MONEY INFLATIONA presentation by-

Aditi SoniAnushka Sinha

INTRODUCTIONMoney inflation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system. A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market.

FLUCTUATION IN INR COMPARED TO DOLLAR AND

EURO

48.00

50.00

52.00

54.00

56.00

58.00

60.00

62.00

53.29 53.77 54.39 54.22

56.50

59.70 61.12 INR to USD

Months

Exch

ange

rate

62.00 64.00 66.00 68.00 70.00 72.00 74.00 76.00 78.00 80.00 82.00

72.23 70.68

69.54 70.98

73.68

77.98

80.95

INR to EURO

Months

Exch

ange

rate

The Indian Rupee has depreciated significantly against the US Dollar marking a new risk for Indian economy.

The rupee touched an all-time low of Rs 61.17 /$ on 31 July 2013, breaching its previous historic low of Rs 59.98/1$ of 2008. At the end of day it was Rs 61.12/1$.

CAUSES

Huge Trade Deficits

Since India imports more goods (in value terms) than it exports, it results in a huge imbalance in trade, or what is called a trade deficit.

Trade deficit has widened by 40,000 crores in the last quarter. This has resulted in increased imports and spike in dollar demand.

India recorded a trade deficit of 10,556.10 USD million in October 2013.

•Although India has become an attractive destination which can attract foreign capital as well as money from non-resident citizens, it is not enough to make up for the trade deficit.

•Uncertainty about India's commitment to economic reforms, retrospective taxes, and policy paralysis within the government have forced foreigners to either postpone their investment decisions, or take money out of Indian stock markets.

Lower Capital Inflows

Devaluation PressureIn such a situation, more people tend to sell rupees to buy dollars.Importers scamper for dollars to cater for their needs to buy goods abroad.Exporters cannot bring in enough dollars; in fact, they keep their foreign earnings abroad as they expect the rupee to fall further.Meanwhile, foreign investors increase the demand for dollars as they convert their rupee assets into dollars to take their money out.This demand-supply gap between the dollar and the rupee leads to devaluation.

Low Growth and InflationAnnual economic growth of 6% in 2012-13.Couple this with high inflation due to high food and fuel prices. The rate of inflation may rise this year to double digits if the government is unable to curb its fiscal deficit.In this scenario, most foreigners as well as Indians tend to take money abroad, or keep it away from India.Global investors are also nervous about investing abroad in nations such as India due to the economic crisis in their respective countries.

Rupee SpeculationThe Reserve Bank of India's bid to sell dollars in the open market to restrict the rupee slide has failed in the past few weeks and months.This has complicated the situation further.Once currency traders and speculators realize that India's central bank is unable to manage its exchange rate, and reduce the adverse impact on its currency, they may enter the market in a big way to sell the rupee.As a result, the rupee may devalue more than it should.

IMPACTS

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Impact On Importers Depreciating rupee will have an adverse effect on import because now import companies are supposed to pay higher prices for importing the goods or services. Importers have to make the payment in terms of dollars for importing any good or service, which makes import an expensive affair.

Impact On EmploymentDiminishing rupee will adversely affect job market as well. Companies dealing in various sectors like manufacturing, power, oil and gas, automotive sectors, electronics, telecommunications might slow down their hiring process to cope up with the high import prices of equipment and machineries. There is anticipation that employees will not see any hike in their salaries.

Impact on SalesDepreciating rupee will show its adverse effect on sales also. Prices of mid-range and low-range electronics are expected to rise because of their major parts being imported. Supply of electronics in India is greater than demand; many companies will suffer under such circumstances. On the contrary, handset manufacturers of India can earn a lot of profit by exporting mobile parts to developed countries.

Impact on IT IndustryAt such a time, when all the other industries are going to badly suffer due to the fall in rupee, IT industries will earn profit with falling rupee. India-based IT companies are expected to earn a huge margin if currency remains depreciated for a long time. But it is yet to be seen, for how long this process continues.

Impact on ExportsExport oriented companies such as software companies, textile companies; tourism companies will earn huge margins by exporting their good and services to overseas clients. Depreciating currency will provide the best opportunity to export driven companies as they can earn a huge profit for themselves during this period.

MEASURES

RBI should sell forex reserves and buy rupees in an immediate action in order to arrest the further decline in the value of rupees.

Hiking the interest rates to reduce the money supply in the economy.

Making investments attractive –Easing Capital Control by increasing the FII limit on investment in government and corporate debt instruments and introduce higher ceilings in ECB’s.

Measures that should be taken by RBI

Measures to control Current Account DeficitThe first set of measures should include a careful evaluation of the import tariff structure and increase it wherever such levels are lower than WTO requirement.Curb on Import of non essential & unproductive products by imposing higher taxes.To reduce import we should bring in import substitution by supporting the domestic organizations by providing subsidy, tax benefits, grants and proper Infrastructure. Subsidy on import products such as oil should be discontinued.

Measures to increase foreign capital inflows

Government can create a stable political and economic environment. Providing infrastructure and local support to the investors is another, admittedly more difficult avenue that can be explored in this regard.One of the measures being looked at is allocating a separate quota for sovereign wealth funds (SWF) in PSU divestment issues. This reservation could be as high as 30 percent.Making government bonds available to non-resident investors will also increase the inflow of dollars in to the country.

CONCLUSIONThe value of the rupee in terms of dollars will depend over time on the erosion of its value in terms of purchasing power internally. If inflation has been at say, 7 percent, the rupee will have to fall to that extent unless the importing countries are themselves victims of inflation. That is not the case. Hence, the rupee has fallen the most compared to other currencies because India has had a very high rate of inflation. Eventually, the rupee will stabilize, barring short-term disturbances, after correcting the loss in its domestic purchasing power.

Thank You!