Indian Rupee, the most talked subject in recent day news !!

The government and the Reserve Bank of India (RBI) are trying hard in their own capacity to restore some sanity in the currency, but so far all the measures taken put together have failed to give desired results.

Our Government tried to blame recent depreciation of the rupee against the US dollar citing

Rupee has fallen because Indians buy too much gold, we have often been told over the last few moths

Rupee has fallen because foreign investors have been withdrawing money in response to the decision of the Federal          Reserve of United States to go slow on money printing in the time to come.

While there is no denying that these factors have been responsible for the fall of the rupee, but the truth is a little more complicated than just that. The rupee was more or less stable against the dollar between November 2012 and end of May 2013. It moved in the range of Rs 53.5 - Rs 55.5 to a dollar. This stability in no way meant that all was well with the Indian economy. In 2007, the current account deficit of India stood at $8 billion. In technical terms, the current account deficit is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances. The foreign exchange reserves of India in 2007 stood at $300 billion. So the foreign exchange reserves were 37.5 times the current account deficit. For 2013, the current account deficit is at $90 billion whereas the foreign exchange reserves are down to around $275 billion. So the foreign exchange reserves are now just three times the size of the current account deficit, in comparison to 37.5 times earlier. Another worrying point is the import cover (foreign exchange reserves/monthly imports). It currently stands at 5.5 months, the lowest in 15 years. Hence the demand for dollars has gone up much faster than their supply. And this did not happen overnight. It did not happen towards the end of May, when the rupee rapidly started losing value against the dollar. The situation has deteriorated over the last five to six years, while the government was busy doing other things.

Can we compare it to 1991 crisis?

Officials like to compare the current situation to 1991 and tell us that the current situation is not a repeat of 1991. In 1991, the import cover was down to less than a month. Currently it is around 5-6 months. Hence, the situation is not as bad as 1991. But the import cover is just one parameter that one can look at. The current account deficit in 1991, stood at 2.5% of the gross domestic product. Currently its around 4.8% of the GDP. Hence, the situation is much worse on this front than in 1991. The government has tried to control the fall of the rupee against the dollar by making it difficult for Indian companies as well as individuals to take dollars abroad. But that was already happening. The amount of money Indian corporates invested abroad in 2008, stood at $21 billion. It has since come down to $7 billion. The amount of money taken abroad by individuals through legal channels remains minuscule.

How did the Federal Reserve decision influenced our market?

Over the last few years, the Federal Reserve has been pumping money into the American financial system by printing money and using it to buy bonds. This ensures that there is no shortage of money in the system, which in turn ensures low interest rates. The hope is that at lower interest rates people will borrow and spend more, and this in turn will revive economic growth. After nearly 5 years, some sort of economic growth has started to comeback in the United States. And given this, the expectation is that the Federal Reserve will start going slow on money printing in the months to come. This has pushed interest rates up in the United States making it more interesting for big international investors to invest their money in the United States than India. This has led to them withdrawing money from India. Since the end of May nearly $10 billion of foreign money has been withdrawn from the Indian bond market. When these bonds are sold, foreign investors get paid in rupees. They need to convert these rupees into dollars, in order to repatriate their money abroad. This puts pressure on the rupee. And this is how the decision of the Federal Reserve to go slow on money printing in the days to come has led to the fall of the rupee. This is the story that the government officials and ministers have been trying to sell to us. But the point to remember is that the decision of the Federal Reserve of United States to go slow on money printing was just the ‘spark’ that was needed to explode the ‘sulfurous coating on the match’ that the Indian economy had become. The spark could have come from somewhere else and the ‘sulfurous coating on the match’ would have still exploded leading to a crash of the rupee. Also, it is important to remember that foreign investors have not abandoned India. When it comes to the bond market they have pulled out money to the tune of $10 billion. But they are still largely invested in the equity market.

Pressure of proposed food security bill on Rupee?

A day after the Loksabha passed the UPA government's flagship Food Security Bill, expected to cost the government some Rs.1.3 trillion a year, the rupee ended at Rs.66.19. It lost 2.84% on the day—the steepest daily decline since February 1996. In absolute terms, the dollar rose Rs.1.84, the biggest gain since March 1993. Passage of Food Security Bill is one big overhang on markets and rupee, as most analysts feel that it will have negative impact on fiscal deficit number. Finance Minister had earlier allayed fears saying that the Food Security Bill will not have a negative impact on the fiscal deficit. "The government can afford a vast new food programme for the poor despite concern about its impact on the strained public finances," Finance Minister P Chidambaram said. One will have to wait and see the results !!

Overall economic contraction

 

Poor economic growth in the manufacturing, agricultural and mining sector has dented investor sentiment and they have become wary of investing in India. Reflecting a persistent slowdown, industrial production in June contracted by 2.2 percent. Last month RBI cut its growth forecast to 5.5 percent for the fiscal year, from 5.7 percent. Unless a better sentiment prevails, confidence in the rupee will stay shattered. However one must not be completely cynical about bouncing back of rupee. There’s no magic wand. A medium to short-term approach towards growth has to be adopted by the government. Constant efforts of the government might bring a very marginal respite for the rupee, but to bring it back to 55-level will be an uphill struggle.

Note: All the above stated statistics have been gathered from various sources and might not be the latest figures.

Thanks

Nag