“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…”

We keep hearing the volatile Roller coaster between US dollar vs. Rupee and other currencies in the world. Recently the Rupee vs. dollar was in news again in the context of post Chinese devaluation and the growing strength of Dollar vs. Rupee.

During the first half of 2013 the Rupee was going up against the dollar and now it is going down.

What does this exactly mean? How does this happen? and What is the Impact? How does the Government manage this? Let us understand some basics.

Section I Background 

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. That’s 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. 

Learning Outcome:

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.

Date                               Rs/$

Mar 1990                    22.40

Mar 1991                    26.41

Mar 1992                    31.23

Mar 1993                    31.24

Mar 1994                    31.37

Mar 1995                    31.50

Mar 1996                    34.35

Mar 1997                    35.92

Mar 1998                    39.50

Mar 1999                    42.44

Mar 2000                    43.61

2013 -14                     60 plus and  minus

Source: Business World 

Rupee weakening/depreciation or dollar strengthening/appreciating:

When we say rupee depreciated it means that the rupee has lost its 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).

Section II IMPACT

When rupee depreciates-

Benefits:

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 NRI’s (higher flow of NRI investments into Banks example Kerala and other places).

Problems:

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. Sometimes 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 rationalize 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

Source: TNN

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.

Factors:

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.