Cecily, you will read your political economy in my absence. The chapter on the fall of the rupee you may omit. It is somewhat sensational... -The importance of Being Earnest, Oscar Wilde
PART 1 The Rupee vs. Dollar Duet
Actually, why should the rupee concern us at all? It is merely the price of a piece of paper. Is it any different from the pair of another bit of paper say a movie ticket? Yes it is. Changes in the price of movie ticket only affects only film producers and viewers. Your movie visit becomes either cheaper or more expensive. Thats all. With the exchange rate, things are not that simple. The price of the rupee affects all of us -from the price of we pay for an imported soap to the ability of software firms to undercut the global competitors. Get the exchange rate wrong, and the entire economy is in deep trouble.
The rupee is back in the news. Now, the reason is its raising value. Last one year the falling rupee was giving nightmare to the business, corporates and the policy makers. The falling or weakening rupee was the headlines every second day for almost most of 2013. Now, it is the other way round
Let us understand what makes this duet of rupee vs dollar. 'A simple demand-supply framework for making sense of the rupee's movements'
How does one understand this mysterious complexity of foreign-exchange markets? Let us start with the most simple understanding of this process. To start with, a falling rupee (known as depreciation of rupee)and rising dollar (appreciation of dollar) means that dollars are in short supply and in great demand and hence the value of dollar goes up. A rising rupee (appreciation of rupee) and falling dollar (depreciation of dollar) means the reverse - an oversupply of dollars.
|What we need to understand is why and how does this happen and what are the likely impacts and the government policies to manage this issue.|
Headlines such as The rupee has appreciated or depreciated 30 paise or so many percentage against the dollar appear on a daily basis. Such reports on currency invariably attribute the reasons for In India, the conventional measure of the Rupee value is to compare it to the US Dollar. It is first important to remember that similar to how there are two sides to a coin, there are two sides to an exchange rate: two currencies.
RUPEE DOLLAR OVER THE YEARS
1949 -52 the rupee is pegged to the pound. The latter is devalued and the rupee falls in tandem. There are calls for a revaluation to help lower inflation and the cost of capital goods.
1952-65 the rupee is kept steady despite balance of payments problems. India bailed out with international aid.
1966 the big devaluation. A severe forex crisis and drought send the government rushing to Washington for help. Is forced to devalue the rupee, sparking of political controversy.
1967- 81 the two oil shocks of 1973 and 1979 sends economy reeling. Remittances from workers in West Asia create a buffer. A current account surplus in the late 1970s keeps the rupee stable.
1982-90 the obsession with a stable rupee goes. Successive governments devalue the rupee. Exports boom. But there is trouble as the fiscal deficit and ECBs start climbing.
1991 the year of crisis. The rupee is devalued sharply in response to near bankruptcy. The reforms process is kicked off in earnest.
1992-2001 the rupee is gradually freed of controls. The RBI gradually devalues the rupee by 3-4 % a year. India avoids emerging markets meltdown.
2002 -03 Software exports change the rules of the game. India starts earning huge current account surpluses. Capital inflows, to pick up. The rupee starts going against dollar.
2012-13 Major depreciation in Rupee-breaches 60 plus mark.
2014 Rupee bounces back.
|2013 -14||60 plus and minus|
Rupee weakening/depreciation or dollar strengthening/appreciating:
When we say rupee depreciated it means that the rupee has lost it value against dollar where the dollar has become stronger (for example we can say one dollar is change from 61 rs to say 62 rs. The reverse is true when we say rupee has appreciated (When the Rupee is trading at 62 against the US Dollar, it can appreciate to 61 against the Dollar due to Dollar weakness or Rupee strengthening).
That is, a rupee is said to fall or weaken or depreciate when more rupees are needed to buy a dollar. It is said to rise or strengthen or appreciate when less rupees are needed to buy a dollar (Most exporters may want a weak currency (here rupee) why? See the impact para).
In this article let us discuss in detail about the rupee depreciation its causes and impact.
Depreciation and Devaluation:
It is important to note that rupee depreciation is different form devaluation. While in depreciation the value of currency is driven by the market forces (currency movements influenced indirectly by supply and demand, uncertainty in markets, markets/investors reaction to government decision, or some Economic/Political issue), whereas in devaluation the currency value is deliberately influenced (depreciated) by the government policy measures. Most often devaluation is done to boost the exports of the country (Indian government adopted the devaluation measures during 1966 and in 1991 during economic reforms).
When rupee depreciates:
The depreciating rupee will be positive for the exporting industries. For example, Indian IT sector which generates more than 80-90 per cent of their $100 + billion revenue from the overseas markets and this kind of appreciation in foreign currency will enhance their actual realization of revenue in dollar terms. According to some experts, every one per cent change in rupee-dollar has a 50 to 60 basis points impact on the margins on the net profit numbers of IT services companies(depends on the prevailing exchange rate). Individually, expatriates living outside India too gain by rupee depreciation.
Most exporters may want a weak currency (here rupee) why? Because when a currency depreciates, the exporters get more of the local currency for every unit of foreign currency though the quantum of trade remains unchanged. But this depends upon the nature of the product they export. Say for example if they are exporting manufacturing goods, machineries ,automobiles and other product which use imported components as a part of their finished final product, then they do not benefit much since the imported goods become costly due to the depreciation of domestic currency ( say rupee).
It is to be noted that, with the recent depreciation of rupee the remittances from abroad have jumped substantially since the conversion brings in a higher returns for the NRIs (higher flow of NRI investments into Banks example Kerala and other places).
When a currency loses its value it creates many problems for the economy. It leads to high inflation, as India imports around 70 per cent of its crude oil requirement and the government will have to pay more for it in rupee terms. Due to the control on oil prices, the government may not easily pass the increased prices to the consumers. Further, this higher import bill will lead to rise in fiscal deficit for the government and will push the inflation, which is already hovering around the double-digit mark. Since the last few years, oil companies cited the fall in the rupee value to the dollar to increase petrol prices recently. For oil marketing companies with every fall in the rupee, the gap in their balance sheet increases.
On the other hand, Indian companies will also have to pay more in rupee terms for procuring their raw materials, because of a depreciating rupee against dollar. Some times corporate, who have foreign currency loans on their books, continue to do so despite a depreciating rupee, keeping in view the affordable interest rates in developed markets (it would be better to hold on to foreign currency debt as one can borrow at relatively low interest on dollar debt compared with high interest on rupee debt). The depreciation of rupee has impacted the some sectors in three ways. First, input costs have risen as these companies use imported components. Second, some companies will have to pay higher royalty to foreign parent firms/. Third, many companies have foreign currency loans in the form of external commercial borrowings and foreign currency convertible bonds. Companies with high exposure to Foreign Currency Convertible Bonds (FCCBs) may face default problems.
Individually, traveling abroad becomes more expensive as travel cost can go to higher levels. Students studying abroad too will be hit as more rupee will go out to pay for the courses and stay.
Not only is the rupee falling, for some, the pay cheque may shrink as well. Every industry which is dependent on imports will have to face an increase in cost of production and operations. In order to nullify the increase, these companies will have to rationalise costs within their control. One of this will be human resources. So, either lesser number of people will be hired or the salary bill will be kept constant or reduced.
When Rupee value depreciated
Reflection in the Stock Market:
Depreciation of rupee also affects the money flow in the Indian stock markets. FIIs, the main investors in the Indian equity markets, also start withdrawing their investments from the markets fearing loss of value. In terms of portfolios, theoretically as discussed earlier investment returns on the stock of companies who procure their raw materials (import) the returns will take a hit as the shares of these companies will fall(since higher cost of imports will affect their profitability). On the other hand stocks of Information Technology (IT) companies and export-oriented units may do better.
It is important to note that what causes this upward and downward movement of dollar vs rupee. We understand firm the above discussions that if the supply of dollar in the market is less, the value of dollar is bound to go up against rupee. Also the supply of dollar impacts the overall capital flow in the economy and thus impacts the exchange rate and the overall economic activity.
Now, let us look at the instances where supply of dollar and hence the overall capital flow gets affected. Dollar supply in the market comes from the following sources
There are four main ways in which India gets USD.
Exports- When we export goods and services we get paid in USD.
Investment. When foreign investors invest in India they bring in USD and thats another channel we get USD. Dollars come in through a variety of means - through, for instance, foreign institutional investors (FIIs) into the stock markets, foreign direct investment (FDI) into Greenfield projects or acquisitions
The third way which is remittances - NRIs sending in money to India (deposits by non-resident Indians).
Assistance or aid from multilateral institutions and borrowings by companies.
In essence, the demand for dollars arises from import needs, debt payments and outward remittances. Oil prices play a crucial role. In addition, to it and the external investments building up of mega projects (say a mega refinery project, power or any other infrastructure project) within the domestic economy also increases the dollar demand.
Overall, all the above factors influence the capital flows in the economy. When there is low capital flow (low supply of dollar) then the rupee depreciation takes place. Specifically, when a rupee depreciates it is due to the following factors
Increasing Trade deficit Balance of the country (increasing current Account deficit) due to more imports than exports, Oil prices.
Lower FII (Foreign Institutional Investors) and FDI (Foreign Direct Investment) investment. Government policy (both domestic and foreign) and the state of the economy. Volatility in the capital markets
Higher borrowing by Indian corporate for funding the business.
The reverse is true when the capital flows are positive i.e more capital flow and hence more dollars and low dollar value compared to rupee (rupee appreciation)
The recent volatility of Dollar has been a combination of all the above said factors. Also, it is to be noted that these factors are inter related and affects each other. For example, increasing oil prices leads to higher out flow of forex payments and thus resulting in higher current account deficit. This further affects the availability of dollar(less supply of dollar) in the market and hence its value (dollar value increases as more rupee is required to buy a dollar) against the domestic currency (say rupee). The increased value of dollar leads to higher payment of import bill which further widens the current account deficit and thus the vicious cycle continues.
Let us briefly discuss these factors,
Increasing trade deficit (Current Account deficit)
The biggest problem seems to be India's huge current account deficit, which hit a record high 4.8 per cent of gross domestic product in the year 2013. The measure of whether export-import equation is fine or not is called CAD (Current Account Deficit), which is largely the difference between exports and imports and in Indias case, the CAD is becoming higher and higher with each successive month, and this means that Indias foreign exchange reserves are diminishing. It is well known that India is a net importer (imports more than what it exports) which means it has a deficit and the deficit has been surging to new heights since the last few years especially with the increasing import of Oil and Gold. Also, since India has to bring in the majority of its requirement from outside the country and the demand for oil in India has been going up every year and this has led to the present situation. As and when the demand for oil increases in India or there is an increase in oil prices in the global market, there also arises a need for more dollars to pay the suppliers. This also results in a situation of higher deficit where the worth of the decreases significantly in comparison to the dollar. Worsening trade deficit is bad news for the rupee as the demand for US dollars goes up. A higher current account deficit weakens the currency. 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. CAD thus effectively measures the amount of net capital inflows from abroad that an economy depends on, whether in the form of borrowings or investment. Two factors have been blamed for widening of CAD. One is the import of gold. India is one of the largest consumers of gold and the heavy import of gold widens CAD as the government has to provide for dollars for every ounce of gold imported. The other factor is crude oil imports. India imports more than 75% of its crude oil requirement. A slowdown in inflows from foreign investors also leads to a weak currency.
In the past two years India has witnessed volatility in the flow of the FII. From the initial surge of flow of investments, there has been a slowdown in the FII flow during the second half of the 2013 due to the following reason-
The proposed unwinding of the bond purchase programme (also called quantitative easing)
Crisis in the Eurozone
There are several factors. But the recent bout of weakness is fuelled by the prospect of the unwinding of the bond purchase programme (also called quantitative easing) of the US Federal Reserve. The US Fed had been printing money to bolster its economy. Now that there are signs of some strength in the US economy, it may start winding down the programme of adding more money into the system.
A possible winding down of the asset purchase programme of the US Fed and improvement in the health of the US economy will strengthen the US dollar. Investors will withdraw investments from emerging markets such as India in the short term and chase assets in the US, since assets in a strengthening US economy are seen as attractive. Thus the Federal Reserves decision to reduce its Quantitative Easing has also contributed to the present situation as every asset class has been affected by the decision. The fear of Fed pulling the plug on easy money has triggered a selloff by foreign institutional investors (FIIs). Also, lower rating by credit rating agencies, negative view by investors, investment bankers normally leads to a corresponding fall in India's weight and hence capital outflow.
The outflow of money from emerging markets may lead to currency weakness. Concerns over the pace of economic reforms, the health of the domestic economy and a yawning trade deficit are also impacting the rupee. Available statistics with the government show that both the debt market and the equities have witnessed a reverse flow of money. The fear is that the tempo of the outward flows might increase in the coming days.
India would need strong foreign capital flows to finance the current account deficit. However, with FII flows too came down, the pressure got accentuated and rupee nearly breached the 60-mark. Moreover, the global volatilities also had an impact in the entire Asian markets, including, India, The rupee weakness was also influenced due to the European crisis.
According to some experts, the problems are fundamental and our policy makers do not seem to realise the basic problem which is the huge deficit on current account and over dependence on capital inflows. The basic problem is we continue to live on borrowed money year after year.
At a time when the rupee is depreciating, foreign portfolio investors are wary of investing in India since any rupee income they earn could get eroded by a higher exchange rate when they want to take back that income out of India. Thus, a sort of vicious cycle is triggered as the rupee dips, FIIs tend to pull out money and that in turn makes the rupee dip further. This can be offset by policy measures which can boost longer term capital flows from abroad like FDI or overseas borrowings. In fact, of late, the FIIs have been heading to greener pastures owing to the greater operational efficiency and lesser bureaucratic problems that have unsettled the Indian business fraternity and hampered its overall economic growth.
As discussed earlier, one of the big factors worsening Indias CAD is the ever increasing gold and oil imports. Reducing the import of Oil and Gold is not easy. Reducing their dependency has its own repercussion on the industry and the overall growth in the economy. These things tell us that it is absolutely essential for us to have a steady flow of USD or other big currency coming in the country in order to finance our Oil bill and pay for our other imports, if we run out of foreign exchange; we will be in big trouble. According to some experts, a major part of Indias external reserves, are not export earnings but dollars accumulated by the RBI when it mopped up dollars coming in through short-term flows. Therefore, bulk of the reserves is in the nature of debt and do not in real terms belong to the country. This further enhances the uncertainty and volatility of capital flow. One of the key reasons for this is the surge in short-term external commercial borrowing by companies on the assumption that the increasing supply of money and the very low interest rates will prevail indefinitely which may not be true in the long run.
Volatility in the equity market
The equity markets in India have been volatile for a certain period of time. This has put the FIIs into a dilemma as to whether they should be investing in India or not. In recent times their investments have touched an unprecedented level and so if they pull out then the inflow will go down as well. According to a report, the international investors in India have withdrawn to the tune of INR 44,162 crore during June 2013 and this is a record amount. This has also created a current account deficit (CAD) that is only increasing, thus contributing significantly to the depreciation of the INR.Also, some experts historically, the Indian Rupee has been depreciating roughly in line with the fall in its Purchasing Power Parity (PPP) since the early 1980s. While the PPP was 15 around 1982, the actual exchange rate was Rs 9.30 per US Dollar. It is the inflation that negatively impacts PPP and pushes a currency down. But the present spike was rather sharp on the back of debt default concern in the euro zone
Now let us see how does the Government or the RBI (RESERVE BANK OF INDIA) manages the value of currency in the market. If there is a sudden choking in the supply of dollars, the rupee weakens. When this happens, the RBI steps in and sells dollars from its foreign-exchange reserves. This increases the supply of dollars in the market. Also within the domestic market, when the rupee weakens, the RBI tries to control the supply of the rupee (i.e. its liquidity) by raising its price as reflected in interest rates and by asking banks to keep money with it to decrease rupee supply (by hiking the cash reserve ratio).Conversely, when dollars are pouring in the RBI purchases dollars through a variety of means. From time to time the RBI funds public-sector crude imports directly to relieve the pressure on the market.
Also, RBI periodically urges them to bring back exporters earnings as soon as it is realized, since, exporters are allowed up to 180 days to bring back their earnings. What happens is that exporters, anticipating a depreciation, keep their money out till the very last minute causing pressure on the supply. Companies also borrow abroad but keep the money outside for long periods. This also has leads to pressure in the system.
RBIs intervention to buy Foreign exchange during surge in capital investment leads to build-up of (foreign exchange) reserves, which provides self-insurance against external vulnerability of rupee.
When RBI sells its foreign exchange reserves, it stems (halts) the fall of rupee.
Higher foreign exchange reserve levels restore investor confidence and may lead to an increase in foreign direct and indirect investment flows boost in growth and helps bridge the current account deficit.
Some economists believe that if the RBI actually allows supply and demand to operate, the rupee's volatility will be lower.
It is to be noted that as the financial system develops, the growing integration of this forex market with the money market and the government securities market has meant closer linkages between monetary policy and exchange rate policies.
The government's recent decision to hike duty on gold, the second biggest import item, has helped cut imports of Gold to a larger extend compared to previous months. Of course the side effect of this is its impact on the gold and Jewellery industry business. However, if, FIIs continue to pull out, the government will have to come up with new plans.
According to economists, the key solution lies in better investment climate that helps people get other alternates to gold for investment domestically and for encouraging capital flows regularly. According to experts, there is a need to create a climate where exports rise (services exports declined last month), foreign investments (long term), NRI investments come into the country, and all that in turns help the CAD. Also, this situation can only be addressed by exporters who can bring in dollars in the system. As discussed earlier if the investments can be wooed back, then this imbalance can also be addressed to a certain extent. To make this happen the government should take relevant policy measuers.
NRE, NRO AND FCNR
To 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 (FCNR) account is the same as the NRE account except that the deposits are in foreign currencies. Though interest earned on NRE and FCNR accounts is tax-free in India, the interest income from NRO accounts is liable to tax. However, NRIs living in countries with which India has a Double Taxation Avoidance Agreement (DTAA) can avail of lower tax rates.
When rupee Appreciates
Year 2014 started with a different note. The rupee started appreciating after a great downfall. The quick trend reversal was unexpected however was obvious since the capital flows are increasing along with the increasing FII and reducing current account deficit. One of the largest appreciation of rupee happened during 2002-03. The rupees rise would have been far sharper had the RBI not frantically bought dollars from the market to keep the rupee down.
As discussed earlier a strong domestic currency may strain the countrys export competitiveness. During 2003 the surging invisibles which include receipts from overseas workers and export boom in software and IT enabled services caused the major flow of dollars and thus the appreciation of rupee. Also, one of the main reason for this was the huge current account gap of the U.S (over $500 billion) during this time. With the subsequent collapse of interest rate and the fall in equity market the foreign investors were wary of pouring money into dollar assets thus leading to a weak dollar.
During the appreciation of rupee the following trend or strategy is observed in the markets
Economic Theory of Foreign Exchange valuation
VALUATION OF THE CURRENCY
The judgement about the "right" value (whether the rupee is overvalued or undervalued) for the rupee is always debated among the experts.
Overvaluation and Undervaluation
It is quite common to hear people claim that a country's exchange rate is overvalued or undervalued. The first question one should ask when someone claims the exchange rate is overvalued is, overvalued with respect to what? There are two common reference exchange rates often considered. The person might mean the exchange rate is overvalued with respect to purchasing power parity (PPP), or it may mean the exchange rate is overvalued relative to the rate presumed needed to balance the current account.
Undervaluation of a currency
If a nation's currency is "undervalued," it means the rate at which it can be exchanged for other world currencies is too low. If you buy goods made in foreign countries -- or work for a company that sells goods overseas -- then currency values have a real impact on your purse.
A currency is considered undervalued when its value in foreign exchange is less than it "should" be based on economic conditions, at least in the opinion of currency traders, economists or governments. For example, say that foreign exchange traders believe $1 is the equivalent of 50 rupees. But if the actual exchange rate is 60 rupees to the dollar then the rupees is viewed as undervalued. That it is highly undervalued or depreciated against the dollar and the rupee explores its true value by appreciating to that level. According to a report during 2012 by the International Monetary Fund (IMF) rupee is highly undervalued against the dollar.
A currency may be undervalued simply because
There's insufficient demand for it or no one wants to buy
Currency undervaluation benefits the home country which does it since it makes their export cheap, boosts demand and hence revenue and the same time make the import expensive. Theoretically, undervalued currency allows a country to essentially impose a tax on imports, but without breaking the international trade rules that prohibit taxes that are actually called taxes(tarrifs/quotas/trade barriers in case of international trade). Sometimes it is alleged that governments also deliberately undervalue their currencies -- for example, by manipulating the money supply or setting artificially low exchange rates.
REER- Real effective exchange rate
In India, The RBI uses a six -country real effective exchange rate (Known as REER-6) against a basket of 6 other national currencies) to judge competitiveness. REER is the nominal exchange rate adjusted for inflation differentials. REER is the weighted average of any countrys currency to the basket of other (adjusted for inflation).A country whose REER Index is close to 100 is considered to be fair valued. When REER goes above 100 levels its believed to enter over-valued zone and less than 100 is undervalued.
INDIAN REER 6
The weighted average of a country's currency relative to an index or basket of other major currencies adjusted for the effects of inflation. The weights are determined by comparing the relative trade balances, in terms of one country's currency, with each other country within the index.This exchange rate is used to determine an individual country's currency value relative to the other major currencies in the index, as adjusted for the effects of inflation. All currencies within the said index are the major currencies being traded today: U.S. dollar, Japanese yen, euro, etc.
INDIAS ECONOMIC REFORMS EXTERNAL SECTOR -BACKGROUND
Ecconomic Reforms in india
Around two decades ago, the then, India's finance minister and the present prime minister Dr. Manmohan Singh unleashed a set of economic reforms (Liberalisation, Privatization and globalsiation). Indian economy was facing a major crisis in the foreign exchange front. They are
Continuously depleting foreign exchange reserves due to the impact of gulf war on the oil prices (only two weeks of FOREX was available).
Near -financial bankruptcy with 67 tons of treasury gold mortgaged by the Indian government to the Bank of England
Thus the government took some bold macroeconomic reforms. Some of the key reforms to manage the forex crisis and to ensure steady capital flow includes
Liberalised Exchange Rate Management System (LERMS) that created a dual exchange rate for the rupee. The partial float of the rupee was a fig leaf for one of the steepest controlled rupee devaluations in Indian history. On July 1, 1991, the exchange rate was 18 to the dollar. By March 1993, the exchange rate had plunged to 32 to a dollar - a decline of 77% in a little over 18 months.
The 'partial float' of the rupee led eventually to current account convertibility but not to the full capital account convertibility. The rupee 20 years later remains partially convertible on the capital account with the Reserve Bank of India ( RBI) allowing Indians to remit only up to a fixed amount $200,000 a year for capital investments abroad.
Since Dr Singh's interim Budget of July 1991 and his magical Budget of February 1992, the rupee has depreciated by more than 100% in 20 years (from 25.95 in February 1992 to just under 60 plus today). According to experts, a constantly weakening rupee pushes up the cost of imports, widens the trade and current account deficits, raises the external debt burden, makes petro products more expensive and fuels inflation (this trend could be observed since last two decades).
Reasons for reforms:
Prior to 1991, India followed License-quota-system and import substitution strategy. During that era, the encouragement for foreign companies to invest in India was less. Imported products attracted heavy custom duty (which led to rise of smugglers and mafias). Also, thanks to the license-quota-raj, the private Indian companies werent big or exposed enough to compete in international market so export was also low. Thus during that time incoming money (via export, investment) was very low. Hence RBI couldnt build up huge forex reserve. As discussed earlier 1991, the Forex reverses of India were about to exhaust. Then India had to open up its economy for private and foreign sector investment. Remove the license-quota-inspector raj etc. to boost the incoming flow of dollars and other foreign currencies. Hence post LPG reforms, RBI has been actively buying/selling dollars, pound yen etc. from the currency market, whenever FII/FDI inflow is high. Nowadays RBI intervenes in the FOREX market, only to stop the excess volatility (fluctuation) in rupee exchange rate.
Foreign currency assets (FCA) (US dollar, euro, pound sterling, Canadian dollar, Australian dollar and Japanese yen etc.)
Special drawing rights (SDRs) of IMF
Reserve tranche position (RTP) in the International Monetary Fund (IMF)
The level of forex reserve is expressed in US dollars. Hence Indias forex reserve declines when US dollar appreciates against major international currencies and vice versa.
RBI gains Foreign exchange reserves by
Buying foreign currency (via intervention in the foreign exchange market
Funding from the International Bank for Reconstruction and Development (IBRD), Asian Development Bank (ADB), International Development Association (IDA) etc.
According to some experts a weak rupee may be more helpful in a country like china which has a huge manufacturing base with substantial exports. On the contrary: a current account deficit arising from an import bill of billion of dollar erodes the currency, pushes up inflation and lowers competitiveness. According to critics, a stronger rupee will not only trim our trade and current account deficits and temper inflation, it will attract more FDI and FII. The biggest long-term beneficiaries of a stronger rupee would be India's manufacturing productivity. Since, cheaper imports would allow companies to ramp up foreign technology and build infrastructural and manufacturing assets. These, in turn, would lead to a spike in competitiveness, boosting exports based on quality. Experts also point out that the Economists recent Big Mac Index shows that the rupee is undervalued Vis-A -Vis the US dollar by 61% while the yuan is undervalued by 41%.
NOTE ON CURRENCY
The Indian rupee is the official currency of the Republic of India. The issuance of the currency is controlled by the Reserve Bank of India. The modern rupee is subdivided into 100 paise (singular paisa), though as of 2011 only 50-paise coins are legal tender. Banknotes in circulation come in denominations of 5, 10, 20, 50, 100, 500 and 1000. Rupee coins are available in various denominations of 1,2, 5,10, 20, 50, 60, 75, 100, 150, 500 and 1000. The only other rupee coin has a nominal value of 50 paise, since lower denominations have been officially withdrawn.
The Indian rupee symbol ' (officially adopted in 2010) is derived from the Devanagari consonant (ra) and the Latin letter "R". The first series of coins with the rupee symbol was launched on 8 July 2011.The Reserve Bank manages currency in India and derives its role in currency management on the basis of the Reserve Bank of India Act, 1934. Recently RBI launched a website Paisa-Bolta-Hai to raise awareness of counterfeit currency among users of the INR.The Indian rupee sign is the currency sign: for the Indian rupee, the official currency of India. The new form of Indian rupee designed by Mr. Udaya Kumar (a student of Indian Institute of Technology). It was presented to the public by the Government of India on 15 July 2010, following its selection through an open competition among Indian residents. Before its adoption, the most commonly used symbols for the rupee were Rs, Re or, if the text was in an Indian language, an appropriate abbreviation in that language.
1US Dollarequals 59.96Indian Rupee
The Renminbi is the official currency of the Peoples Republic of China. The name (simplified Chinese: literally means "people's currency. The yuan is the basic unit of the renminbi, but is also used to refer to the Chinese currency generally, especially in international contexts. (The distinction between the terms "renminbi" and "yuan" is similar to that between sterling and pound).
The United States dollar (sign: $; code: USD; also abbreviated US $), is referred to as the U.S. dollar, American dollar, US Dollar or Federal Reserve Note. It is the official currency of the United States and its overseas territories. It is divided into 100 smaller units called cents.
The U.S. dollar is fiat money. It is the currency most used in international transactions and is the world's most dominant reserve currency. Several countries use it as their official currency, and in many others it is the de facto currency. It is also used as the sole currency in two British Overseas Territories: the British Virgin Islands and the Turks and Caicos islands.
The pound sterling (symbol: ; ISO code: GBP), commonly known simply as the pound, is the official currency of the United Kingdom, Jersey, Guernsey, the Isle of Man, South Georgia and the South Sandwich Islands, the British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence (singular: penny). A number of nations that do not use sterling also have currencies called the pound.
Rupee Denominated Debt
Rupee denominated debt refers to that part of Indias total external debt that is denominated in Indias domestic currency, the Rupee.
In contrast to foreign currency denominated external debt, in case of rupee denominated debt the currency risk (the risk arising from appreciation or depreciation of the nominal exchange rate) is borne by the creditor and not by the borrower. The contractual liability (principal and interest that is designated to be paid by the borrower as agreed upon in the debt contract) is settled in foreign currency. Accordingly, the borrower always pays back the foreign currency equivalent of the rupee denomination valued at the spot exchange rate prevailing at that point in time. Thus, if the domestic currency appreciates vis--vis the foreign currency, the creditor stands to gain vis--vis the borrower since he receives more dollars per unit of Rupee.
In India rupee denominated debt comprises the following categories;
Rupee Debt; Includes the outstanding defense and civilian state credits extended to India by the erstwhile Union of Soviet Socialist Republics (USSR). The repayment is primarily through exports of goods to Russia.
Rupee denominated Non-Resident Indian (NRI) Deposits including the Non-Resident (External) Rupee Account (NR(E)RA) and Non-Resident Ordinary Rupee (NRO) account.
Foreign Institutional Investors (FII) investment in Government Treasury-Bills and dated securities
FII investment in corporate debt securities.
What are the lessons learnt. The above information and discussion indicates the following
The rupee dollar rate is a two way movement. That is they can swing either way. The trend has shown market (read business sentiments) tend to believe that it is always one way. During the appreciation everybody believes that the rupee will continue to gain against the dollar and the same belief exists during depreciation which is not right.
Exchange rates are no laughing matter. They have wrought havoc-in Mexico in 1992, East Asia in 1997(Thailand and others), Russia in 1998 and Argentina in 2002.The inevitable result: inflation and unemployment.
1997 Asian financial crisis
The Asian financial crisis was a period of financial crisis that gripped much of East Asia beginning in July 1997 and raised fears of a worldwide economic meltdown due to financial contagion.
With the financial collapse of the Thai baht after the Thai government was forced to float the baht due to lack of foreign currency to support its fixed exchange rate, cutting its peg to the US$, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.
Indonesia, South Korea and Thailand were the countrys most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump. China, Taiwan, Singapore, Brunei and Vietnam were less affected, although all suffered from a loss of demand and confidence throughout the region.
Foreign debt-to-GDP ratios rose from 100% to 167% in the four large Association of Southeast Asian Nations (ASEAN) economies in 199396, and then shot up beyond 180% during the worst of the crisis. In South Korea, the ratios rose from 13 to 21% and then as high as 40%, while the other northern newly industrialized countries fared much better. Only in Thailand and South Korea did debt service-to-exports ratios rise.
Although most of the governments of Asia had seemingly sound fiscal policies, the International Monetary Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currencies of South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis. The efforts to stem a global economic crisis did little to stabilize the domestic situation in Indonesia, however. After 30 years in power, President Suharto was forced to step down on 21 May 1998 in the wake of widespread rioting that followed sharp price increases caused by a drastic devaluation of the rupiah. The effects of the crisis lingered through 1998. In 1998 the Philippines growth dropped to virtually zero. Only Singapore and Taiwan proved relatively insulated from the shock, but both suffered serious hits in passing, the former more so due to its size and geographical location between Malaysia and Indonesia. By 1999, however, analysts saw signs that the economies of Asia were beginning to recover. After the 1997 Asian Financial Crisis, economies in the region are working toward financial stability on financial supervision.
Until 1999, Asia attracted almost half of the total capital inflow into developing countries. The economies of Southeast Asia in particular maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result the region's economies received a large inflow of money and experienced a dramatic run-up in asset prices. At the same time, the regional economies of Thailand, Malaysia, Indonesia, Singapore, and South Korea experienced high growth rates, 812% GDP, in the late 1980s and early 1990s. This achievement was widely acclaimed by financial institutions including IMF and World Bank, and was known as part of the "Asian economic miracle."
In 1994, economist Paul Krugman published an article attacking the idea of an "Asian economic miracle". He argued that East Asia's economic growth had historically been the result of increasing the level of investment in capital. However, total factor productivity had increased only marginally or not at all. Krugman argued that only growth in total factor productivity, and not capital investment, could lead to long-term prosperity. Krugman himself has admitted that he had not predicted the crisis nor foreseen its depth.
The case of East Asia (Thailand) and capital account convertibility
The Thais had it good for too long. They had enviable foreign currency inflows, booming exports, a reasonable debt service ratio and an exchange rate which did not show any signs of budging. All thanks to the Bank of Thailand, its central bank which supported the currency in the face of strong capital inflows. When the Thai baht took a sudden beating the authorities were forced to devaluate the baht. The corporates and other investors went overboard with their short term overseas borrowings. Easy access to funds meant substitution of domestic short term loans within off-shore short term borrowings. Since the baht value was fixed the Thai investors merrily borrowed overseas without hedging. With falling exports, some of them possibly in anticipation of depreciation started covering their exposures abroad i.e. buying forward dollars.
Ideally, under such conditions the currency should show a tendency to depreciate. But this did not happen. In fact, the bank of Thailand was defending the baht even in the face of growing curren
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