depreciation of the indian rupee

7/27/2019 Depreciation Of The Indian Rupee

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Depreciation Of The Indian Rupee A Short Commentary

On 28th August 2013 the Indian Rupee plunged to an all time low of 68.85 to the USDollar a depreciation of nearly 25% since January 2013. Lets examine some of theissues that brought the rupee to such a state.

Well start by going back in time when after independence in 1947, India adhered tosocialist policies. Attempts were made to liberalise the economy in 1966 which wasreversed a year later in 1967. Another attempt was made in 1985 by the then PrimeMinister Rajiv Gandhi which came to a halt in 1987. In 1991, after India faced aBalance of Payment crisis, it had to pledge 20 tonnes of gold to the Union Bank ofSwitzerland and another 47 tonnes to the Bank of England as part of a bailout dealwith the International Monetary Fund. Additionally the IMF required India toundertake a series of structural economic reforms. The economic liberalization ofIndia started on 24th July 1991 which included policies such as opening forinternational trade and investment, deregulation, initiation of privatisation, taxreforms and inflation control measures. These policies started showing results whenin 2007 India recorded a GDP growth of 9%. However, the economy slowed toaround 5% in 2012-13 as compared to 6.2% in the previous fiscal (considering thatthere was a global financial meltdown in 2008 the figure of 6.2% is comparativelyokay). Indias GDP which had grown by 9.3% in 2010-11, went south by nearly 50%in 2012-13 in a span of just 2 years. (GDP Graph)

Until the liberalisation of 1991, India was largely and intentionally isolated from theworld markets to protect its economy and to achieve self-reliance. Foreign trade wasrestricted and subject to import tariffs, export taxes and quantitative restrictions.Since independence, Indias Balance of Payment had been negative until 1991(India's Balance of Trade Graph). After liberalisation, Indias exports have risencovering 80.37% of its imports in September 2013, up from 66.20% in 1990-91.

At this juncture a little history here is warranted. The British came to India in 1608when the East India Company established a settlement in Surat, Gujarat . After themutiny of 1857 the East India Companys powers were transferred to the Crown.From 1858 till 1947 India was ruled by the Crown in what is now known as theBritish Raj. India got freedom from British rule on 15 th August 1947. The Rupeewhich was linked to the British Pound from 1927 to 1946 had its value at par withthe US Dollar. After independence there were no foreign borrowings on India'sbalance sheet. To finance welfare and development activities, especially with theintroduction of the Five-Year Plan in 1951, the government started externalborrowings. This required the devaluation of the rupee. On 24th September 1975, theRupees ties to the British Pound were broken. India conducted a managed floatexchange regime with the Rupees effective rate placed on a controlled, floating basisand linked to a basket of currencies of Indias major trading partners the USDollar, the British Pound, the Japanese Yen and the Deutsche Mark. The year 1993 is

very important in Indian currency history. It was in this year when the currency waslet free to flow with the market sentiments. The exchange rate was freed to be
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determined by the market, with provisions of intervention by the central bank underthe situation of extreme volatility. In 1993, one was required to pay `31.37 to get adollar. In the last decade, the rupee traded in the range of 40-50 to the US Dollar;touching a high of 44.61 in 2007. The Indian currency has gradually depreciatedsince the global 2008 economic crisis

Lets now pay a visit to the final days of World War II. In an effort to create a newglobal economic order; 44 leaders from all the Allied nations met in Bretton Woods,New Hampshire, USA in what is now known as the Bretton Woods System. TheBretton Woods System of monetary management established the rules forcommercial and financial relations among the world's major industrial states in themid-20th century. The Bretton Woods System was the first example of a fullynegotiated monetary order intended to govern monetary relations amongindependent nation-states. With much of the global economy in tatters, the USemerged as the worlds new economic leader to replace a debt-ridden and war-tornGreat Britain. The chief features of the Bretton Woods System were an obligation foreach country to adopt a monetary policy that maintained the exchange rate by tyingits currency to the US Dollar and the ability of the IMF to bridge temporaryimbalances of payments.

This historic meeting created an international gold-backed monetary standard whichrelied heavily upon the US Dollar. At this point, an appropriate question to beasking yourself is: ''Why would all of the nations be willing to allow the value oftheir currencies to be dependent upon the US Dollar?".

The answer is quite simple. The US Dollar would be pegged at a fixed rate to gold.

This made the US Dollar completely convertible into gold at a fixed rate of $35 perounce within the global economic community. This international convertibility intogold allayed concerns about the fixed rate regime and created a sense of financialsecurity among nations in pegging their currency's value to the Dollar. After all, theBretton Woods arrangement provided an escape hatch: if a particular nation nolonger felt comfortable with the Dollar, they could easily convert their Dollarsholdings into gold. This arrangement helped restore a much needed stability in thefinancial system. But it also accomplished one other very important thing. TheBretton Woods agreement instantly created a strong global demand for US Dollarsas the preferred medium of exchange. By the end of the war, nearly 80 percent of theworlds gold was sitting in US vaults and the US Dollar had officially become theworlds undisputed reserve currency. As a result of the Bretton Woods arrangement,the Dollar was considered to be safer than gold.

Initially, this Dollar system worked well. However, by the 1960s, the weight of thesystem upon the United States became unbearable. On 15 th August 1971, PresidentRichard M. Nixon shocked the global economy when he officially ended theinternational convertibility from US Dollars into gold, thereby bringing an officialend to the Bretton Woods arrangement.


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Two years later, in an effort to maintain global demand for US Dollars, anothersystem was created called the petroDollar system. In 1973, a deal was struckbetween Saudi Arabia and the United States in which every barrel of oil purchasedfrom the Saudis would be denominated in US Dollars. Under this new arrangement,any country that sought to purchase oil from Saudi Arabia would be required to firstexchange their own national currency for US Dollars. In exchange for Saudi Arabia'swillingness to denominate their oil sales exclusively in US Dollars, the United Statesoffered weapons and protection of their oil fields from neighbouring nations,including Israel.

By 1975, all of the OPEC nations had agreed to price their own oil suppliesexclusively in US Dollars in exchange for weapons and military protection. ThispetroDollar system, or more simply known as an "oil for Dollars" system, created animmediate artificial demand for US Dollars around the globe. And of course, asglobal oil demand increased, so did the demand for US Dollars. Today the mosttraded currency is the US Dollar having a share of 85% of the global foreignexchange market turnover.

India imports crude oil, precious stones, machinery, fertilizer, iron, steel andchemicals. Since India is heavily dependent on coal and foreign oil imports for its

energy needs; India's main import is crude oil (more than 35% of total imports), andthe countries it imports from unfortunately only accept US Dollars or other majorcurrencies. Therefore, India needs to have a large reserve of US Dollars and othercurrencies to pay for the crude oil (US$ 2,49,324.60 million of foreign currencyreserves as on 4th October 2013). India receives Dollars in three ways: throughexports, through foreign investments into India, and through NRI remittances intoIndia. The less Dollars there are in the market, the more the Dollar is worth (basiclaws of demand and supply), and, so, the Rupee depreciates.

From 2003 to 2008, the Rupee appreciated against the US Dollar; thereafter, it hassharply depreciated. Between 2010 and 2012, the Rupee value had depreciated byabout 30% of its value to the US Dollar in 2010. On 28 th August 2013 it plunged to anall time low of 68.85 to the US Dollar.

Historical Indian Rupee Rate V. US Dollar (Average exchange rate)

Year INR/USD Year INR/USD Year INR/USD Year INR/USD

1973 7.66 1984 11.36 1995 32.43 2006 45.17

1974 8.03 1985 12.34 1996 35.52 2007 41.20

1975 8.41 1986 12.60 1997 36.36 2008 43.41

1976 8.97 1987 12.95 1998 41.33 2009 48.32

1977 8.77 1988 13.91 1999 43.12 2010 45.65

1978 8.20 1989 16.21 2000 45.00 2011 46.61

1979 8.16 1990 17.50 2001 47.23 2012 53.34

1980 7.89 1991 22.72 2002 48.62


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1981 8.68 1992 28.14 2003 46.60

1982 9.48 1993 31.26 2004 45.28

1983 10.11 1994 31.39 2005 44.01

One of the most important questions that many are asking is why the Rupee hasfallen to its current state. Exchange rate can be best understood as nothing more thana benchmark for a nation's money supply. When the Rupee depreciates against theDollar, it simply means value of the Indian currency has gone down relativelyagainst the greenback (US Dollar). This can happen because of two things: 1)increase in Rupees in the market; or 2) decrease of Dollars in the market.

Since the beginning of Quantitative Easing program the emerging markets havebeen the biggest beneficiaries of the Feds loose monetary policy, which has pumpedextra liquidity since the global financial crisis of 2008. According to the IMF,

emerging markets received nearly $4 trillion in capital flows from 2009 to early thisyear.

The recovery in the US economy is expected to prompt the central bank there to endthe loose monetary policy by the year end. There is ample reason for concern thatcapital outflows from India and other emerging markets will rapidly accelerate if theFederal Reserve decides to curtail its bond-buying program on 17 th September 2013.This move would lead to higher interest rates in the US and investors may dumprisky emerging markets assets in favour of safe havens. Anticipating this, foreigninvestors are pulling out their money from India to invest it back in the US, which is

resulting in a scarcity of Dollars in India. This has created a shortfall in supply of theDollar in India. This is not India specific. All emerging market currencies arewitnessing a similar capital flight. US recovery is also boosting the dollar strength.The FIIs have also been heading to greener pastures like Singapore owing to thegreater operational efficiency and lesser bureaucratic problems that have unsettledthe Indian business fraternity and hampered its overall economic growth.

Secondly, importers (mostly oil companies since we import most of our crude oil)are the major entities who are in need of the Dollar for making their payments. Thisagain creates a demand for the US Dollar.

This situation can only be addressed by exporters who can bring in dollars in thesystem. Secondly, if somehow the FIIs can be wooed back, then this situation canalso be addressed to a certain extent. FII net investments have plungedfrom `1,78,537.80 crores in 2012-13 to `(-)37,062.40 crores as on 30thSeptember 2013.From June 2013 till September 2013 the FIIs have withdrawn from the Indianmarkets. Despite a modest recovery in the rupees value between 4th and12thSeptember 2013, the investors remain wary of Indias excessive dependence onvolatile hot money flows to finance its current account deficit. The investorsborrowed cheap short-term money in the US and invested in higher yielding assets

in India, Indonesia, South Africa and other emerging markets. This resulted in moremoney flowing into debt, equity and commodity markets in these countries. In India,


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many companies resorted to heavy borrowings overseas (since interest rates werelower there). The massive capital inflows also enabled India to comfortably financeits trade and current account deficits rather than addressing the structural aspects ofCurrent Account Deficit (CAD).

India's Gross Domestic Product grew only at 4.4 percent in the second quarter of2013, the worst quarterly rate since 2002, hurt by a decline in mining andmanufacturing. When a countrys imports far exceeds its exports the CAD increaseswhich is a cause for worry. This certainly seems to be a large contributor to thedepreciation of the rupee. Over the past 2 years, India's money supply grew ataround 29 per cent, while it's GDP grew at a much lower pace. This caused inflationto go into the two figure realm. By limiting the money supply, inflation and,potentially, the rupee's value would be controlled- but it would severely impact thecountry's growth. India's GDP has dropped from 6.2 per cent to 4.4 per cent in latestquarter of this fiscal year, so India's growth would be hampered by lowering itsmoney supply.

India should let the markets remain open and democratic- eventually, Indian goodswill be cheap enough to a point where they will be easily exported. India'surbanisation is not going to stop, wages will continue to rise, and inflation will becontrolled since the money supply can be kept at par with GDP growth. The rupeewill probably rise in the short term but at a certain point, equilibrium will kick in.There is a high level of pessimism in the markets. It goes without saying that Indianeeds to address the rising current account deficit and slow growth on a war footingto ensure that the rupee does not depreciate any further.

depreciation of the indian rupee

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