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The Dangerous Fall: Cause and Effect Equation of the Dramatic Depreciation of Rupee

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(Author: Mr. Vipul Maheshwari )

The Dangerous Fall: Cause and Effect Equation of the Dramatic Depreciation of Rupee

TheFall

In last the week of August 2013, the Rupee, Indian Currency, depreciated to an unprecedented level against US Dollar. Here we are not concerned with daily fluctuations in the Indian currency rate. But for some time now i.e. since around April 2013, Rupee, after breaching the psychological barrier of 60 then later on 65 to a dollar, has sustained there despite the best efforts of our central bank, RBI, Finance Ministry and Capital Markets Regulator SEBI.  The efforts to smoothen the volatility in the currency market does not seem to be abating as the exchange rate is adjusting to its market determined level, Said D. Subbarao, RBI Governor, in his latest lecture where he was reflecting on the challenges faced by the economy. He attributed economic slow down to supply side constraints and governance issues.

Given the kind of impact depreciating currency has on overall purchasing power of the citizenry and also on the capital gains derived from any returns which come to investors. So it is worth our while to understand the dynamics of this depreciation, its impact and the measures taken by various govt. agencies to stem the rout.

 

The Causes

Though there are differing views on the causes of the steady depreciation of rupee. But for sure it can be said that it is the combined effect produced by the dynamics of domestic and international  economy and politics. The difference in perception could not be sharper then the differing reasons ascribed for the fall by the Prime Minister and the Central Bank Governor. While the former believes that it is the tapering in the US monetary policy that has caused foreign capital to fly away but the latter believes that  it is the domestic structural factors  which have caused such drastic depreciation. The reasons are more local than global. Because when current account deficit (CAD) is run for 3 years well above the levels it could sustain itself in a row, due to the easy liquidity in the global system, and your govt. continues to keep increasing fiscal deficit then you have nobody else but your own self to blame for it. The various causes are as follows:

  • Regulatory Uncertainty Scares the Investors Away:The Govt. has for long been accused of policy paralysis.And because of this, key economic reforms and policy initiatives could not be carried out or taken. For one reason or the other clearance to important FDI investments just could not be granted. If some of them managed to receive clearance from one department of the govt. then they either got stuck with another one. Like if FIPB approved your project then you remained caught up with the environment ministry. And even if you managed to cross the ministry hurdle then either the difficulties complicated by a complicit state govt. coupled with crony capitalism bungled in such a manner that acquiring land for projects became impossibility or annulled by Judiciary. And when none of this was the case then the Tax department produced a beauty by bringing retrospective changes to tax laws so as to tax transaction, which were held legitimate even by the Supreme Court of the country. So all this created such a regulatory muddle that even the best legal brains kept on speculating as to the regulatory or judicial outcome of a particular situation. And great Indian growth story came down crashing like ahouse of playing cards. Even then some foreign investors remained still invested in the country either due to adverse international economic situation or just out of sheer optimism. But the moment US economy started looking safe and profitable after the announcement of Federal Reserve about their monetary policy, the foreign investors started fleeing and Rupee came crashing down.

 

  • Difficult Fiscal Situation and Falling Industrial Production

The dramatic devaluation has also been due to the high current account deficit. when current account deficit (CAD) is run for 3 years well above the levels it could sustain itself in a row by the Govt. due to the easy liquidity in the global system and you do nothing but just enjoy the ease then you have nobody else but your own self to blame for it. The deficient Indian current account,due to its structural dependency on costly oil and gold imports, is likely to continue in the coming years. The current account deficit coupled with falling industrial production makes the economy unattractive for the foreign investors and they simply flee the economy.

Why Dangerous: The Impact

Those who are directly affected by the lower value of the rupee are importers, peopletravelling  abroad or students taking foreign education courses. But the fall affects everyone in the economy because it feeds directly and indirectly into general inflation, which is a continuing problem even as output growth decelerates, and therefore hits common people hard.The immediate impact is on

  • Shoots up Petroleum Prices:the prices shoot up because apart from globally traded price of fuel, the exchange rate also determines the domestic oil prices. So if the rupee faces devaluation the energy prices also go up and thus feed into general inflation. As we know fuel being prime mover of the economy causes high inflation into all other prices production costs shoot up and so also the transport costs.
  • Slows, Already, slowing Industrial Activity: As many industries have increasingly become import-intensive, so they too immediately face the music in terms of rising cost pressures when devaluation occurs. Apart from those durable consumer goods such as automobiles, white goods and electronic items and non-durable goods such as soaps and toiletries also become costlier.
  • Costlier Imports also affect exports: The increasing costs of imports can also affect exports, thereby wiping out any global cost advantage accruing from the devaluation.

 

Counter Measures

 

The Rupee rout forced the govt. to take measures aimed at attracting overseas investment into India, cause liquidity squeeze in the economy and restricting non essential imports by way of heavy import duties. In other wordsRBI, responded to the situation over the last two months by increasing the short term rates by curbing liquidity in the financial system, reducing the amount of foreign exchange that locals can take out of the country, and most recently opening a special window for oil marketing companies to buy dollars in a desperate attempt to curb the rupee’s fall. More specifically the measures ranged from raising duties on non-essential goods to relaxing norms for overseas fundraising by corporates, to stabilise the rupee.  It also included measures to attracting foreign inflows by relaxing external commercial borrowings (ECB) norms for corporates apart from luring the Foreign Institutional Investors.

Conclusion

So in conclusion it can be said that the situation is really grim and unless correct measures are not taken then it will be the poorest of the poor who will suffer most. But as we know in India good economics has never been good politics. And probably because of this, while important economic legislations gather dust in the file rooms of the Parliament populist bills like Food Security Bill are being legislated at lightening fast speeds.

 

 

 

 

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