Best efforts by:Pranav Singla

Sahil Gupta XI-C

Devaluation of Indian Rupee

INDEX Introduction1) Reasons2) Impact Conclusion

INTRODUCTIONThe rupee is in trouble, and nobody seems quite sure what to do about it. The Indian currency closed at an all time low of 64.11 against the U.S. dollar on Wednesday alongside a tumbling market, feeding widespread anxiety over the fact that the government has yet to curb the currency’s downward trajectory since it started tumbling in May. On Wednesday, Deutsche Bank issued a report saying the rupee may reach as low as 70 in the coming months.

DEVALUATION OF RUPEE

2008 2009 2010 2011 2012 20130

1020304050607080

INR

Axis Title

Reasons

HUGE TRADE DEFICITSince 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.

India's Commerce Secretary Rahul Khullar has predicted that the trade deficit may be slightly lower in 2012-13, due to falling global crude prices and recent government curbs on gold imports.

A $1 per barrel decrease in crude price reduces the country's deficit by $900m at existing import volumes.

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.

But 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

HIGH CURRENT ACCOUNT DEFICITThe country's current account

deficit - a broader measure of the trade deficit - has also ballooned due to the above reasons.

In 2011-12, this deficit was more than $74bn, a huge jump from less than $46bn a year ago. In 2012-13, it may be even higher at $77bn.

The result is that India's foreign exchange reserves have dropped from a peak of $320bn in September 2011 to $290bn now

DEVALUATION PRESSURE

• In 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 INFLATION

This trend is accentuated by low growth and high inflation in India.

Annual 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.

Impact

POSITIVE IMPACT• Export-oriented sectors could benefit.

Companies in the information technology (IT) and textile sectors should benefit from a weak rupee. Rupee depreciation helps IT companies .

• The Indian rupee fell 0.7 per cent against the US dollar at 67.71 on the back of a weak trade data. The Indian rupee has shed close to 25 per cent value over the past one year. It is likely to fall further.

NEGATIVE IMPACT• Corporate India is a net borrower of dollar and to that extent

a depreciating rupee impacts its balance sheet adversely. Companies with foreign debt on their books are badly impacted. With the rupee depreciating against the dollar, these companies will need more rupees to repay their loans in dollar. This will increase their debt burden and lower their profits. Obviously, investors would do better to stay away from companies with high foreign debt.

Bharti Airtel is one such company that has raised money overseas.

Then there are oil marketing companies like HPCL. BPCL and Indian Oil, which could also be negatively impacted. Since these companies import crude oil, they will end up paying more rupees for the same dollar value of imports.

CONCLUSION The 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 we had nearly the highest inflation. Eventually, the rupee will stabilize, barring short-term disturbances, after correcting the loss in its domestic purchasing power.