THE CASE OF THE FALLIING INDIAN RUPEE AGAINST AMERICAN DOLLAR – A SUCCINCT ANALYSIS

Since June 2013 the Indian Rupee has fallen by 20 per cent against the American Dollar. As of now the Rupee/Dollar rate is hovering around Rs. 67 to 68 and expected touch 70 in the near future. This has been an additional strain for the Indian economy which is already having a slowdown in its GDP growth rate (4.5 percent in the first quarter of 2013), a ‘Twin Deficit’ situation in Fiscal and Current Account of 4.8 and 5.8 percent of GDP respectively. All these are going to have a cascading cumulative effect on the business confidence which is reflected in stock and bond market fluctuations and reduced investment.  A fall in industrial production, particularly in the core sector and stagnant infrastructure sector has added to this adverse predicament.   All these factors are going to have a cascading effect on the total economy in the near future in terms of reduced business and industry confidence and hence on the investment potential.
Conceptual framework
A simplistic conceptual frame work for analyzing the case of rupee depreciation is to identify the cause-effect relationship in terms of the total Demand and Supply mechanism for dollars presently obtaining in the Indian economy.  This situation can be analyzed broadly in terms of demand for dollars exceeding supply of it. This can occur in two ways. First, demand increasing while supply is more or less constant.  Second, demand increases with a decrease in supply.  The present situation is more akin to the latter.
Major Supply Sources
 For any further analysis, the major respective factors affecting the demand and supply have to be identified.
The major components of supply of dollars in to the Indian economy are:
          Exports of goods and services
          Portfolio foreign investment in the Indian Stock and Bond Markets
          Direct Foreign Investment
          NRI Transfers.
Theoretically, currency depreciation is favorable to increase the exports as the prices become more competitive. But this depends on three factors. First, How far are our exports price-elastic?   Second, has the global demand for our exports increasing potential instantly?  And third, is the depreciation a common occurrence to all the currencies of countries with similar export compositions thus neutralizing our price advantage?  The reality is that all the above factors are operating concurrently to our disadvantage.  Our exports, by and large, are less price elastic.  The persisting global recession has reduced the demand and there is a general depreciation of currencies of almost all the countries in South East Asia who are our competitors in one or the other items of our exports.  Our export growth has been on a downswing for some time and continues to be that in spite of the rupee depreciation. Efforts need to be taken to provide governmental support for export stimulus through pre and post-shipping financing which is underway. Another worrying factor is most of the exporters station their dollar earnings abroad to take advantage of the continuously falling rupee rate which has led to a speculative motive rather than transaction one.
Portfolio investments are mostly done by the Foreign Institutional Investors (FIIs) who are the major players in our stock and bond markets.  These investments are purely guided by the relative returns they get in different countries and highly volatile and short-term in nature.  That is why this is called as ‘Hot Capital’.  Movement of this capital in and out of the country is less predictable and uncertain. At present the confused signals given by the Governor of American Federal Reserve Bank regarding phasing out of Quantitative Easing (QE) in that country has created a flutter in resulting an outflow of this capital back to that country.  In addition to this the green shoots of substantial growth of the American Economy resulting in relatively reduced unemployment rate has created optimism regarding the investment potential in that country. Any withdrawal of portfolio investment has a direct bearing on the demand for and supply of dollars in our country.  This is basically a weak link in our Foreign Exchange Reserve funds.
The Direct Foreign Investment is the next source of supply of dollars. Our policy makers have been taking a number of positive measures to attract foreign direct investment in to the country over the years in terms of liberalizing the Indian business and industry for foreign collaborators with full or partial participation. The prohibitive list for foreign collaboration is gradually reduced to only strategic sector.  In spite of all this, we have not been able to attract the direct foreign investment to our expectations.  In fact compared to China, our performance in this area is not substantial to efforts. This is because FDI is conditioned by the structure of the economy and the transparency in policy and procedural mechanism. Far more significant are the factor of political stability and the nature of governance. With the General Election coming in early 2014 and with the prevalent economic downturn, it is bit too optimistic to expect a positive reaction immediately for all the relaxation we have made for allowing higher participation of FDI. The slush of recent measures sound like an act of forced desperation rather than a sustainable long term action.  There has been a back and forth movement on the taxation policy regarding foreign M&A in India. Vodafone has been a classic example. On the other hand some of the foreign investors have withdrawn like Arcenol- Mittal and some limited their operations like Posco withdrawing from Karnataka and confining only to Odisha. There also Posco is having problems in land acquisition.  Recent Land Acquisition Bill passed by both the Houses of Parliament apparently has all the seeds of discouragement for FDI to an extent.  The effect is yet to be seen.
NRI Transfers has shown an increase over the years even though it is a minor source for supply of dollars, thanks to a variety of incentives given by the Central Government to promote this inflow. This has happened in the normal economic situation.   Burt in the prevailing predicament of consistent and continuance  rupee depreciation, as usual it has led to a speculative motive of NRIs to wait and watch the extent of fall  and to take advantage of it before the rupee gains some stability.
Considering all the above factors, it almost leads to an inference that it will be difficult to manage the situation from the supply side of dollars in the immediate future. If it happens it would be a Miracle!!
The other alternative to increase the supply of dollars in the market is to release additional dollars by the Reserve Bank of India drawing from the Foreign Exchange Reserve.  RBI has resorted to this to an extent over the recent days but not with any sustainable recovery.  More over FER is around $ 270-280 billon which is sufficient to meet the import bill for 8 to 9 months.  Any reduction in the reserves without any matching or substantial increase would aggravate the situation further akin to 1991.
Major Factors influencing Demand
The major components of demand for dollars in the country are
          Imports of Fuel
          Imports of Gold
          Imports of Non-Essential  Items
           Indian Foreign Investment and other outflows
Imports of fuel in terms of Petrol and Petroleum products account for more than 70 per cent of our import bill. Rupee depreciation has further affected the dollar value of these imports.  In addition, the international price of crude oil is fluctuating on the higher side around $100 per barrel which is going to hit still higher due to Syrian Crisis.  Any reduction in our fuel bill can happen due to unaffordable hike in the deregulated internal fuel prices.  Any measure to control the fuel consumption has to start at the governmental levels who are the major consumers. How far the austerity programs work is suspect. The domino effect of increased fuel prices on industrial production would be adverse. It will have a cascading effect on inflation which is already on a higher side over the last couple of years in spite of RBI monetary policy efforts. Still hovering around 9% to10 %. The alternative is to locate an alternative non-dollar source for fuel imports such as Iran.  This would lead to foreign relations complexity that too in the wake of Syrian situation.
The second major item in the import bill has been imports of gold which increased because our favorable economic situation during 2009-11.  The demand for gold has two components.  One is the demand by business for value addition as jewelry, a part of which is exported.  The other one is the household buying.  The buying of gold has witnessed an unadapting spree because of the global and internal economic downswing.  Gold has become a safest avenue for investment with lesser risk and high security.   This is an area Government has taken measures to limit the imports of gold and control the buying of gold by households resorting to bank loans.  How much this will ease the demand for dollars is yet to be seen.
Because of our comfortable economic growth rate during 2009-11, we became complacent in allowing imports of non-essential luxury items of international repute in products like mobiles, chocolates, toiletries and consumer durables.  Rightly, the Government has put a brake on these imports.
Government has also put reduced caps on the outflow of dollars by business and individuals for transfers and also purchase of real estate abroad.  These capital controls had its own initial psychological adverse reaction particularly in the stock markets.  Falling rupee has also adversely affected the aspirants of education abroad and also the foreign travel.
Parameters to assess the Alternatives to Alleviate the Problem. 
Two sets of parameters are suggested here, to identify the alternatives needed for alleviating the problem of continuous fall in the Indian Rupee against American Dollar.
First is to identify the Macro- Alternatives under three categories
          Controllable Measures  by the Government
          Semi Controllable  Measures by Government along with Indian industry and Business and Society at large
          Uncontrollable –Global factors which need close monitoring and action plan.
Second set of parameters is based on time perspective as
          Short term
          Medium Term and
          Long Term
These two sets are not exclusive but interactive and telescoping to each other.
So far, the measures taken by the Government are broadly perceived by one and all as short term knee-jerk reactions without much of an effective impact.  One of the reasons given for this limited impact advocated by the Finance Minister is that the Indian Rupee has been notionally appreciated over the years and hence should be left to market forces to find its right level through permissible depreciation.
This is measured by the Real Effective Exchange Rate (REER) of Rupee which is measured by weighted average of bilateral trade real exchange rates (nominal rates deflated by inflation rate) with weights equal to trade shares with each country.  Indian Rupee is pegged to a basket of six currencies and if 2004-5 is taking as a normal year when REER is 100, it is calculated that the present in 2013 is 105.6. According to this Indian Rupee has an appreciation of 5.6 per cent over the exchange rate in 2005 and the present rate should be RS68.  Hence, Indian Rupee may be allowed settle at this rate and till then there is no need for panic. Only when it overshoots this rate, serious corrective measures have to be taken to stabilize it.  Till now it is hovering around 67-68.  Any way this depends on how far we can control the inflation rate that too with the fuel prices increasing.
Conclusion
Even though the Rupee depreciation is considered as a short term abrasion, in reality it is a symptom of the structural imbalance of the Indian economy saddled with low growth rate , twin deficit of fiscal and current account, lack of infrastructural development and consistent high rate of inflation based  on consumer price index.  What is required is a strategic long-term Action Plan.  This can happen only with the new Government in 2014 with a long term focus to put the economy back on progressive track.
Dr Ramesh.G.Tagat

Academic Mentor and Professor

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