be to avoid a nominal appreciation or

depreciation whereas in the case of active intervention, the objective is to avoid disruptive

market corrections.


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Factors that affect currency fluctuations as root sources of continuous changes among

currencies:

1. Unexpected economic data from a specific country

2. Supply-demand factor on currencies.

3. Foreign investment

4. Export/import balance

5. Productivity

6. Growth rate in terms of economical values

7. Unemployment

8. Interest rates

9. Gross National Income of a specific country

10. Deficits of central banks, firms or citizens


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Rupee/ Yen Exchange Rate Trend

The following graph shows the trend of rupee/ yen exchange rate from the year 1992 to 2009.

The exchange rates between the two currencies have been volatile; there have been major ups

and downs.

Japan is currently Indias third largest source of foreign direct investment; Japanese companies

have made cumulative investments of around $2.6 billion in India since 1991.

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Rupee/Yen Exchange Rate


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1992: LERMS (Liberalized Exchange Rate Management System) was instituted in March 1992

and Convergence of the dual exchange rates was made effective from March 1993.

1998: Rupee depreciated a lot against Yen. It moved from 30.2357 in 1997 to 36.2409 in 1998

due to East Asian crisis which had a profound effect on the trading activities in East Asian

countries including Japan.

1999: Rupee again depreciated again from 36.2409 to 41.9457 in 1999. The Japanese economy

enters a recession due to the collapse of land and property prices. The Japanese government

implemented a rescue package for Japanese banks following the collapse of the property

market and $500bn in bad debts. This led to the sharp appreciation of the Japanese currency

against INR. Also, India conducted nuclear tests in 1998 which led to sanctions from Japan

which brought about an appreciation of Yen. India experienced some of the fluctuations in the

currency that affected the East Asian economies

2001: Following the bursting of the dot com bubble lead to a sharp appreciation of the rupee

from 41.7262 to 37.6112. Also, in India Interest rates are cut to their lowest level since 1973,

falling by half a percentage point to 6.5%. Japans Financial Services Agency was created in

2000, and launched a special inspection of bank loans in 2001. This finally brought some order

to the classification of bad loans, and to the health of banks balance sheets.

The exchange rate was quoting in a managed range from 2001 onwards till 2007. It was only

after 2003 that the functioning of the banking system in Japan started to improve. The banking

crisis only really ended in 2005 when the non-performing loan ratio of major banks declined to

a level (2.9 per cent) below the target set by the government. This led to the stability of theexchange rate; however the exchange rate became very volatile in 2007 onwards.

The INR/Yen exchange rate jumped from 35.1526 in 2007 to 53.3716 in 2008. The main reason

was the subprime crisis. Profits in Japanese banking sector took a 1.2 trillion yen (5.3 billion)

hit from the US sub-prime mortgage crisis. Economy of Japan entered into a recession and the

global economic slowdown curbed the demand for Japanese exports. Also, Indian economy was

not much affected by the ongoing crisis at that time. Indian banks did not have much exposure

to the US mortgage market; as a result the crisis did not have a profound effect on India.

However, the Japanese economy entered into a recession, which led to the depreciation of

rupee.

The following graph shows the monthly data for the INR/Yen exchange rate for the years 2010

and 2011:


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The above chart shows that there was not much volatility in the exchange rate in 2010 and

2011.

It was in the year 2010 that Japan was overtaken by Chin a as the worlds No 2 economy. The

Indian government came out with a stimulus package of around $100 billion; one of the major

initiative was to keep the exchange rate within a narrow range.

There was a devastating earthquake in Japan in Mar 2011, causing widespread damage in

Japan. In addition to the loss of life and destruction of infrastructure, the tsunami caused a

number of nuclear accidents. Though the loss was huge, this did not have much impact on the

exchange rate. INR appreciated slightly in April 2011, because Bank of Japan offered 15 trillion

(US$183 billion) to the banking system in an effort to normalize market conditions. INR

appreciated because Japanese firms and investors repatriated their assets, selling dollars to

prepare for the cost of building their domestic economy, which would have pushed yens value

up had the central Bank of Japan not intervened in the market.

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Rupee/ Pound Exchange Rate Trend

As a member of the EU, the UK is part of a single market that ensures the free movement of

people, goods, services, and capital within member states. Nevertheless, the UK still maintains

its own economy and has chosen to continue using the Pound Sterling as its national currency

rather than converting to the Euro.

During its heyday as the British Empire, the UK was the largest and most influential economy in

the world. As the birthplace of the first Industrial Revolution during the 18th century, the UK

ushered in what economic historians agree to be the most significant event in mankinds

history. The UK was also able to be at the forefront of technological advances during this time,

giving it a strong economic advantage over any other country in the world.

However as other countries began to catch up technologically wise, UKs economy was also

greatly affected by the two World Wars and the breaking up of the British Empire. Although the

UK economy has since recovered, it is unlikely to reclaim its former position as the topeconomic power in the world.

The following graph shows the trend of Rupee/ Pound exchange rate from the year 1992 to

2009. The exchange rates between the two currencies have been volatile; there have been

major ups and downs.

India is currently the second largest investor-country in the economy of UK, which is also one of

the largest investors in India.


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The Pound has appreciated viz-a-viz Rupee from the year 1993 to the year 1997 continuously. It

is interesting to see that the Pound has eroded its value during this period from 78.1861 to

90.8148, which means that value of Rupee has eroded more than the Pound during this period.

Year Pound (Jan 2005 = 100)1991 87.9457

1992 85.5692

1993 78.1861

1994 79.6884

1995 76.8084

1996 78.4961

1997 90.8148

India, affected by the Asian Currency Crisis, suffered and Rupee depreciated about 10% from65.19 in the year 1996 to 71.1 in the year 1997 against Pound.

In the year 1998, India conducted nuclear tests that led many countries to impose economic

sanctions on it. Due to this, Rupee lost value against major currencies including Pound.

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Rupee/Pound Exchange Rate


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In the year 2001, the dot com bubble-burst leading to cut in Interest rates o their lowest level

since 1973, falling by half a percentage point to 6.5% in India. Similarly, UK too cut its interest

rate from 6.5% to 4%.

Pound appreciated sharply from 69 in the year 2001 to 84.84 in the year 2004 due to the RBI

cutting interest rates to 4.5% in the year 2004. Interest rates in UK remained at unchanged for

sometime only to increase to 6% in the year 2006 when the interest rates were at the 5.25% in

India. This led to Pound appreciating to 87.7.

Pound depreciated sharply from 87.7 in the year 2006 to 75.78 in the year 2009, thanks to the

subprime crisis in the US that spread rapidly to the Europe and affected the whole world. India,

whose banks did not have large exposure to US, did not get affected badly experiencing a

slowdown in the economy. UK got into recession for few quarters forcing Bank of England to

cut interest rates to their lowest levels in decades. During this time, interest rates in India were

very high leading to depreciation of Pound viz-a-viz Rupee.

The following graph shows the monthly data for the Rupee/Pound exchange rate for the years

2010 and 2011:

UK was the 6th largest economy in the world in terms of nominal GDP and the 8 th largest in

terms of GDP (Purchasing Power Parity).

From the graph, it is clear that the movement of Pound has been very volatile. Its depreciation

from above 74-levels to 68.5 in June, 2010 marks the most important phase of the UK economy

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Rupee/Pound exchange Rate


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as it managed to come out of recession in the month of February. Interestingly, the credit card

interest rates touched their peak during this month. Exchange rates have broadly remained in a

narrow range amid uncertainty in the recovery in US and Europe while India is struggling from

stagflation (high inflation, slowing growth). RBI has raised the repo rate about a dozen times in

the last 15 months indicating high inflationary pressure.

The exchange rates are expected to remain volatile in the next two quarters as Europe

(including UK) is struggling to recover and get back to the path of growth. Moreover, UK is

expected to have the slowest growth amongst the G7 economies which is a matter of grave

concern.


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Rupee/ USD Exchange Rate Trend

Dollar became a dominant international currency following World War II. During Bretton Woods system

most currencies were pegged to dollar, much trade and finance was done in dollars and internationalreserve currency was the dollar. Although International Economy has changed dramatically but still the

dollars performance in international currency markets has absolutely enormous implications for

American and foreign investors, speculators and other countries alike. Behavior of dollar has dramatic

effects on the equity markets, bond markets, interest rates, commodities and trade markets globally.

With this in view lets study the trend in INR vs USD exchange rate.

The following is a graphical representation of the exchange rate from 1992-2009

Major trends that have affected the INR/USD equation.

In 1991 the government undertook a comprehensive plan to deal with the crisis, among which,

one was to devalue the exchange rate and transform the system from a discretionary, basket

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Rupee/Dollar Exchange Rate


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pegged system, to a market determined, unified exchange rate. The Rupee was devalued by

18%.

Since 1993, the exchange rate has exhibited fluctuations that have been more severe during the

crisis period.

In 1994, the rupee became convertible on the current account and the process of integration of

the Indian financial market with the rest of the world is underway. Several types of exchange

controls have been dismantled and the Indian rupee is no longer pegged. The Reserve Bank of

India (RBI) however, continues to follow a policy of dirty or managed floating.

The year 1995-96 witnessed periodic speculative pressures on the exchange rate of the rupee, and the

exchange rate of the rupee vis--vis the US dollar depreciated from a monthly average of Rs. 31.6 in

August 1995 to Rs. 36.6 in February 1996. While some easing of the nominal exchange rate of the rupee

during this period was consistent with economic fundamentals and maintaining India's competitiveness

abroad, speculative pressures had led to an overshooting. The RBI's policy responses to counterspeculative pressures against the rupee were effective in restoring stability in the foreign exchange

market and correcting the demand-supply imbalance. The exchange rate of the rupee per US dollar

recovered to Rs. 34.4 in March 1996 and further to Rs. 34.2 in April 1996.

The foreign exchange market has moved in an orderly fashion from 1996-97. The exchange rate of the

rupee vis-a-vis the US dollar moved in a narrow range of Rs. 35.0 to Rs. 35.9 between May 1996 and

January 1997. However, the rate of inflation in India, which was significantly higher than the inflation

rates in India's partner countries, tended to offset the competitive advantage gained by the nominal

depreciation of the rupee.

The Asian crisis saw higher volatility of the Rupee Dollar exchange rate from November-

December 1997 to May-July 1998. The RBI used its intervention strategy to temper the volatility

of the exchange rate following periods of large fluctuations in the exchange rate during the

crisis period. Monetary policy was tightened in a phased manner from November 1997

onwards as RBI interventions were deemed inadequate in controlling the volatility of the

foreign exchange market. This resulted in an increase in interest rates and increased the

reserve requirements. Other than CRR and repurchase operations, the RBI also used export

credit and surcharges on import finance.

2000-2006

The period experienced further depreciation of the Indian Rupee as against Dollar and the

movement ranged from 1 USD = Rs 44-48. The main reasons for this depreciation were:


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1. The prospect of rising interest rates in the US leading to a reduction and even reversal of

capital flows to the emerging markets as a whole.

2. This coupled with the defeat of the incumbent BJP government in 2004. Uncertainty

about the economic policies of the new UPA government which depended on the

support of the left leaning parties led to major fall in the stock markets and furtheroutflow of capital.

3. Rising oil prices put a downward pressure on the rupee because India imports a large

fraction of its oil.

4. Rising inflation further fuelled this depreciation.

2007-2008

By mid 2007, the seeds for the subprime crisis had been sown. The sustained foreign

investment flows into the country caused a sharp increase in Indian Rupee against the dollar.

This posed a lot of problems to the exporters and the BPO firms in the country. The RBI, fearing

a further rise of the rupee, accelerated dollar purchases and bought a sum of $70 billion from

September 2007 to March 2008 an average of $10 billion a month. But even this did not stop

the Rupee from crashing below Rs. 40. By the end of 2007 it traded at around Rs. 39 per dollar.

After Lehmans bankruptcy in 2008, the rupee depreciated sharply, breaching the level of Rs.50

per US dollar. The RBI had lost control of the rupee. It scaled up its intervention operations and

despite significant easing of crude oil prices and inflationary pressures in the second half of the

year, declining exports and continued capital outflows led by global deleveraging process and

the sustained strength of the US dollar against other major currencies continued to exert

downward pressure on the rupee up to the first quarter of 2009.


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2010-2011

Since 2010, the Indian Rupee has relatively stabilized but still remains volatile in the range of Rs 44-46.Concerns about the growth, employment figures, low interest rate and highly leveraged economy in the

US on one hand and high interest rates in India have led to huge capital inflows in the capital which has

strengthened the rupee against the dollar. At the same time, concerns over inflation, scams like CWG

and 2G, corruption rallies striking workers at various industrial plants, fiscal deficits and issues over

corporate governance have raised questions about India being a competitive destination to invest. The

Euro debt crisis and its impact on the stock market has also let to the outflow of capital in the recent

months. The rupee has been volatile in the range of Rs. 44-46, but is expected to strengthen in the near

future due to the positive outlook for economic growth.

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IFM Project v1(Yen, Pound and USD)