Project Report

On

“RUPEE DEPRECIATION IMPACT ON INFLATION”

MASTER OF COMMERCE

(2012-2013)

Submitted by

KHOT ZARA ARSHAD

K.M.E.Society’s

G.M.MOMIN WOMEN’S COLLEGE

THANA ROAD, BHIWANDI-421302

k.m.e.s Society’s G.M Momin College Thana Road Bhiwandi

CERTIFICATE

(2012-2013)

This is to certify that Miss Zara Arshad Khot of M.Com (2012-2013) has successfully completed the project on “Rupee Depreciation Impact on Inflation” under the guidance of Prof.Pawar

Date:

Place:

-------------------- ----------------------

Prof.Naznin Momin Mrs.Kamala

HOD balasubramainum

--------------------- ------------------------------

Prof.Pawar External Examiner

Project Guide

Declaration by student

I ,Khot Zara Arshad the student of M.Com(2012-2013) hereby declare that I have completed the project on “Rupee Depreciation Impact on Inflation” successfully.

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

Thank you,

Yours faithfully

----------------------

Declaration by guide

Date:-

I,the undersigned Prof .Pawar have guided MISS.KHOT ZARA ARSHAD, ROLL NO-6,for her project on “ Rupee Depreciation Impact on Inflation” successfully.

I hereby ,declare that information provided in this project in this project is true as per of my knowledge.

Thank you,

Yours faithfully

--------------------

ACKNOWLEDGEMENT

I would like to thanks all the people who helped me in undertaking the study the completing the project,by imparting me with valuable information and guidance that was required at every stage of my project work.

First of all,I would like to thank our Principal Mrs Kamal Balasubramanium, for giving me an opportunity and encouragement to prepare the project .

Last bot not the least ,I would like to thank my project guide, Prof. Pawar for guiding and helping me throughout the preparation of my project, right from selection of the topic till its completion.

INDEX

Sr no. Topic Page no

1 Introduction 1

2 Rupee depreciation adding to inflationary pressures

15

3 Impact of Rupee appreciation on Indian Economy

18

4 Rupee plunge may blunt India’s inflation fight 28

5 Five aspects of Rupee depreciation to keep in mind

37

6 Conclusion and bibliograhpy 40

INTRODUCTION

Indian currency (INR) has depreciated close to 22% in the last 1 year. In the

article we will try to study the concerns of a country facing depreciating

currency, the factors that led to this depreciation and the measures government

can take to stabilize the situation. Most importantly we will see if global

economic uncertainty rides over all the other domestic factors to determine

strength of a currency especially in developing economies.

Why don’t we need a depreciating INR?

The persistent decline in rupee is a cause of concern. Depreciation leads to

imports becoming costlier which is a worry for India as it meets most of its oil

demand via imports. Apart from oil, prices of other imported commodities like

metals, gold etc will also rise pushing overall inflation higher. Even if prices of

global oil and commodities decline, the Indian consumers might not benefit as

depreciation will negate the impact. The depreciating rupee will add further

pressure on the overall domestic inflation and since India is structurally an

import intensive country, as reflected in the high and persistent current account

deficits month after month, the domestic costs will rise on account of rupee

depreciation. Exchange rate risk also drives away foreign investors which in

turn depreciates the local currency. Indian Rupee is currently caught in this

vicious cycle; it will have to find a stable level to regain investors’ confidence.

The depreciating rupee has serious effects on the external debt figures of the

nation. The total external debt has increased by Rs. 2186.8 billion to Rs 16384.9

billion by the end of November 2011.

Factors that pushed INR into the well

Continued Global uncertainty: Owing to uncertainty prevailing in Europe and

slump in international market, investors prefer to stay away from risky

investments (flight to security). This has significantly affected the portfolio

investment in India. Credit rating agency’s downgrade of India to BBB- with a

negative outlook, the last of the investment grade has not helped the cause. Any

outward flow of currency or decrease in investment will put a downward

pressure on exchange rate. This Global uncertainty has adversely impacted the

domestic factors (current and capital account etc.) and caused the depreciation

of rupee.

 Current Account Deficit: While a country like China will be more than happy

with a depreciating currency, the same doesn’t apply for India. China exports

more than it imports, thus a depreciating currency makes its exports cheaper in

the International market, in turn making China more competitive. India on the

other hand does not enjoy this luxury, mainly because of increasing demand of

oil, which constitutes a major portion of its import basket. The fall of oil price

to $90/barrel has helped India to fight the depreciating rupee up to some extent

but at the same time Euro zone, one of the major trading partners of India is

under severe economic crisis. This has significantly impacted Indian exports

because of reduced demand. Thus India continues to see current account deficit

of around 4.3%, depleting the forex reserve and thus depreciating INR.

Capital Account flows: Deficit countries need capital flows and surplus

countries generate capital outflows. India needs dollars to finance its current

account deficit. Institutional investors investing in India are directly impacted

by the global market uncertainty. In 2008 India had a net outflow of $14billion

of FIIs and INR depreciated from 39 level to 52 against dollar. A volatile

currency is never good for a foreign investor as it increases the transaction risk.

Thus the relation becomes a vicious cycle, thereby further magnifying the

volatility. Though RBI has intervened through open market operations to arrest

the downfall of INR (managed float) but the reserves of $290billion don’t

provide enough room to make a significant impact.

Persistent inflation: India has experienced high inflation, above 8%, for almost

two years. If inflation becomes a prolonged one, it leads to overall worsening of

economic prospects and capital outflows and eventual depreciation of the

currency. The Real Effective Exchange Rate (REER) index (6 currencies- Euro,

Yen, Pound Sterling, US Dollar, Hongkong Dollar and Renminbi) has fallen by

13.84% during the last one year while the nominal rate has depreciated by 24%.

REER index measure includes the level of inflation differences across nations;

it reflects a country's competitiveness in international trade. Thus the trend

suggests that the country's competitiveness (measured by REER) has not

improved as much as the decline in nominal exchange rate points out mainly

because of increase in domestic costs. Under normal circumstances inflation is

tamed by increasing interest rates, but since India already has high interest rates,

it does not leave that option open, as it may lead to further slowdown in growth.

Interest Rate Difference: Higher real interest rates generally attract foreign

investment but due to slowdown in growth there is increasing pressure on RBI

to decrease the policy rates. Under such conditions foreign investors tend to stay

away from investing. This further affects the capital account flows of India and

puts a depreciating pressure on the currency.

Lack of reforms: Key policy reforms like Direct Tax Code (DTC) and Goods

and Service Tax (GST) have been in the pipe line for years. A retrospective tax

law (GAAR) has already earned a lot of flak from the business community.

Attempts are being made to control the subsidy bills but fiscal deficit continues

to hover around 5% of GDP. The government announced FDI in retail but had

to hold back amidst huge furore from both opposition and allies. This has

further made investors sentiment negative over the Indian economy.

1. Measures By RBI:

a. Using Forex Reserves: RBI can sell forex reserves and buy Indian Rupees

leading to demand for rupee. But using forex reserves poses risk also, as using

them up in large quantities to prevent depreciation may result in a deterioration

of confidence in the economy's ability to meet even its short-term external

obligations. And not using reserves to prevent currency depreciation poses the

risk that the exchange rate will spiral out of control. Since both outcomes are

undesirable, the appropriate policy response is to find a balance. Recent data

shows that RBI had indeed intervened by selling forex reserves selectively to

support Rupee.

Source:RBI

b. Raising Interest Rates: The rationale is to prevent sudden capital outflows

and ultimately lead to higher capital inflows. But India’s interest rates are

already higher than most countries. This was done to tame inflationary

expectations. So further raising interest rates would lead to lower growth levels.

c. Make Investments Attractive- Easing Capital Controls: RBI can take steps to

increase the supply of foreign currency by expanding market participation to

support Rupee. RBI can increase the FII limit on investment in government and

corporate debt instruments. It can invite long term FDI debt funds in

infrastructure sector. The ceiling for External Commercial Borrowings can be

enhanced to allow more ECB borrowings.

2. Measures by Government: Government should take some measures to bring

FDI and create a healthy environment for economic growth. Key policy reforms

that should be initiated includes rolling of Goods and Services Tax (GST),

Direct Tax Code (DTC), FDI in aviation and retail, Companies Bill and diesel

decontrol. Efforts should be made to invite FDI but much more needs to be

done especially after the holdback of retail FDI and recent criticisms of policy

paralysis. The government took steps recently to loosen rules for portfolio

investment in the Indian market, indicating its desire to sustain external inflows.

The measure to increase External Commercial Borrowings (ECB) to $10bn will

help in borrowing in dollar at a less cost. It may take similar steps to encourage

FDI as well, helping sustain external funding.

Is India the only loser?

The ongoing euro zone crisis and declining demand in the developed nations

has created risk-aversion in the markets. It explains why China's growth has

decelerated so acutely and also India's. It also tells us that it is the global factor

that is primarily responsible for India's economy running into rough weather not

coalition politics, lack of leadership, corruption, assembly elections or any of

the things we have been hearing about.

Source:www.x-rates.com

Above data shows that INR is not the only currency depreciating. Except for

China almost every developing country has shown a deprecating pressure on

their currency. Not everyone can be blamed for poor monetary policy or

ineffective governance.

Source:SEBI

The FII investment data for 2012 shows that India had huge capital inflows for

the first two months and started declining only after the euro zone crisis reared

its head again. This shows that the absence of reforms alone cannot account for

the sheer magnitude of the slowdown. The fact that we have had a comparable

slowdown only at the peak of the subprime crisis does suggest that external

conditions must be primarily responsible this time as well.

Through interest rate and inflation data we tried to formulate a model to

calculate expected spot rate and compared it with actual spot rates and it was

found that in 2010 and 2011 these rates were very close to each other, but in

2012 there is massive 20% difference(almost same as INR depreciation in last

year) in these rates.

Source: www.global-rates.com

INR appreciated by 2.69%, the biggest ever single day gain on 29th June just

after the announcement of Eurozone rescue plan by the leaders of 27 European

Union. All the above mentioned reasons are a testimony to the fact that global

economic factors are playing a bigger role than any domestic economic or

political condition.  

Rupee depreciation adding to inflationary pressures: FM

The government, on Wednesday, maintained that even as it

had been taking a number of fiscal and administrative

measures to contain the price spiral, it was the rupee

depreciation that had been contributing to inflationary

pressures.

“The decline in the exchange rate value of the rupee makes

imports expensive. In situations where the higher cost is

passed on to the consumers, it would contribute to inflationary

pressures and general price rise,” Finance Minister P.

Chidambaram told the Lok Sabha in a written reply.

Even as the rupee is now hovering around the 55.40-55.45

level against the dollar, after having touched a record low of

57.32 on June 22, and the WPI (wholesale price index) inflation

also easing marginally to 7.25 per cent in June from 7.55 per

cent in the previous month, Mr. Chidambaram said: “The

government has taken a number of fiscal and administrative

measures to check inflation, which resulted in moderation of

inflation to around 7-7.5 per cent in the recent months.”

The decline in rupee value, the Finance Minister pointed out,

was mainly on account of supply-demand imbalance in the

domestic foreign exchange market.

“This is due to widening trade and current account deficits and

slowdown in portfolio flows on account of escalation in euro

crisis and strengthening of the dollar in the international

market,” he said.

To stem the rupee slide, the government and the Reserve Bank

of India (RBI) had taken a number of steps to facilitate capital

inflows, boost exports and, thereby, augment the supply of

foreign exchange into the country. Among the steps taken

were a hike in the FII investment limit in debt securities, a

higher interest rate ceiling for foreign currency NRI deposits

and deregulation of interest rates on rupee-denominated NRI

deposits.

In another written reply, Minister of State for Finance Namo

Narain Meena said “The uncertainty in global financial

markets due to recent developments in the eurozone had some

impact on India.

“The government has been calibrating economic policies to

mitigate the impact.”

Impact of Rupee appreciation on Indian Economy

. Impact of Indian exports enjoyed the advantage of slow depreciation of

currency during the period of mid-2005 to mid-2006. Rupee showed a turn

around since August 2006. In terms of Real Effective Exchange Rate (REER), it

rose steadily between August to November 2006 and slipped slightly

thereafter. From March 2007 onwards, Rupee experienced a rise in its value. As

per REER (Graph 3.1), rupee has appreciated by almost 8% during March to

May 2007. Appreciation was much higher against US Dollar compared to Euro.

Another round of appreciation is visible between August-October 2007, which

has been relatively mild. REER provides the trade weighted average change in

exchange rate vis-à-vis major currencies. Hence, the appreciation rate as

reflected in REER provides a combined pictureof how Indian Rupee got

appreciated in recent times.

Rupee got depreciated during July to October 2005 and then February to

August 2006. In Rupee terms, monthly exports grew by 51% and in US Dollar

terms monthly exports growth rate was 41% during this period July to October

2005. In the entire period of 2005-06, exports grew by 23.44% in US Dollar

terms and touched US $ 103 billion. In terms of Rupee, growth was around

21.6% and total exports in 2005-06 were Rs.4.6 trillion. During the period 2006-

07, India’s exports grew almost by 22.5% in US Dollar terms and total exports

reached to US$ 126 billion. In Rupee terms, growth was 25.3% and total

exports were Rs.5.7 trillionchanging values

of currency on exports has not been significant during 2005-06 and 2006-07 as

both the periods were marked by appreciation as well as depreciation of

currency which played an overall neutralizing role. Moreover, impact of

appreciation of Rupee on exports requires at least four to six months time to

get realized.

Since April 2007, as there has been sharp rise in the value of Rupee, there is a

severe impact on the export growth rate (Table 3.1). The cumulative exports

during the period April-October in 2005 was US $ 57 billion (Rs. 2.5 trillion)

which increased to US $ 71 billion and (Rs.3.2 trillion) in April-October of 2006

registering a growth rate of almost 24.4% in US Dollar terms (30% in Rupee

terms). The cumulative exports during April-October of 2007 have been US $

85.5 billion (Rs.3.5 trillion). In US Dollar term the growth was around 21% but in

Rupee terms the growth declined to only 7% implying a serious blow in terms

of rupee realization of Indian exports.

In case of imports, cumulative value of imports for the period April-October,

2007 was US $ 130 billion (Rs. 5.3 trillion) as against US$ 103.7 billion (Rs. 4.8

trillion) registering a growth of 25.31% in Dollar terms and 11.07% in Rupee

terms during the same period of 2006. The import growth rate for the same

period in 2006 over 2005 was 26% in US Dollar terms and 32% in Rupee terms.

Slowing down of import growth in 2007 has been mainly because of less growth

in POL import. This has proved that India’s import has not increased

significantly despite the fact that Indian rupee has appreciated significantly in

recent months. In fact, slowing down of import growth rate implies that India’s

import is less elastic with respect to exchange rate.

Currency Appreciation and Export Value: Recent Experience

In 2006-07, India witnessed large trade deficits to the tune of US $ 65 billion

and current account deficit was as high as US $ 10 billion. The level of trade

deficit should have been enough to depreciate the rupee, as supposed in

traditional exchange rate theories. However, interest rate cuts by the US

Federal Reserve led to higher inflow of portfolio investments into the country

resulting in unprecedented and continuous rupee appreciation. Foreign

portfolio investment recorded an inflow of US $ 20.7 billion during April-July

2007. FDI inflow was also significantly high and recorded US $ 6.6 billion during

April-July 2007 (US $ 3.7 billion in April-July 2006). Large inflow reflects

expansion of domestic activities, positive investment climate, and positive view

towards India as a long-term investment destination. All these have raised an

upward pressure on Indian Rupee (INR).

Table 3.1

India’s Exports vsi-a-vis Exchange Rates

India’s Exports to World Average Value

Period (Rs. Million) (US $ Million) Rs. Per Euro Rs. Per US $

Apr-Oct

20052,494,969 56,928 54.09 43.81

Apr-Oct

20063,250,912 70,838 58.03 45.86

Apr-Oct 3,477,939 85,583 55.73 40.68

2007

Source: Calculated from India Trades, CMIE

Rupee depreciated steadily for a decade after being floated in 1993, dropping

from an average annual rate of Rs. 31.37 per US Dollar in the 1993-94 fiscal

year (April-March) to Rs. 48.40 per US Dollar in 2002-03 (an average annual

depreciation of nearly 5%). From 2003-04 to 2005-06, however, the rupee

appreciated against the US Dollar by 3% on average a year. But the rate of

appreciation of Indian Rupee has been unprecedentedly high from July 2006 till

date, falling by about 16.3 % (46.97 to 39.25 per US Dollar). The average

rupee-US dollar rate in November 2007 was the lowest since 1999-2000.

On the other hand, though the Indian Rupee appreciated against Euro, Pound

Sterling and Yen also, the rate of appreciation has been much lower. Moreover,

the upward rallying of rupee against these currencies more or less leveled off

since May 2007, though there have been high fluctuations in weekly

movements. Against Euro, Indian Rupee shows a slight but steady depreciation

from July onwards. The trend of exchange rate vis-à-vis US Dollar and Euro is

given in Table 3.2 and Graph 3.2 and 3.3 below.

Table 3.2

India’s Exchange Rate 

Source: Reserve Bank of India

Graph 3.2

Source: Monthly exchange rate available in India Trades, CMIE and RBI

Source: Monthly exchange rate available in India Trades, CMIE and RBI

The current upward rallying of Rupee evidently is a natural outcome of India’s

robust economic growth over the last decade. With low interest rates in US,

India and other emerging markets are becoming increasingly attractive as an

investment destination for US and other countries. As more and more Dollar

flows to India, its supply exceeds demand and result in depreciation against

Indian Rupee. As most of India’s trade is through US Dollar, continuous

appreciation of Indian Rupee against US Dollar has a significant impact on

exports. Exports through Euro were unable to balance the loss incurred in

exports earning through US Dollar.

Graph 3.4 below explains the dynamics of India’s export growth. Export values

in terms both Rupees and US Dollar are described in the diagram. Rupee values

are measured on the left hand vertical axis and values in US Dollar in right

hand axis. The average monthly growth (calculated through CAGR) of exports

during April-September in 2006 was 4.54% in US Dollar (5.08% in Rupee

terms). Higher growth in Rupee terms compared to US Dollar implies the

advantage of depreciated currency in realization of exports. The monthly

average growth rate during the same period of 2005 was 2.07% in US Dollar

(2.15% in Rupee). However, during 2007, though exports were growing but

decline in growth rate is very much visible. In the period April-September of

2007, Indian exports grew by 3% per month in US Dollar and in terms of Rupee

the rate was 2.15%. Lower growth rate in rupee terms compared to US Dollar

shows that due to appreciation, the export income in Rupee is slowing down.

The growth of India’s exports in 2006 was both due to fast growth of world

exports as well as due to its depreciated currency. In 2006, according to WTO,

world export growth was around 8%. Export growth may slow down to 6% in

2007 due to moderate deceleration of World economic growth. Hence, slowing

down of Indian exports is also partially due to slow down of world demand in

2007 and not completely due to Rupee appreciation. Also it is important to note

many other currencies have shown the tendency of appreciation (Graph 3.5)

and as a result competitive disadvantage of Indian exports due to appreciated

currency have also partially

neutralized. Some of these countries have given extra thrust in increasing

productivity and perhaps India is loosing its advantage due to that. The rise in

world merchandise exports in 2006 was also due to global inflation. Almost

40% of exports value was due to this price effect. As the world inflation slows

down, the extent of price effect will also come down in the export market. This

might have contributed to slow down of India’s export growth also.

Graph 3.5

Dollar changes vis-à-vis selected major currencies, 2001-2006 

(Indices, January 2001=100)

a. Trade weighted currency basket of the Korean won, the Singapore dollar and

Chinese Taipei dollar.

Source : http ://www.wto.org/english/news_e/pres07_e/pr472_e.htm

Effect on Labour Intensive Exports

Rupee appreciation affects different sectors, differently. High-import intensity

sectors like automobiles, petroleum products, gems and jewellery, fare better

in face of a stronger rupee as appreciation renders their imported inputs to a

lower value. However, the appreciating rupee could significantly erode net

profit margin of low-import intensity sectors like textiles and leather, as

exporters of these sectors remain in a disadvantageous position especially in

price sensitive international markets. Many of the low-import intensity sectors

also operate with very low margins, making them feel the heat of rupee

appreciation more. The impact on employment is also directly related to the

factor intensity of production both in the export units as well as in the input

sector. An analysis of this is given in Table 3.3.

If the input sector is labour intensive and export units use largely imported

inputs, employment in input sector will get the hit as they will be replaced by

cheap foreign inputs. This implies that even though high import-intensity

sectors benefit from the appreciating rupee it does not necessarily mean that

in the longer run the economy, as a whole, will be benefited.

Continued rupee appreciation could have a long lasting impact on employment

as most low import-intensity sectors are highly labour-intensive and they lay off

labour quickly as rupee appreciation erodes their profitability. Also

Table 3.3

Impact of Rupee Appreciation on Exports and Employment

 

employment in import-competing industries may get hit later on. Job losses

were already reported in certain sectors, such as textiles and leather. The

strain on the labour market became visible ever since last year when number

of registered job seekers in the country shot up by more than 2 million to 41

million. Significantly, the increase came after two consecutive years of decline

in registered work applicants.

Rupee plunge may blunt India’s inflation fight

If the government and the Reserve Bank of India (RBI) were hoping that a high

base effect, which kicks in from December, would block the inflation spiral,

they may find their estimates going awry, yet again.

The rupee’s relentless slide vis-a-vis the US dollar is likely to fuel inflationary

pressures in the economy and weaken the central bank’s defences against high

prices as it offsets some of the moderating impact of last 21 months’ rate hikes

on domestic demand.

“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 Abheek 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.

Traders have been buying the ‘safe haven’ dollar amid the prolonged debt crisis

in the euro zone. Back home, demand for the greenback from oil companies,

major importers of crude oil, is further pulling the rupee down.

On the other hand, the headline inflation rate has remained above the 9% mark

since December last year. Latest data show WPI inflation was 9.73% in

October, compared with 9.72% in the previous month.

Both government and independent think tanks are of the view that the inflation

print for December could be sharply lower from the current level, as the index

had risen 1.53% month-on-month a year ago.

The December index had risen to 146.0 from 143.8 in November last year.

Thanks to this high base, inflation was widely seen slipping December onwards

towards the RBI’s target of 7% by the end of the fiscal in March.

“There could be a 1.00-1.25% fall in inflation in December from the current

level on the basis of the base effect,” an economist at a private bank had

estimated.

December WPI inflation data will be released on January 16.

However, the rupee’s recent fall—especially if the downtrend sustains—holds

the potential to upset these calculations.

In its Macroeconomic and Monetary Development report in October, the RBI

had also acknowledged that the depreciation of the rupee raises the risk of

imported inflation.

“The rupee has depreciated by about 11% against the dollar during 2011-12 so

far. India’s 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 rupee’s depreciation.

State-owned oil marketing companies, which sell diesel and cooking fuels at

government-controlled prices, are also piling up revenue losses as a falling

rupee is pushing up the cost of oil imports.

Every rupee’s fall against the dollar pushes up the combined gross revenue loss

for Indian Oil Corp Ltd, Bharat Petroleum Corp Ltd and Hindustan Petroleum

Corp Ltd by a staggering `8,000 crore.

The current year’s gross revenue loss of these oil companies is already pegged

at a massive `130,000 crore, and the government will now increasingly come

under pressure to bear at least a part of the jump in production costs.

The dwindling rupee may have further complicated the labyrinth of issues

facing the economy, but economists say easing commodity prices may be the

silver lining here.

“The counter-impact of rupee depreciation on inflation could be the easing of

global commodity prices,” Yes Bank said.

Prices of long steel futures on the National Commodity and Derivatives

Exchange have slipped about 3% so far this month. Iron and steel have a 6.36%

weight in the WPI basket.

From $103.37 per barrel on November 17, crude oil prices have eased to $97.26

today. Petroleum, crude and oil products have a 10.26% weight in the WPI

basket.

If a barrel of oil is currently at $100 with rupee at 48 to a dollar, its domestic

price will be 4,800 rupees. If the rupee falls to 50, the cost will rise to s5,000.

However, if, at the same time, the price of crude eases to $97, the price will

settle lower at Rs4,850 and negate the impact of rupee fall to an extent.

“I don’t think the rupee fall has overwhelming concerns yet, as we are seeing

falling commodity prices,” said Robert Prior Wandesforde, chief India

economist at Credit Suisse.

Market participants don’t expect the rupee to recover sharply in the near future,

as global concerns in Eurozone continue amid lack of strong intervention by the

RBI.

Last week, RBI deputy governor Subir Gokarn said market forces must

determine the level of the rupee, indicating that the central bank was not keen to

intervene in the currency market.

“Gokarn’s comments at a juncture when the rupee was around 51 per dollar

level shows that the RBI is not extremely uncomfortable with the rupee at these

levels, and they may not intervene,” said an economist at a private bank. NW18

Will the Rupee really appreciate in 2013?

The Indian currency was mostly unstable in the year gone by. The first two

months saw the rupee appreciating as the RBI took effective steps such as

banning the rollover of forward contracts and limiting the overnight positions in

currency. 

This was assisted by strong capital inflows by the FIIsinto the country. However,

as the government remained politically inactive and charges of corruption

emerged almost consistently, the Indian currency spiraled down. Worries about

the high twin deficits also led the currency to depreciate by around 16% from

the beginning of March to mid of June. 

The situation improved with a slew of reforms in the third quarter. This helped

in arresting the fall in rupee. Increasing the FDI limits in sectors such as retail

and aviation and reduction in the diesel subsidy were the domestic measures

taken by the Indian government. The Federal Reserve's decision to continue

injecting liquidity led foreign funds into the country thereby improving demand

for rupee. This situation was though short-lived. With the finance

minister failing to come up with a proper guidance on restricting the fiscal

deficit to 5.3%, once again the rupee showed weakness and wiped off the gains

in the third quarter. 

So, would the current year be positive for rupee or would it continue to

depreciate further? The answers to these questions hinge on the movement

of interest rates and how successfully the twin deficits are dealt with. Though

in the near term interest rates are expected to be benign to

encourage investments in the economy, there is an uncertainty looming large

over how the government deals with twin deficits. 

One of the biggest determinants in the movement of the domestic currency will

be the stance taken by the RBI. The central government has been keeping a tight

position on the Repo rate in the wake of high inflation. With the

latest inflation numbers showing positive signs the RBI is expected to pay heed

to the flagging growth rate. Most of the analysts in the street expect a rate cut in

the next RBI monetary review. 

The fall in rates will surely lead to lower foreign investments in the

debt market but this will be made up by the investments in the equity market.

With lower interest rates, the investment cycle will see a fresh upturn and will

bring relief to major sectors such as capital goods, infrastructure and realty,

which are currently under stress. To put it simply, reduction in interest rates will

set India again on the growth platform.

Revenue growth of TCS, Infosys, Wipro, HCL to remain

modest: Analysts

An average estimation based on the forecasts of five brokerages and projection

of the ET Intelligence Group, revenue for the top four IT players is expected to

increase by 2.6% sequentially and by 15% from the year ago. Net profit is likely

to fall by 2.5% from the quarter ago and to increase by 12% year-on-year. The

sample includes TCS BSE 0.60 % , Infosys, Wipro BSE -1.46 % , and HCL

Technologies BSE 1.00 % .

"We expect a modest, flat to (around) 3%, sequential dollar denominated

revenue growth in the December quarter, due to fewer working days and client

specific challenges", mentioned Mital Ghosh and Kunal Tayal from Bank of

America Merrill Lynch in a recent report. According to them, cuts in

discretionary spends highlighted by some vendors may impact the demand for

the quarter.

Profit margins are expected to remain under pressure compared with the

previous quarter. IDFC BSE -1.69 % mentioned in its report that margins are

likely to remain in a narrow range of 50 basis points for large cap IT players

with no major triggers.

Barring Wipro, other three players are likely to report a sequential drop in net

profit for the December quarter. The loss of Infosys, the second largest among

publicly listed IT players in the country, is expected to be the highest at 7% with

Rs 2,203.7 crore in net profit. Wipro, on the other hand, is expected to report

1.1% sequential increase in net profit at Rs 1,628 crore.

Analysts expect a cautiously optimistic commentary from IT exporters on

demand scenario in 2013. "Vendors could benefit from pent-up demand for

transformationrelated IT spend and likely faster decision cycles post US

Presidential elections.However, clients are proceeding cautiously stage by stage

resulting in smallerprojects sizes, lower visibility and delayed decisions,"

mentioned Bank of America Merrill Lynch in the report.

The value of any currency in an economy is hard to bet, to be stable for a long

period of time as there are number of factor influencing its appreciation and the

depreciation. The currency value of an economy influences the growth rate of

GDP in an economy. Several other factors that have a direct influence on the

over or the undervaluation of a currency are listed below:

Capital flows and the stock market of India 

It's important to note that in spite of suffering recession, an economy can grow

if the capital inflow is constant or continuously rising. In India even if the GDP

rate is less, the currency can still get overvalued due to excessive capital inflows

made by the FII's in the Indian economy. 

Global currency trends 

Like many other currencies Indian rupee have also tied its knot with some of the

big economies of the world including the names of UK, US, Japan and Canada.

The depreciation or appreciation in the currency any of these, especially in the

US dollar, influences the valuation of the Indian currency in one way or the

other. 

RBI Intervention 

The valuation of the Indian currency highly depends on RBI that manages the

'balance of payments', slight modification in which can define the over or the

under valuation of the Indian currency. 

Oil factors 

India is a major importer of oil and the valuation of Indian money gets easily

affected by the increase in the prices of the crude oil. It can further result in

spreading inflation in an economy due to the over valuation of the Indian

currency. 

Political factors 

Several other factors that affect the currency stability are some political factors

like change in the government set up, introduction of new export and import

policies, tax rates

and many more.

Five aspects of Rupee

depreciation to keep in mind

A lot of the downward pressure that’s been on the Rupee in the past few months

has been due to the political environment in the country, and the uncertainty

caused by issues like GAAR, retrospective taxation, inability to pass any policy

reforms and other clouds surrounding the Indian economy.

Unlike the last time the Rupee depreciated which was a time of global crisis,

things aren’t as bad globally this time, and most of the trouble that’s brewing is

domestic (although things aren’t peachy globally either).

These circumstances hardly inspire investor confidence and as a result money

has been flowing out of Indian equities and that’s led to the downfall in the

market.

Effect of Rupee depreciation on exporters

If you look at exporters specifically, then all other things being equal, Rupee

depreciation is good for them as the conversion rate is higher but the problem is

that all other things aren’t equal and they have to face a slowing market in

Europe and US, and that means that business is slowing down for them there.

The recent Cognizant 2012 guidance, and the drop in share prices of all IT firms

subsequently is a good example of that.

Effect of Rupee depreciation on oil bill

This one is the most talked about and I’m sure everyone has heard about this.

Since India imports most of its oil from abroad, every time oil prices shoot up,

India’s oil bill shoots up and since the government subsidizes oil, the oil subsidy

goes up with this.

A lesser known aspect of this is that India has actually got surplus refining

capacity, and oil also happens to be India’s biggest export item. While there are

price controls in the domestic market, refiners are free to sell at market rates

internationally, and that’s led to big oil exports from Indian private oil players,

and helps offset some of the big oil bill. In fact in an earlier post about India’s

exports in 3 simple charts I spoke of how oil exports might just hold the key to a

trade surplus one day.

Effect of Rupee depreciation of Indian funds that hold US assets

Currently, I think there is just one fund in India which is the MOSt Shares

Nasdaq 100 ETF which is a practical option to get exposure to the US markets,

and this fund has grown about 20% Year to Date but the underlying NASDAQ

has just grown 12.6% in that time period.

The remaining gains are due to the depreciating rupee as the stocks that the fund

owns are worth more in Rupees now than they were when the fund bought

them.

This is a slightly more complex relationship and you can’t really say that Rupee

depreciation will always be good for the fund because the other variables that

this depends on is how much money flows in the fund at that price level, what

kind of redemption takes place at various levels, and how much the fund owns

at any given time. I have however seen that the a falling Rupee is good for such

funds, and I think if a fund continues to grow its asset under management

steadily this would remain true.

Effect of Rupee depreciation on companies that have borrowed in USD

This could potentially become a big problem because a lot of Indian companies

borrowed in foreign currency to take advantage of the low interest rates, but

didn’t sufficiently hedge to protect themselves against the adverse exchange rate

movement that could take place.

Now, they will have to spend a lot more INR to buy the same level of USD they

borrowed and not only will this nullify any interest rate savings that they may

have benefited from, it will put a big dent on their resources because this is akin

to a penalty on the loan.

These are 5 things that come to my mind when I think about Rupee depreciation

and these are not necessarily the five most important ones, just the ones that

came to my mind as I read the original question.

Conclusion

The Indian Rupee has depreciated significantly against the US Dollar marking a

new risk for Indian economy. Grim global economic outlook along with high

inflation, widening current account deficit and FII outflows have contributed to

this fall. RBI has responded with timely interventions by selling dollars

intermittently. But in times of global uncertainty, investors prefer USD as a safe

haven. To attract investments, RBI can ease capital controls by increasing the

FII limit on investment in government and corporate debt instruments and

introduce higher ceilings in ECB’s. Government can create a stable political and

economic environment. However, a lot depends on the Global economic

outlook and the future of Eurozone which will determine the future of INR. 

BIBLIOGRAPHY

Rupee depreciation impact on inflation .

Thomas Oatley, International Political Economy: Interests and Institutions in the Global Economy (Harlow: Longman, 2007), p. 104

Bhagwati, Jagdish, 1988, “Export-Promoting Trade Strategy: Issues and Evidence,” Research Observer 3(1), January 27-57.

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