“While the net impact of the reduction in value of Indian currency as compared to other currencies has been negative, economists maintain that all is not lost yet and the future is not as bleak as is projected to be. With fixed exchange rate having been long done away with, the export sector standing to gain from the current trend and future planning to reverse the devaluation trend, things...
“While the net impact of the reduction in value of Indian currency as compared to other currencies has been negative, economists maintain that all is not lost yet and the future is not as bleak as is projected to be. With fixed exchange rate having been long done away with, the export sector standing to gain from the current trend and future planning to reverse the devaluation trend, things may still look upbeat for the Indian economy”
Recently, there has been considerable devaluation of the Indian rupee, leading to catastrophic effects for the Indian trade and services market. What has alarmed investors (both foreign and Indian) is not just the quantum of this depreciation, but also its speed and frequency. The news about the Indian rupee losing further ground to the US dollar has become a common phenomenon. Since the downward spiral started in May 2011, the Indian rupee has lost over 18 per cent of its value and is being traded at an average of '55.72 to $1 as of August 2012. This has caused an unparalleled ripple effect at both macro and micro levels for the Indian economy.
Devaluation of currency refers to reduction in the value in relation to another currency. Theoretically, it is employed as a measure of comparative value of different currencies. As world economic history has shown, devaluation of currency is not as simplistic and uni-directional but has a cascading effect on the economy as globalisation has changed the business environment forever, leading to an exponential increase in the commercial opportunities, complexity of the business environment, multiplying the risks and opportunities, further magnifying the impact of devaluation on any economy.
Devaluation of currency is not always outside the control of an economy and is generally a result of the country’s Monetary Policy, which allows it to organise the flow of credit in the economy. This happens mostly in countries, which do not allow currency prices to be determined by market forces. To avoid counterintuitive and sharp fluctuations in the value of the currency, countries across the globe, in the wake of liberalisation and globalisation, have aligned themselves to allowing global market forces determine the same.
The impact of devaluation of the Indian rupee is that imports have become expensive, thereby amplifying overheads of production and operation, and ultimately profitability of industries. Further, given that India is a net importer and heavily dependent on the import of oil, food items and other crucial raw materials, with a sizeable trade deficit, the net impact has to, a priori, be negative. In fact, a recent study conducted by ASSOCHAM India, has revealed that the Indian rupee cost of imports have increased by '65,999 crore.
Besides the escalating operating costs and depressing profit margins, the transmission of these increased costs to consumers has also lead to renewed inflationary pressures. Companies that may have subscribed to dollar-denominated borrowings are also finding it expensive to service their loan commitments. It is also a myth that domestically-oriented companies have remained largely unperturbed by the declining rupee as they too find the inflationary impact inimical to their business interests.
The 'Fast Moving Consumer Goods industry' (FMCG), is being viewed as the worst affected by devaluation. This is attributable to the pre-existing inflation, significant inter-industry competition and low purchasing power of the consumers whereby, the manufacturing companies bear the maximum burden and lose out on profit margins.
Instances of falling prices of imported commodities have also been mitigated as the depreciating rupee has meant that the importer gets no respite as they need to pay more to purchase the same quantity of raw materials. The depreciating rupee would keep the price of imported commodities elevated and adversely affect the industrial sector, especially the key commodity sectors like oil.
The illustration below throws light on the drastic adverse effects of the increasing exchange rate of the USD, on the price per barel of crude oil.1 The impact on this industry can at best be understood by the fact that although, the global prices of crude oil in November 2011 were lower than that in April 2011, the depreciation of the rupee has meant that the importer has to pay an additional '489.8 billion to import the same quantity of crude oil. Since India imports most of its crude oil, the companies, investors as well as consumers are adversely affected by the depreciation. While, a depreciating rupee makes import of crude oil more expensive, which directly leads to an increase in the operating expense of the companies, thereby affecting their profit margins, the real burden is borne by the consumers, as most of the impact on the company from the rise in import prices of crude oil is passed on to the consumers.
Similar is the story for ‘vegetable oils’, which collectively refers to olive oil, palm oil, soybean oil and sunflower oil. Even though the global vegetable oil prices have declined by $157.6 per metric tonne, due to rupee depreciation, the import cost in domestic currency has increased by '69,41.6 per metric tonne. Another significant impact to note is that palm oil is used as a raw material in the FMCG industry and an increase in price of the input, also adversely affects that industry. The illustration below throws light on the drastic adverse effect of the increasing exchange rate of the USD, on the price per barel of vegetable oil.
2 From the aforementioned discussion, we have witnessed how the rupee devaluation affects almost all sectors of the economy. However, the economists also feel that all has not yet been lost and the situation may not be as bleak as is being projected. Fortunately, for India, it had done away with the policy of fixed exchange rate or managed exchange rate, i.e., assigning a value to the rupee rather than allowing the market forces to determine the same as history reveals how India, in the years 1966 and 1991 has witnessed the most critical devaluation of rupee owing to the destructive inflationary economic policies in conjunction with a fixed exchange rate regime it had been following. The dip in the value of rupee in both these years were overnight events rather than a correction witnessed over a period of few months.
"The fundamentals of the Indian economy remain strong as has been witnessed from India’s robust growth rate during recessionary times. Given the strong resilient forces of the Indian economy, steadfast corrective decisions in the tax and FDI reforms in key sectors will go a long way in boosting investor confidence, higher export realizations and jettison India back to the 8 per cent growth trajectory."
Another silver lining is perhaps the export sector, the one sector, which stands to gain by this devaluation, as this depreciation increases price competitiveness of domestic products in the overseas markets, which may aid the volume-led growth of exports of these sectors. Mr. Pranab Mukherjee, the then Finance Minister of India, had once cited global economic recession and volatility in the Middle East as the reason for the current weakening3. This justification, however, is only marginally correct as the current policy paralysis in matters of Foreign Direct Investment (FDI) in important sectors, pending tax reforms, lack of efforts towards increasing the exports capacity and heavy reliance on imports is much more responsible for the current account deficit. Therefore, by planning ahead, the prevailing devaluation trend can be reversed.
Some suggestions in this regard are:
- Encouraging futuristic solution oriented measures and initiatives that have been adopted by the government and RBI to tackle the steep decline in the value of the rupee and to curb the speculations. For instance, the limit for investment by the Securities and Exchange Board of India (SEBI) registered foreign institutional investors (FIIs) in government securities has been enhanced by a further $5 billion. This would take the overall limit for FII investment in G-Secs from $15 billion to $20 billion.
- RBI has also decided to allow Indian companies in the manufacturing and infrastructure sector and earning foreign exchange to avail of external commercial borrowing (ECB) for repayment of outstanding rupee loans towards capital expenditure and/or fresh rupee capital expenditure under the approval route, thereby, bolstering support to the companies and mitigating losses accruing from the currency value differentials.
- It will be advisable that the Cash Reserve Ratio and Statutory Liquidity Ratio must be increased so as to reduce the liquidity in the system.
- The Government could also consider attracting NRI dollar deposits by offering attractive interest rates. Wherever possible, the Government could reschedule / delay paying off its dollar debts with the hope that the rupee would regain strength subsequently.
For now, the Government must act on the pending issues of liberalising foreign investments in insurance, aviation and retail, infrastructure sector, agro-based businesses as well reduce subsidies from various sectors. This would be one of the best moves for the economy, ensuring long term money injection in the form of FDI and FII. This is also the time to act as the GAAR (General tax anti-avoidance rules), which will come into existence by 2013, is being viewed by foreign investors as a threat in the foreseeable future, which would further impact the devaluation of rupee.
Although, outflows on the FII front have undermined the rupee in recent months, the fundamentals of the Indian economy remain strong as has been witnessed from India’s robust growth rate during recessionary times. Given the strong resilient forces of the Indian economy, steadfast corrective decisions in the tax and FDI reforms in key sectors will go a long way in boosting investor confidence, higher export realizations and jettison India back to the 8 per cent growth trajectory.
Footnote: Website of the International Monetary Fund: Available online at http://www.assocham.org/arb/general/Rupee_Exchange_Depreciation_Impact_Analysis-2012.pdf last visited on 3rd August, 2012. 2 Website of the International Monetary Fund: Available online at http://www.assocham.org/arb/general/Rupee_Exchange_Depreciation_Impact_ Analysis-2012.pdf last visited on 3rd August, 2012.; 3 Rupee’s devaluation due to national, international factors: Pranab Mukherjee, The Economic Times, 27th May, 2012, http://economictimes.indiatimes.com/news/economy/indicators/rupees-devaluation-due-to-national-international-factors-pranab-mukherjee/articleshow/13570160.cms
Disclaimer–The views expressed in this article are the personal views of the author and are purely informative in nature.