1

DEPRECIATION OF RUPEE

On completion of the project, I would like to express my sincere gratitude to all the persons

without whose support this project would not have been completed.

At the onset, I would like to thank my institute “St. Xavier’s College (Autonomous)” for giving

me the opportunity to undertake this research project.

I would also like to acknowledge the constant help and encouragement of my project guide Prof.

S. Lowbo, who has given his valuable suggestions and expert guidance and support.

I would also like to thank my office colleagues and friends who helped me make this project a

success.

Finally, I would like to acknowledge all those who have directly or indirectly helped me in the

preparation of this project.

2

FOREWORD

3

4

INTRODUCTION

Rupee was under volatile trend, caused by sudden changes in demand and supply forces in forex

markets. In a very short span rupee has depreciated more than 20%. US Dollar (USD) to Indian

Rupee (INR) exchange rate reached highest in its lifetime 68.85 INR on 28 Aug 2013. A major

international event which triggered the steep fall of ₹ against US$ was the statement of Chairman of

US Federal Reserve, Mr. Ben Bernanke expressing tightening of Quantitative easing and restricting

supply of US $ 85 billion per month to boost US economy. International trade and investment

decisions have become very difficult due to volatile exchange rate because volatility increases

exchange rate risk. If the participants in international trade are aware about exchange rate risks,

they may prefer to switch to domestic activities where profits are relatively less uncertain rather

than continuing trading in foreign markets.

India is not the only emerging nation experiencing a steep decline in its currency’s value. Several

emerging market nations are also experiencing sharp depreciation over the prospect of imminent

tapering of the US Federal Reserve’s policy of quantitative easing (QE)program. The South African

Rand and the Brazilian Real touched four-year lows against the US $ in June 2013. Except the

Chinese Yuan and Bangladeshi Taka, most Asian currencies have witnessed sharp depreciation

since the beginning of 2013. Nevertheless, the Indian rupee has fared more poor than other

emerging nation currencies because of its twin deficits – current account and fiscal deficits.

5

INTRODUCTION

6

CAUSES OF RUPEE FREE FALL

FIIs had resulted sellers in June due to the sharp decline seen in the rupee. With US economy

showing signs of improvement, the dollar strengthened, causing currencies across the emerging

markets to decline in June-July. The rupee fell by a little more than 10% since June 11.

Improving employment data and lower inflation in the USA were conceived as indicators of a

recovering economy, leading investors believed that the Quantitative Easing-3 (stimulus) would be

phased out sooner than expected; causing funds to flow away from emerging markets like India,

back into developed markets. Emerging economies had been the biggest beneficiary of the QE3

bond-buying programme, worth $85 billion per month.

FII Investment Activity in August 2013

FII Activity is a date wise list of Gross Buy ( in Crores) and Sell ( in Crores) investments done by

Foreign Institutional Investors, their Net Investment Positions for those dates and Cummulative

Investments as on that date in Million $ with a break up of Investments made in Equity and Debt

instruments.

FII Activity for the Year so far

Month

Gross

Purchase

(Cr)

Gross

Sale

(Cr)

Net

Investment

(Cr)

Cummulative

Investment

($Mn)

January 2013 77,858.80 55,799.80 22,059.20 4,059.32

February 2013 78,888.30 54,449.10 24,439.30 4,575.56

March 2013 66,766.60 57,642.70 9,124.30 1,675.48

April 2013 61,007.30 55,593.10 5,414.10 1,000.27

May 2013 74,468.90 52,300.40 22,168.60 4,067.42

June 2013 55,321.40 66,348.50 -11,026.90 -1,852.15

July 2013 60,371.00 66,624.20 -6,253.30 -1,042.88

August 2013 69,308.40 75,231.10 -5,922.50 -902.51

7

Huge Foreign Institutional Investor Outflow

September 2013 73,123.80 60,066.50 13,057.80 2,062.27

October 2013 57,051.30 41,344.90 15,706.20 2,491.97

November 2013 55,806.50 47,690.80 8,116.10 1,300.71

December 2013 64,259.40 48,173.60 16,085.80 2,601.84

FII Investment Activity in August 2013

FII Activity is a date wise list of Gross Buy ( in Crores) and Sell ( in Crores) investments done by

Foreign Institutional Investors, their Net Investment Positions for those dates and Cummulative

Investments as on that date in Million $ with a break up of Investments made in Equity and Debt

instruments.Debt

FII Activity for the Year so far

Month

Gross

Purchase

(Cr)

Gross

Sale

(Cr)

Net

Investment

(Cr)

Cummulative

Investment

($Mn)

January 2013 17,918.20 14,971.00 2,947.10 551.08

February 2013 36,165.60 14,839.50 21,326.20 3,958.94

March 2013 25,019.40 19,224.50 5,795.10 1,066.01

April 2013 25,196.00 19,861.60 5,334.40 992.20

May 2013 27,205.00 21,235.90 5,969.00 1,152.37

June 2013 11,676.20 44,811.00 -33,134.90 -5,683.48

July 2013 12,036.10 23,015.40 -10,979.20 -1,834.34

August 2013 17,467.60 27,240.40 -9,772.90 -1,554.43

September 2013 20,451.60 26,129.90 -5,678.30 -910.94

October 2013 14,770.90 28,348.60 -13,578.00 -2,144.19

November 2013 9,960.80 15,944.20 -5,983.50 -957.49

December 2013 15,873.20 10,582.70 5,290.40 857.80

8

CAD occurs when a country's total imports of goods, services and transfer is greater than the

country's total export of goods, services and transfers. This situation makes a country a net debtor

to the rest of the world. The High current account deficit is putting a lot of pressure on rupee. The

CAD reached to 4.8% of GDP which has breached the comfort level of 2.5% of GDP as mentioned by

RBI in 2012-13. The Primary reason for ballooning CAD is high imports as compared with exports.

9

High Current Account Deficit

India is Importing crude oil as our country can only produce 20% of the demand , rest 80% is being

imported from different oil Producing countries first being Saudi Arabia followed by Iraq. The

steadily worsening balance of payments (BoP) outlook has been a central point of concern to not

only RBI, but to the finance ministry as well. According to the minister of commerce Mr. Anand

Sharma, total import of crude oil is $150 Billion and the import of Gold is $60 billion. The total

current account deficit is $150 in 2012-13. The facts show that fertilizer imports surged by 30% in

the last two years and coal imports have doubled. Therefore, the problem of CAD continues to

persist.

With the reduction in exports and an increase in imports, on one hand the current account deficit

has swelled while on the other, the fiscal deficit is also expected to be above the comfort levels due

to increased subsidy by government. A slowdown in the global economy has drastically reduced the

demand for Indian goods and services.

The fall in commodity prices on the other hand have increased imports which resulted in an

imbalance between payments and receipts. S R Rao, India’s trade secretary said that India is

unlikely to achieve the export target of $ 350bn which could result in higher current account deficit

due to which there will be fall in rupee value.

A large fiscal deficit forces central bank (RBI) to print more money and encourage inflation. This

further hurts the rupee value.

10

The United Nations Conference on Trade and Development (UNCTAD) June 2013 pointed out that

the foreign direct investment in India gone down by 29% to $26 billion in 2012. When dollars come

into India through the foreign direct investment (FDI) route they need to be exchanged for INR.

Hence, dollars are being sold and rupees are bought. This pushes up the demand for INR, when we

increase the supply of dollars, it helps rupee gain value against the dollar or at least hold stable.

In 2012, the FDI coming into India has fallen dramatically. The situation is likely to continue in the

near short term.

The corruption scandals revealed in the 2G and the coal-gate scam hasn’t improved India’s image

abroad. In fact in the 2G scam telecom licenses have been cancelled and the message that was sent

to the foreign investors was that India as a country can go back on policy decisions. This is

something that no big investor who is willing to put a lot of money at stake, likes to hear.

Opening up multi-brand retail sector was government’s other big plan for getting FDI into the

country. In September 2012, the government had allowed foreign investors to invest upto 51% in

multi-brand retail sector. But between then and now not even a single global retail company has

11

Reduction in FDI Inflow

filed an application with the Foreign Investment Promotion Board (FIPB), which scrutinizes FDI

proposals.

This scenario doesn’t look like it is changing as still foreign investors struggle to make sense of the

regulations as they stand today. Dollars that come in through the FDI route come in for the long run

as they are used to set up new industries and factories or to have joint venture in existing

companies. This money cannot be withdrawn overnight like the money invested in the stock market

and the bond market by FIIs.

12

Over the years another important factor for movements in exchange rates has been interest

differential i.e. the difference in interest rates between major countries. Currencies with higher

interest rates attract large no. of investors seeking a better opportunities for their investment. This

makes the currency more attractive as a form of investment and increases the demand for the

currency. The opposite relationship exists for decreasing interest rates i.e. lower interest rates tend

to decrease exchange rates. The interest rate decisions are taken in India by the Reserve Bank of

India's Central Board of Directors. The official interest rate is the benchmark repurchase rate.

13

Interest Rate

By and large a country with a consistently lower inflation rate faces a rising currency value and high

purchasing power as compared to other currencies.

Figure shows volatility in Indian Rupee exchange rate in last two decades.

Exchange Rate against Dollar 1990-2013

Source: http://ibnlive.in.com/news/interactive-graph-indian-rupee-vs-us-dollar-dec-1990-to-june-

2013/401983-53.html

As a general rule the countries with higher inflation face depreciation in their currency in relation to

the currencies of their trading partners . This is also usually followed by the higher interest rates.

Inflation Rates in India 1959 – 2012

In 2013 the average inflation rate is: 11.14% (based on Consumer price index)

14

Inflation Rate

Love for gold by Indians has been prime reason behind significant demand for the dollar. Gold is

bought and sold internationally in dollars. India extracts very little gold on its own and hence has to

import almost all the gold that is required in the country. When gold is imported into the country,

the payment has to be done in dollars, thus pushing up the demand for dollars. As many have

argued in the past that there is some logic for the love that Indians have had for gold. A major

reason behind Indians buy gold is high inflation. Consumer price inflation is still very high. India

imported record 162 Tonnes of Gold in May’13, what can also add to the demand is the recent fall in

price of gold, which will get those buyers who preferred to stay away from gold because of the

rising price, back to the market. All this means a higher demand for dollars. Gold is the 2nd largest

commodity after crude being imported by the Govt.

Also India has been importing a huge amount of coal lately to run its thermal power plants. India’s

coal imports drastically grew by 43% to 16.77 MT in May’13, as compared to the same period in

2012. Importing coal again shows increased demand for dollars.

The irony is that India got huge coal reserves which are still not being extracted. The common logic

here is to blame Coal India Ltd, which more or less has had a monopoly to produce coal in country.

The government has tried to bring private sector investment in the coal sector but that has been

done in a haphazard manner which resulted in the Coalgate scam. This has delayed the process of

bigger role that the private sector could have played in the mining of coal and thus led to lower coal

imports. The situation cannot be improved overnight.

The major reason for this is that the expertise to get a coal mine up and running in India has been

limited to Coal India till now. To develop the similar expertise in the private sector will take time

and till then India should continue to import coal, which will need dollars.

15

Unreasonably High Imports

While the supply of dollars will remain a problem, the need for them will continue to remain high. A

major demand for dollars will come from firms which have raised loans in dollars over the last few

years and now have to repay them. In beginning 2004, the RBI has approved nearly $220 billion

worth of external commercial borrowings and foreign currency convertible bonds (FCCB), at the

rate of a slightly over $2 billion a month. About two-thirds of this amount was approved in the past

5 years. Much of this ECB will have to be repaid this financial year, putting further pressure on the

Indian currency.

A lot of companies have raised foreign loans over the last few years simply because the interest

rates in India are very high as compared to outside world. These firms will need dollars to repay

their foreign loans as they are nearing maturity. The other thing that may happen is that firms

which have cash, might look to repay their foreign loans earlier rather than later. This is simply

because as the dollar is appreciating against rupee, it takes a greater amount of Indian currency to

buy dollars. So if companies have idle cash lying around, it makes greater sense for them to pre-pay

dollar loans. The trouble is that if a lot of companies decide to prepay loans then it will add to the

rise in demand for the dollar and thus put further pressure on the INR.

Historical Value of Exchange Rate

Indian currency i.e. rupee has been in news because of recent fall against the dollar. Rupee has

fallen more than 15% in just 3 months’ time against dollar. India rupee has been depreciating

against dollar for long time now. Post liberalization, the fall in the rupee against dollar has been

rather steep. It is important to note that rupee has started falling against dollar more frequently

after partial convertibility of rupee was introduced. The partial convertibility gave it more elbow

room to automatically adjust against the dollar.

16

Time to Repayment of External Commercial Borrowings

17

Measures taken to curb Rupee Fall

 

Regulators toughened rules for derivatives trading in the currency market in a order to check the

steep decline of the Indian rupee, which fell to a record low against the dollar on 8th July.

The RBI, in a notification issued late on 8th July, restricted banks from proprietary trading in

domestic currency futures and the exchange-traded options market.

In a separate order, SEBI doubled the margin requirement on the domestic dollar-rupee forward

trade, which means investors will now have to pay two times as much in margins for a transaction

at the time of the trade itself. SEBI said in a circular that it has reduced the exposure that brokers

and their clients can take on currency derivatives and also doubled their margins on dollar-rupee

contracts. The exposure to all currency contracts for a broker has been capped at 15% of their

overall exposure or $50 million, whichever is lower.

SEBI said that the new norms will come into force from July 11 and the changes have been decided

in consultation with RBI because of recent turbulent phase of extreme volatility in USD-INR

exchange rate. The current exposure limits for brokers and clients were the higher amounts of 15%

of their overall exposure or $50 million, and 6% or $10 million, respectively. The margin

requirements vary across different categories and they are being revised upwards by 100% of the

present rates for rupee-dollar derivative contracts.

18

India's regulators toughen rules for derivatives trading in currency markets

With the rupee depreciating sharply against the US dollar, the RBI on 9th July 2013 ordered state-

owned oil companies (OMCs) to purchase their dollar requirements from single public sector bank

to curb volatility in the currency. State oil-refiners, who are biggest dollar guzzlers, agreed to

implement the RBI order with immediate effect. The OMCs were even willing to accept RBI selling

dollars directly to them through a single window.

The RBI issued orders to Indian Oil (IOC), Hindustan Petroleum (HPCL), Bharat Petroleum(BPCL)

and Mangalore Refinery (MRPL) to stop seeking quotes from several banks for their USD 8-8.5

billion of monthly US dollar need. Oil firms seeking multiple quotes for their dollar requirement was

felt to be one of the prime reasons adding to speculation on demand for the USD and volatility in the

local unit.

IOC, the nation's largest refiner, will buy their monthly requirement of USD 3.8-4 billion dollars

from its official banker State Bank of India. Similarly, BPCL, HPCL and MRPL will buy their dollar

requirement from a single particular bank.

19

RBI directs OMCs to buy dollars from single PSB.

The Reserve Bank of India on Monday, 8 July 2013, eased norms for non-bank asset finance

companies to raise debt from beyond the borders by allowing the lenders to raise such funds

through the automatic route as against the approval route earlier, in a step aimed at improving

dollar supply amid a weakening rupee. NBFCs can borrow from outside India up to $200 million in a

financial year to finance import of infrastructure equipment, the RBI said. The RBI also allowed

them to raise such debt from all recognised lenders with a minimum average maturity period of 5

years. The rupee ended at 60.61/62 to the dollar, after suspected dollar sales by the central bank

through state-run banks pulled the unit off from its lifetime low of 61.21 on 8th July.

The Reserve Bank of India (RBI) extended the time limit for telecom companies to refinance rupee

loans through the external commercial borrowing (ECB) route till 31st March, 2014 for 3G

spectrum won in telecom auction in 2010. Earlier, the RBI had said overseas loans should be raised

within 12 months from the date of payment of final instalment to the government. The Reserve

Bank of India has made it easier for property developers to access foreign money in an effort to

improve the pace of low-cost housing projects, such as slum rehabilitation. The RBI has extended

the limit of $1 billion that can be borrowed through the external commercial borrowing (ECB)

scheme to the FY15 from this year.

The RBI also reduced the minimum experience required by companies to have to undertake these

projects from 5 years to 3 years.

20

RBI eases overseas borrowing norms for firms.

The Reserve Bank of India (RBI) announced measures late on 15th July 2013 to curb the rupee’s

decline by tightening liquidity and making it costlier for banks to borrow funds from the RBI.

The RBI raised the marginal standing facility (MSF) rate and Bank Rate each by 200 basis points to

10.25%, capped the amount up to which banks can borrow or lend under its daily liquidity window

and announced a sale of government securities through an open market operation. This could lead

to some increased dollar inflows as overall interest rates in the economy will increase.

The RBI said total funds available under its repo window will be capped at 1% of banks’ deposits –

roughly 750 billion rupees. Further, it announced a 120 billion rupee sale of government bonds.

The MSF is the rate at which banks can borrow from the RBI at an elevated rate against government

securities during times of tight cash. The bank rate is linked to the MSF.

21

RBI Tightens Liquidity

Liquidity adjustment facilities are used to aid banks in resolving any short-term cash shortages

during periods of economic instability or from any other form of stress caused by forces beyond

anybody’s control.

On 23rd July 2013 RBI has reduced the liquidity adjustment facility (LAF) for each bank from 1 per

cent of the total deposits to 0.5 per cent, thus limiting the access to borrowed funds from the RBI.

The limit will come into force with immediate effect and continue till further notice.

In another measure to suck out liquidity from the system, RBI has asked banks to maintain higher

average CRR (cash reserve ratio) of 99 per cent of the requirement on daily basis as against earlier

70 per cent. CRR is portion of deposits that banks are required to keep with RBI.

According senior bankers, the measures could suck out Rs 4,000-Rs 5,000 crore from the system.

The additional measures to check exchange rate volatility comes within 10 days of RBI taking harsh

steps to suck out liquidity from the system.

RBI has reduced the liquidity adjustment facility (LAF) for each bank from 1% of the total deposits

to 0.5%, thus limiting the access to borrowed funds from the central bank. The limit will come into

force with immediate effect and continue till further notice.

RBI said the July 16 instructions regarding the limit on overall allocation of funds at Rs 75,000 crore

under LAF stands withdrawn. The changes in LAF will come into effect from 24th July 2013. The

new norms on CRR will be effective from the first day of the next reporting fortnight, from July 27,

2013.

22

RBI has reduced the liquidity adjustment facility.

UPA government has set off another round of economic reforms with big bang reforms in foreign

direct investment caps. Stepping into a political minefield, the government has changed FDI limits in

as many as 12 sectors. The Government on 16th July 2013 liberalised FDI limits in twelve sectors,

including telecom and defence. Paving way for fresh investments in telecom companies, the

government cleared 100 per cent FDI in telecom sector. To boost the sagging economy, the

government also raised FDI in defence sector from 26 per cent to 100 per cent. But the hike comes

with some conditions. 100% will only be allowed with state-of-the art technology transfer.

FDI in 4 other sectors - gas refineries, commodity exchanges, power trading and stock exchanges

have been allowed via the automatic route.

In the contentious insurance sector, it was decided to raise the sectoral FDI cap from 26% to 49%

under automatic route under which companies investing do not require prior government approval.

A Bill to raise FDI cap in the sector is pending in the Rajya Sabha.

It was decided to allow 49% FDI in single brand retail under the automatic route and above that

through the Foreign Investment Promotion Board (FIPB). In case of PSU oil refineries, commodity

bourses, power exchanges, stock exchanges and clearing corporations, FDI will be allowed up to

49% under automatic route as against current routing of the investment through FIPB.

The decisions taken on 16th July 2013 were based on recommendations of Mayaram Committee

which had suggested changes in investment caps in about 20 sectors, but the meeting approved

only in 12.

In basic and cellular services, FDI was raised to 100 per cent from current 74 per cent. Of this, up to

49 per cent will be allowed under automatic route and the remaining through FIPB approval. A

similar dispensation would be allowed for asset reconstruction companies and tea plantations. FDI

of up to 100 per cent was allowed in courier services under automatic route. Earlier, similar amount

of investment was allowed through FIPB route. In credit information firms 74 per cent FDI under

automatic route would be allowed.

23

Relaxing of FDI

.

The Reserve Bank of India has extended the restriction on advance against gold on co-operative

banks as well, a move to curb the demand for gold on 7th June 2013.

In a notification, the RBI said while granting advance against the security of specially minted gold

coins sold by banks, state/central co-operative banks should ensure that the weight of the

coin/coins does not exceed 50 grams/customer.

Also the amount of loan to any customer against gold ornaments, gold jewellery and gold coins

(weighing up to 50 grams) should be within the Board approved limit. Earlier, similar restrictions

were imposed on commercial banks.

The RBI’s latest move comes after government raising import duty on gold to 8% from 6%.

The central bank has also advised banks not to sell gold coins, finance minister P Chidambaram said

on 6th June 2013. RBI has also imposed restrictions on gold imports by banks.

Surge in gold imports has become a cause of concern for both the government as well as the RBI as

it is putting pressure on the current account deficit, which is around 4.8% of the GDP in 2012-13.

In the first two months of the current fiscal there has been significant spurt in gold imports as the

average foreign buy of the precious metal stood at 152 tonnes in April and May. The monthly

average import in 2012-13 was 70 tonnes.

The increase in gold import is because of slowdown in its prices in the international market.

24

RBI extends restriction on co-operative banks for loan against gold coins.

The central bank put restrictions on the amount of foreign exchange Indian companies and

individuals can invest, remit or spend overseas in an attempt to curb dollar outflows from the

country. Indian companies can now send out only 100% of their net worth as overseas direct

investment (ODI), way below the current cap of 400%, under the automatic route. The restrictions

however not imposed on the Navaratna public sector entities ONGC and Oil India, the RBI said in a

release.

The RBI also capped remittances abroad by resident individuals to $75,000, down sharply from

$200,000 allowed earlier under the liberalised remittance scheme. Further, Indian residents cannot

invest in real estate abroad. Individual remittances abroad totalled about $3 billion during 2012-13.

To encourage banks to collect more dollars through non-resident rupee deposits and foreign

currency non-resident deposits, the RBI exempted banks from maintaining the cash reserve ratio

and the statutory liquidity ratio on incremental NRI deposits with a tenure of three years or more.

With the rupee has depreciated by 13% since April 2013 and having fallen despite measures

initiated by the central bank since mid-July, economists believe that the RBI is readying long-term

initiatives. "The policy is not aimed at tackling any immediate situation, but should be construed as

a safeguard against a more difficult situation," observed Samiran Chakraborty, MD and head of

research, Standard Chartered Bank.

ODI by Indian corporates was $300 million in April-May FY14. In FY13, Indian firms invested $7.1

billion overseas, according to the RBI's August monthly bulletin. The central bank did soften the

blow, saying genuine investment plans, beyond the limits imposed, could be considered under the

approval route.

25

RBI moves to limited capital controls to save rupee

India, the world's biggest consumer of gold, raised import duties for the third time in 2013 to curtail

the current account deficit and stem volatility in the rupee.

The government has increased the customs duty to 10% from 8% on the yellow metal, a move that

helped the rupee edge up against the dollar but will make the commodity costlier by about Rs

600/10 gram.

Customs duty on platinum has been raised to 10% from 8%, and on silver to 10% from 6%. The

government also raised the excise duty on gold and silver bars.

"The basic purpose of enhancing the duty was to curb the import of gold," Revenue Secretary Sumit

Bose told reporters.

The higher taxes on precious metals would fetch the exchequer an additional Rs 4,830 crore.

The increase in import duties on precious metals is part of a series of steps announced by Finance

Minister P Chidambaram on Monday to restrict the current account deficit to 3.7% of GDP in FY14

and ensure its full and safe financing. (Source: Economic Times)

Chidambaram on 12th Aug 2013 said the government's plan is to restrict gold imports to 850

tonnes in the current financial year, compared with 950 tonnes in 2012-13. Gold imports stood at

about 335 tonnes in the April-June quarter.

"This is as much a red line as the fiscal deficit. We will do all to ensure that it is not breached. The

current account deficit will be contained and fully and safely financed," he had said, unveiling his

plan to contain CAD.

26

Import Duty on Gold increased to 10%

Breaking the streak of severe battering it suffered in the last few days, the rupee on Thursday

soared by a staggering 225 paise to end at 66.55 against the dollar and the sensex jumped by over

400 points on the back of RBI opening a special dollar facility for PSU oil companies. After the rupee

plunged to an all-time low of 68.85 on Tuesday, the RBI allowed the three state-owned oil

companies to buy dollars directly, the latest in a series of moves to arrest volatility in the domestic

currency, which has slid over 20 per cent since April 30. With PSU oil firms needing USD 8.5 billion

every month to import 7.5 million tonnes of crude oil, the swap window will help to ease demand in

the spot market. The rupee bounced back to 66.51 before ending at 66.55, a rise of 225 paise or 3.27

per cent — the biggest single-day rise in 15 years. "The separate forex swap window for oil firms by

RBI helped rupee gain. The depreciation was overdone," said Ashutosh Khajuria of Federal Bank.

Mirroring the currency, the sensex surged 405 points on Thursday, the biggest gain in a week. Stock

investors gained over Rs 1 lakh crore on across-the-spectrum rise in share prices. Prime Minister

Manmohan Singh said he would make a statement in Parliament on Friday, after opposition parties

claimed there was panic in the country over the rupee's fall. Some experts are sceptical about

Thursday's turnaround as markets seemed to ignore concerns related to widening current account

deficit and the burden of food subsidy that have plagued investor sentiment recently.

"The sustainability ... will be closely watched as RBI had taken a similar measure in 2008, that gave

short-lived relief," said Abhishek Goenka, CEO, India Forex Advisors. Bank of America Merrill Lynch

said in a report on Thursday the RBI will have to take far more pro-active steps to rebuild forex

reserves, because if the status quo remains, the rupee could touch 75 per dollar by the end of 2014.

Driven by the recovery in the rupee, gold prices in the national capital fell from record high,

plunging Rs 1,575 to Rs 32,325 per ten gram on profit-selling by stockists amid a weakening global

trend.

27

RBI's intervention helps rupee post biggest single-day rise in 15 years

The Indian rupee (INR) is trading at levels that can only be described as disastrous. Levels of Rs 63-

64 to the US dollar mean all-time lows for the currency that has depreciated by a whopping Rs 20 –

or 45 percent – over the last couple of years. What has made the INR tank against the USD and join

the ranks of countries such as Argentinaand Iceland that have seen their currencieslose most of

their value over the last decade? The Brazilian real is the only other currency that has depreciated

more than the INR, falling by over 53 percent in the last two years. Brazil’s problems largely stem

from its sharp fall in GDP growth from levels of 7.5 percent seen in 2010 to below 1 percent seen in

2012. Weak commodity prices, with the Reuters CRB commodity index down by over 30 percent

since the financial crisis erupted in 2007-08, bureaucracy, corruption and weak infrastructure are

to be blamed for Brazil’s GDP growth fall. India’s problems stem from overconfidence on growth,

economic mismanagement, bureaucracy, corruption and weak infrastructure. The INR fall is

completely man-made and policymakers blaming the forthcoming withdrawal of the stimulus by

the US Fed is pure nonsense. India offers a great learning tool for policymakers across the world on

how not to manufacture currency disasters. India’s fall from strength in the mid 2000’s to a position

of weakness post 2010 is well documented. High fiscal and current account deficits, rising inflation,

falling economic growth and weak capital markets are the cause of the INR fall. What did the

policymakers do to take the INR down to record lows and, more importantly, push India out of any

kind of reckoning in the world economic order? The following five man-made factors are the cause

of the INR fall.

1. The government, public and private sector were living in a fool’s paradise believing that

economic growth will never slow down. The government allowed subsidies to burgeon, as rising oil

prices were not passed on to consumers while public sector banks lent heavily to infrastructure

projects of the private sector where revenues were more mythical. The private sector floated

projects based on valuations of licences and commodities rather than on future cash flows. The end

result was a huge subsidy bill taking up the fiscal deficit by 300 bps (100 basis points make 1

percent), rising non performing assets of banks, that have gone up multi-fold, and a fall in valuations

of over 80 percent of many companies in the private sector. Government finances, banking sector

balance sheets and health of corporates weakened considerably, leading to fall in valuations of the

whole country that is reflected in the rupee fall.

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Lessons learnt from the debacle..

2. The illusion of high foreign exchange reserves made policymakers ignore a potential spike in

Current Account Deficit (CAD). India’s foreign exchange reserves touched record highs of around

$320 billion in February 2011 (around 11 months of import cover) but have plummeted by 12.5

percent since then to levels of $280 billion (around seven months of imports). CAD has risen from

levels of below 3 percent of GDP to 5 percent over the last few years. CAD was financed by capital

flows that led policymakers to believe that a high CAD would not impact the INR. Structural issues

of oil and gold imports, rising inflation and high fiscal deficit was ignored until too late.

3. Growth was given priority over inflation. The focus on growth by all stakeholders concerned

pushed inflation to the back seat. The RBI was castigated in public by both the government and the

corporates for taking any action on inflation as it was felt that growth would suffer. The numbers

are stark. In the period 2008-12, wholesale price inflation came down to below zero to over 10

percent levels and then went back to over 10 percent levels. The RBI, in the meanwhile, raised the

benchmark repo rate by 100bps and then cut the rate by 425 bps and then raised the rate by 375

bps. The seesawing of policy rates along with seesawing of inflation indicates that the central bank

was being reactive rather than being proactive. The economy has suffered due to the wide

fluctuations in inflation and policy rates, leading to the INR being dumped later on.

4. A falling INR hurt the pride of the government. The government felt that India was too much of a

growth story for the INR to fall. The noises made by the government when the INR touched Rs 57 in

June 2012 suggested that the INR was being pulled down due to reasons other than macroeconomic

factors. The RBI forced speculators to reduce long USD/INR positions while the government made

noises on reforms and growth. The government and the RBI did not show urgency in tackling the

INR fall last year and that has hurt them heavily this year.

5. The INR fall to levels of below Rs 60 has awakened the ‘animal spirits’ of the government and the

RBI. The FM has been touring the world to bring in foreign investments while the RBI has strangled

liquidity and reintroduced capital controls. The end result is a fall to record low levels of Rs 64.

These hasty “animal spirit” decisions have caused panic in the markets as any hope of economic

growth pulling the INR up has been laid low. Policymakers are not focusingon growth at the right

time and markets know that policy actions cannot stem the fall in the INR. Wrong policies at the

wrong time.

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[1] Economic Times; http://articles.economictimes.indiatimes.com/2013-08-

14/news/41409812_1_gold-imports-customs-duty-current-account-deficit ; July 2013.

[2] Indian Express; http://www.indianexpress.com/news/rbi-moves-to-limited-capital-

controls-to-save-rupee/1155564/2 ; July 2013.

[3] Economic Times; http://economictimes.indiatimes.com/markets/forex/brazil-steps-up-

efforts-to-arrest-real-decline/articleshow/22016545.cms; July 2013.

[4] Reserve Bank of India. 2013. Available at: http://dbie.rbi.org.in/DBIE/dbie.rbi?

site=home ; August 2013.

[5] Money Control Available at: http://www.moneycontrol.com/news-topic/rupee-

depreciation/ ; August 2013.

[6] Fitch Ratings Agency research report at:

http://indiaratings.co.in/upload/research/specialReports/2012/7/3/fitch03Rupee.pdf ;

accessed September 2013.

[7] Government of India (2013), Central Statistics Office (CSO) website

(http://mospi.nic.in/Mospi_New/site/home.aspx), accessed in January 2013.

[8] Reuters, Available at: http://in.reuters.com/article/2013/08/08/india-economy-rupee-

rbi-forex-idINDEE97709I20130808 ; August 2013.

[9] DNA, Available at: http://www.dnaindia.com/analysis/1627432/comment-rbi-

measures-to-ease-pressure-on-rupee ; August 2013.

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References

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