Why Is The Rupee Falling
By : Subhanshu Gupta

The roller coaster ride of rupee was witnessed in the last month when it touched an all time low of Rs 46.07. All the while Reserve Bank of India kept assuring us that the fundamentals of the economy are intact. It was only a few days back when it pushed the panic button and asked all corporate sector borrowers in the markets abroad (external commercial borrowings), exporters and holders of American Depository Receipts to repatriate their dollars. RBI hopes to garner $2 billion in this way.

But the falling rupee has to be seen against a broader perspective, against the news of a fall in business confidence index, fall in industrial growth, a rise in trade deficit and a rise in inflation. The volatile political climate and its repercussions on the stock market, which has been on the decline since February, should not be forgotten either. There is news of millions of dollars being withdrawn ($545.7 million in June and July alone) from the market by the Foreign Financial Institutional Investors (FIIs). With America being India’s biggest trading partner, the rupee fall against the dollar is serious even if the rupee does not fall as much against other currencies. The average person on the street may not be directly affected by it (unless he is planning foreign travel or sending a child abroad to study), but because the fall in the value of rupee is going to result in inflation, everyone, sooner or later will feel the impact, specially the elderly and the poor. The fear of inflation usually triggers central banks into action and it did so in India also recently when the rupee’s value breached the psychological barrier of Rs. 46.

However, the fall in rupee may be a blessing for some sections of the society. They are the exporters. They have been able to sell their products cheaper in markets abroad. They are happy because a lower rupee value for dollar will enable them to compete with China and South East Asia. In fact, ever since the rupee started to slide, the export performance started to improve dramatically. A low rupee will also prevent “dumping” of goods by neighboring countries, which has been creating problems for some major domestic industries. Others who will be happy with the rupee’s fall are those receiving money from relatives abroad. Each dollar will give them more rupees.

The question that haunts our mind is that why is the rupee depreciating against the dollar? Well...like any other price, the price of the dollar is determined by its demand and supply. If the demand goes up, then the price of the dollar also goes up. Recently, the demand for the dollar went up mainly because of the government’s own demand on account of its heavy oil and defense import bill. The corporate sector’s demand also went up because it wanted dollars for imports already in the pipeline. The supply of dollars at the same time, dwindled as the FIIs started withdrawing money from the Indian stock market. Many returned to America since the interest rate hike by the Federal Reserve recently. Foreign direct investment inflows too have been meager and a mismatch between the demand and supply occurred and consequently the rupee fell.

The RBI intervened promptly in its usual manner by raising the bank rate and the cash reserve ratio of banks. It also raised the rates of bank refinance. It believed that people were borrowing rupees in order to speculate in the Forex market. The RBI, however, did not intervene in a big way by selling dollars from its reserves though most central banks would have done so.

The rise in the bank rate, meanwhile prompted commercial banks to hike their own lending rates, sending adverse signals to the corporate sector, namely a higher borrowing cost. Surprisingly, despite RBI’s recent intervention, the rupee kept falling and it reached Rs. 46 on August 11.

Earlier, the RBI stopped its attempts to arrest the fall realizing its futility and instead issued a long explanatory note. It declared that there was to be no more targeting of the rupee to any specific value and the market was going to decide where the rupee would stabilize though monitoring was promised. Seeing it cross Rs. 46 however made it panic.

The rupee will pick up in value once the market has calmed down and more dollars come into the market. While this drama was being enacted, exporters who had been doing brisk business on account of the rupee’s depreciation, stopped bringing back their dollars earned abroad and further exacerbated the shortage of dollars. Once exporters start bringing back the dollars especially after the RBI’s edict, the market would come back to normal. For the rupee to stabilize, inflation has to be brought under control.

RBI is reviewing the Export Earner Foreign Currency (EEFC) scheme to ensure more dollar remittances from abroad. The current reserves of $2 bn in the EEFC account is sizable, which will help it to stand off a further fall in the rupee.

As per the scheme, exporters are allowed to park 50%-70% of their foreign exchange earnings abroad for a period of 180 days under the Foreign Exchange Regulation Act. This is to help them in meeting their day-to-day overseas expenditure. However some exporters are parking their funds beyond this limit. RBI is expected to ask for repatriation of the proceeds of ADRs and ECBs from abroad if they have been parked there for a long time.

Since several corporates have raised over a billion dollars through the ADR route, repatriation of the proceeds could help stabilize the rupee, which has lost over 5% during the current financial year.

The other positive news for the rupee is that during the month of August, Foreign Institutional Investors have turned to net buyers with their current net purchases of Rs 1.4 bn. They were net sellers in the equity market to the tune of Rs 14.1 bn in the month of July. Further the RBI has cleared foreign direct investment (FDI) worth Rs 9.5 bn. With the increasing FII investment, although at a slower pace, clearance of FDI and repatriation of proceeds of ADRs will lead to an increase in the supply of dollars and one can expect it to bring some relief to the falling rupee.

A lower rupee will enable exporters to rake in more dollars in the future. But as oil imports and other essential inputs used in export production will cost more, there will be an escalation of costs for exporters too. Unless they raise their efficiency and productivity, they may wish that the rupee would depreciate further. But what a way to go! From Rs 4.765 to a dollar, the rate before 1966 to Rs. 46 today, all in a matter of a few decades. Yet we are lucky as there were worse cases in South East Asia, when the same amount of depreciation took place within a few weeks.

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