The Falling Rupee

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2 October 2013
Arin Ray
The Indian Rupee has depreciated sharply against the US dollar in the last few months. It is currently down by 15% against the US dollar compared to its highest value reached during this year. Moreover, at its lowest point it has experienced 22% depreciation this year over the highest value it registered (against the dollar) during the calendar year. This blog aims to look at some of the possible explanations that are believed to have caused this. First, it is not just the Indian Rupee that has witnessed sharp depreciation this year against the US dollar. Many other emerging market currencies have experienced the same. As can be seen from the figure, compared to its value at the beginning of the year the Indonesian Rupiah is down by 16% against the dollar, South African Rand is down by 14%, Turkish Lira down by 10% and Brazilian Real down by 7%. Therefore, the 12% drop in the Rupee’s current value over its value at the beginning of the year is not an isolated incident. It can also be seen that the trend in the movement of all these currencies (indexed to their initial exchange rate with USD at the beginning of the year) have followed similar pattern this year. In particular, there was a sharp fall in May in almost all of them. This reinforces the argument that global factors are at least partially responsible for the depreciation of Rupee (and other currencies). The Chinese Yuan has defied this trend and has actually appreciated during the year. China’s case is different from the other countries in that in spite of slow but steady liberalization, its currency is not free from state control and therefore is not free (or as free) as the other countries’ currencies. The main global factor that has contributed in the depreciation of these different currencies is the US Fed’s announcement in May of its plans to end of its bond buying program. This was an indication of economic recovery in the US which prompted international investors to withdraw investments in emerging markets and invest them back in the US. Fed’s latest announcement not to taper its bond buying program as early as was expected after its previous announcement saw many of these currencies somewhat appreciate against the US dollar in the last couple of weeks – this reinforces the argument that Fed’s actions largely determined the short term fluctuations in the Indian Rupee. A part of the depreciation in the value of Rupee was also driven by speculative activities in the currency market, especially in the offshore non-deliverable forwards (NDF) market. Couple of points are worth mentioning about the fundamental issues with the Indian Rupee. Even though the Rupee depreciated drastically since May, it has been in the decline for quite some time now, at least since 2011. So the depreciation of Rupee is not just a short term trend driven by global factors. India has had a current account deficit that has become wider in the aftermath of the global financial crisis as exports have failed to keep pace with imports due to economic slump in the west. This has been further exacerbated by rising oil prices as oil is an essential component in India’s total imports. Even though the government has taken measures to discourage buying of gold by the population – the second biggest contributor to the deficit – success in this regard has been moderate. These have resulted in a growing deficit that contributed to the Rupee’s fall in the medium-long term. The fact that the Rupee has depreciated not only against the US dollar, but also against other major currencies, is a testimony of this wider and longer term problem. For some time now India has been financing the current account deficit by the inflow of foreign portfolio investments. However, portfolio investments are highly volatile and can leave the country any moment. At times of crisis, the combined effect of a depreciating rupee and investment outflow exacerbate the problem, as was seen during the recent episode. The situation is further complicated by high external commercial borrowings by Indian corporates. Most of them borrowed heavily from international markets during the first half of the previous decade, and a substantial part of it is due for payment soon (around US$172bn or 60% of India’s total foreign reserves due by March 2014). Since the aftermath of the Asian financial crisis of 1997 many emerging countries, including India, have built up significant reserves to protect themselves from sudden fluctuations in their currencies. However, the country’s central bank did not intervene much in the currency market to stem the fall in the Rupee during the recent episode. The solution to prevent such situation in the future is twofold. Liberalization of financial markets has meant the currency is exposed to speculation in international markets, and increasingly to monetary policies of the US which has a fiat currency. Some form of capital control may be one way of stemming sharp currency swing in the short term. It is interesting to note that just over three years ago many of the emerging countries were voicing concerns that their currencies were appreciating too much due to strong short term international flows. This prompted the IMF, which was a proponent for free flow of capital for a long time, to reverse its position, and support some form of capital control for developing countries. While this can be an effective strategy in the short term, in the medium to longer India needs to cut down its current account deficit. Too much dependence on volatile foreign portfolio investments may not be the best way to go about it. Increasing foreign direct investments may be one way to increase flow of foreign capital that is less volatile. However, that is often a political decision and needs consensus from various stakeholders. Revaluating import policies may be another way to reduce dependency on import of non-essential items that can reduce the deficit. Data Source for the charts:


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