Why is the Indian Rupee Falling?

By Vinayak on Tuesday, September 3, 2013 with 0 comments


It has been a tough time for foreign investors in India as their USD denominated investments has suffered an average loss of 20%. It does appear as though the policies of the Reserve Bank of India (RBI) have been quite redundant leading to the Indian economy having a downturn as of late. The RBI seems perplexed about policies concerning the liquidity in the economy - to tighten the liquidity or to bring in $1 billion in the market.

The Indian Rupee (INR), as against US Dollar (USD), has is hovering around the 67-rupee mark, with a decline of a shocking 48% in the currency. India's Current Account Deficit (CAD) is being blamed for the tumble in the INR. But the CAD issue has been around for a long time.

India is dependent on foreign money and government policies need to recognize this and make it easy for it to flow into the country. The balance of payments has been financed by the Foreign Institutional Investor's (FIIs) and the Foreign Direct Investment (FDI) for several years.

The Cause of the troubles

India's GDP growth rate has declined from 9-10% two years ago to a 4-6% window this year. There has been a 50% fall in the economic growth in three years' time. Let's take a look at some of the reasons why the Indian economy has tanked along with the Indian Rupee.

The ban on gold imports

If there was one thing that Mr. D. Subbarao didn't expect, it was the way the gold import ban boomeranged on the RBI as the CAD got bigger and not smaller as intended. The RBI has to realize that there is an inelastic demand for precious commodities like gold and even others like oil and food and gold. A curb on the imports of these have expectedly caused even more troubles for treasury.

What is more, the rupee's fall has seen the Wholesale Price Index - the main indicator of inflation - go up by 5.79% from 2012. And all this has brought food and oil prices to higher levels and negatively affected the Indian middle-class.

Foreign exchange reserves

There were massive U.S. dollar inflows as a result of the lower interest rates in the U.S. The RBI did not capitalize and look to build up on their foreign exchange reserves at this time when the rupee was appreciating. The RBI governor was criticized by many for not taking advantage of the quantitative easing in the U.S. with Arvind Panagiriya, Professor of Economics, Columbia University, going to the extent of calling Subbarao's tenure one of the worst performances ever.

Rising interest rates

The growth story caught on with the with the arrival of Pranab Mukherjee as the finance minister in 2011. But rising interest rates and inflation were largely a concern. Nonetheless, as 2012 approached, things were looking up with inflation moderated at 8.9%. However, Mr. Subbarao continued to raise the repo rate from 6.75% in March 2011 to 8.50% in March 2012.  

Pullback Opportunities

A long-term investor may look past all of this. The Indian economy, and the INR, will probably recover by March 2014. India is one of the major G-20 economies. In 2012, it was ranked as the 19th largest exporter and the 10th largest importer in the world. Despite, the sluggish growth the world's third largest economy (by PPP) is experiencing, it is always going to be a good bet for investors - foreign and domestic.

Look for the RBI has to try harder in promoting exports that will bring in much needed foreign currency. The risks remain with the major one being the likelihood of the Fed scaling down its bond buying program that will impact India and other developing countries as it will lower foreign investments from the U.S. The U.S. is looking more attractive than emerging markets with bond yields at a two-year high and an overall improving economy.

Still, the Finance Ministry of India has something up its sleeve with FDI flows coming from deals that have been made because of the devalued rupee. There will be an injection of foreign currency into the Indian economy with the big time deals that have been made, including a domestic airline set-up permission to Air Asia, Etihad's stake acquisition in Jet Airways and Baring Pvt. Equity Asia's plans of buying stock in Hexaware Technologies.

The government has made it clear that cuts in Overseas Direct Investments are temporary and even gone as far as declaring that the CAD will be capped at $30 billion. This will be done by getting funding from FDIs and other inflows. Foreign exchange reserves will not be used to finance the deficits.

Category: Currencies

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