Devaluating indian currency

Devaluating Indian Currency

Introduction• What is Devaluation?

It is the decrease in exchange rate of a currency w.r.t. another currency.

• In common modern usage, it specifically implies an official lowering of the value of a country's currency within a

fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a

foreign currency.

• For example, Rs 24= 1 $. In 1991

while Rs. 65 = 1$ In 2014

• Devaluation is usually undertaken as a means of correcting a deficit in the balance of payments.

• Almost all the countries of the world have devalued their currencies at one time or the other with a view to

achieving certain economic objectives

Scenerio of devaluation of rupee for last 15 years

Path trace of Rupee…

• The Rupee-Dollar parity of 1947

• When India achieved independence in 1947, there were no external borrowings on India’s balance sheet! The exchange rate as on 15 August 1947 was 1 US$ = 1 INR. With the introduction of five year plans, Indian government needed foreign borrowing and this required the devaluation of the Rupee. The trend was exacerbated by the Indo-China war of 1962 and the Indo-Pakistan war of 1965 which forced the government to further devalue the Rupee as the country was in dire need of USD for importing weapons.

• Devaluation during the high inflation period of 1970sIn the year 1966, under the prime minister-ship of Mrs. Indira Gandhi, inflation was increasing at an unprecedented rate. This was also a time when India was under immense pressure from the US to devalue the Rupee to safe-guard the aid received by India from the US. This led to the Rupee being devalued to 1 USD=7 INR. The then members of parliament, Mr. Krishnamachari & Mr.Kamraj opposed the weak Rupee policy but Mrs. Gandhi did not relent, being mindful of the country’s dependence on aid from the US.

• The strong dollar period of 1980sAfter 1970, USD grew stronger against the Rupee under the incompetence of Indian politics coupled with robust economic growth in the US. The exchange rate in 1970 was 1 USD= 7.47 INR, which rose to 1 USD=8.4 INR in 1975, after the political uncertainty following the assassination of Mrs. Gandhi in 1984. The next round of weakness in the Rupee came in the wake of the Bofors scam which toppled Rajiv Gandhi’s government plunging the Rupee to new lows of 1 USD= 12.36 INR in the year 1985. In the year 1990 this rose to 1 USD =17.5 INR.

• Devaluation after the economic liberalization of 1991The economic liberalization in 1991 under the prime minister-ship of Narsimha Rao brought with it a sharp devaluation of the Rupee. At that time the Indian Forex reserve dropped to multi-year lows and a point came when India had only enough forex to be able to pay for 3 months of Import bills! To fill in this gap India borrowed large amounts from the International Monetary Fund’s (IMF) with an obligation to devalue the Rupee. The Rupee hit new lows with 1 US$ = 24.58 INR by the early-nineties from Rs.16.31/1 USD towards the end of the previous decade. The low Rupee policy came as a boom for exporters including the Information Technology industry, which was in its infancy at the time.

Revaluation

• In the period 2000–2007, the Rupee stopped declining and stabilized ranging between 1 USD = INR 44–48

• In 2007, the Indian Rupee reached a record high of Rs.39 per USD, on account of sustained foreign investment flows into the country.

But revaluation was not for a long time

• The trend has reversed lately with the 2008 world financial crisis as Foreign investors transferred huge sums out to their own countries.

• 2013 - True, India did not suffer much - in the sense that the banking industry was much more stable than in the US. But the market abroad was shaken -decreasing our exports. The major imports for India is crude oil, manufactured goods and minerals - and due to local demand of the population, these did not decrease. So exports decreased but demand didn't (it probably increased due to increase in population) again increasing the trade deficit

How the value of currency rate is determined

• Economics is governed by fundamental laws of demand and supply.

• If the demand of particular currency > its supply

than its value will increase.

• Consider an example:

You want to import something from US. For this you would need $. And currently you have Rs. So you go to the Foreign Exchange Market to exchange Rs and $ (giving Rs in return of $). But you are not alone! There are many people who are demanding dollars for rupee. So this leads to increase in value of dollar.

Balance of Payments

Current account

Capital account

Balance of payments

Reasons behind its fall

• Current Account Deficit (CAD)

• Strengthening of dollar

• Insufficient inflow of FDIs and outflow of the foreign investments

• Rising imports

• High inflation

• Trade deficit

• Low forex reserves

Low Forex Reserves

• Foreign-exchange reserves  are assets held by central banks and monetary authorities, usually in different reserve currencies, mostly the United States dollar, and to a lesser extent the Euro, the Pound sterling, and the Japanese yen etc.

• Suppose due to some reasons ,the exchange rate reaches below Rs. 50 per dollar. The RBI will then step in the market and will offer Rs. 50 for each dollar. Those buying rupees against dollar will now purchase from RBI since its offering better rate. Soon other traders will have to arrive at this rate, if they want to participate. Since RBI has the ability to print currency notes, it can keep the lower limit of exchange rate fixed at this value. When demand for rupee is subsided, RBI will step back and let market determine the exchange rate.

• Now in case of opposite,RBI will step in again and will put its dollar reserves on sale at the rate of Rs. 60/ USD. This will stop the further depreciation of rupee but it demands dollars and thus leads to decrease in forex reserves.

Currrent Account Deficit(CAD)

Balance of Trade(Exports-Imports)

Net Factor Income(earnings on foreign investments-payments made on foreign

investors)

Net cash transfers(eg.remittances)

Capital Account

Foreign ownership of

domestic assests

Domestic ownership of

foreign assests

Capital Account

Strengthening of Dollar

• In the last six months the dollar has strengthened by 3.52 percent with the strengthening of the US economy. The dollar has been rising on signs of growing economic momentum . This is something which is beyond the control of the Indian Government and it is hampering the recovery of the rupee.

Insufficient inflow of FDIs and outflow of the foreign investments

• The downfall in the Indian economy has worsened the situation and the government is unable to generate heavy capital inflows. Despite all the government effort to allow Foreign Direct Investment(FDI), there hasn’t been significant FDI inflow. The US federation has withdrawn some of its bond buying programmes, resulting in a sudden outflow of money that in return has left India far behind in the race.Foreign investors has been pulling out of the Indian economy. The month of May has seen a record outflow of foreign investments of Rs. 44162 crore. With the giants like Posco pulling out of its Rs. 300project in Karnataka followed by ArcelorMittal pulling out of its Rs. 50,000 crore project in O00 crore steel plant disha due to delays and land acquisition delays. This has shrunk the total inflow of capital in India. Indian investors have been spending more abroad than foreign investors have been spending in India. This has led to the further deficit of current account.

Rising Imports

• The rising import bill is one of major concern and it has hindered the government’s effort to tackle the falling rupee. Oil accounts for 35% of the total imports and gold 11% on India’s current bill. There has been a heavy demand for the greenback from the exporters of oil, the most prolific buyers of dollar in the world market, thus pushing rupee lower. In the gulf countries, the dealing of oil is done in dollars, i.e, if India has to purchase oil, it has to pay in dollars, so for this India needs to purchase dollars from USA in exchange of rupee. This has led to the further devaluation of the rupee.

Poor Economic Growth• The Gross Domestic Product (GDP) growth has hit its lowest patch in the last 10 years. With fall of the GDP growth to 4.8%, it had significant effect on the stock markets and the falling rupee. Themanufacturing, mining and the agricultural sector has faltered and investors have become cautious of investing in India.

Inflation

• As we all know inflation refers to hike in prices. In this scenario, most foreigners as well as Indians tend to take money abroad, or keep it away from India.

• Example : Consider this: suppose you have Rs 100, and a chocolate costs Rs 10. So you can buy 10 of these. Say the price increases to 20. Now you can buy only 5! Thus the value of Rs 100 has decreased! So you would prefer keeping Rs 100 abroad and bring it in when you know that the value of Rs 100 would be more!

Impacts

Devaluation

Import

Tourism

G.D.PFDI and FII

Export

Fiscal Burden

Tourism

• What effect devaluation has on tourism??

• It increases, but why?

• As the rupee devaluates the foreigner’s coming to India will have more Indian currency in hand and the trip will become cheaper for them.

• So devaluation of rupee favours Indian tourism.

• But it also leds to decrease in no of foreign trips by Indians. As the devaluating rupee makes it more and more expensive for them.

Import

• Imports Decreases

• Why?

• Importers pay in dollar.

Export

• Exports increase.

• Why?

• Because with devaluation of rupee the cost of goods decreases for foreigners.

Effect On Rupee depreciates Rupee appreciates

Importers Imports become costlier and hence importers lose

Imports become cheaper and hence importers gain

Exporters Realization from exports increase and hence exporters gain

Fall in export realization to the extent of forex difference and hence exporters lose

Foreign travel Trip becomes costlier Trip becomes cheaper

Foreign Investment

• As the rupee keeps on devaluating the foreign investor loose a significant amount of money.

• Due to this most of the investors fear while investing in indian market.

• Also many investors are pulling out there money from indian markets.

G.D.P.

• As the rupee keeps on devaluating the foreign investors will hesitate in investing in India and it will hence decrease the GDP of India.

• Another reason for decrease in G.D.P. is that G.D.P. is calculated in dollar and as rupee devaluates so the G.D.P. will also decrease.

Increase in fiscal burden

• The central government fiscal burden might increase as the hike in the prices of imported crude oil and fertilizer might warrant for a higher subsidy provision to be made for these commodities.

• However govt. has decreased the fiscal burden due to diesel subsidies.And it is planning to further decrease it to null.

Why Dollar is used to determine the value of currency??

• This is because 80% of the world’s transactions take place in US Dollar.

• The GDP of USA was approx. 15 trillion in 2012 while that of India was just 1.5 trillion.This may be the easiest way to realize why USD is considered most favourable currency.

Remedies by govt till date

• A planned increase in import duty has been exercised to shore up the decrement in rupee. The customs duty on several red-hot imports like gold and silver is on the rise, it’s a strategic move by the central government to ease the gap between dollar and rupee.

• Government is also considering increasing its import of crude oil from Iran, and pay for it directly in Indian rupees.

• Ministry of Commerce is exploring the possibility of using local currency for trade with major trading partners.

• RBI increased the current overseas borrowing limit for banks from 50% to 100%, and allowed it to be converted into rupees and hedged with the RBI at concessional rate.

• The central government has unraveled a multipronged strategy to bring about an increment in the inflow of dollars and limit the outflow to compensate for the sliding value of rupee.

But are these steps sufficient??

Further Remedies that can help if implemented

• NRI bank deposits can be made more attractive and foreign loan norms eased.• Electronic goods top the list when it comes to making big business. In order to stabilize rupee a

significant increase in customs duty on Electronic goods needs to be exercised.• Govt. should invest in researches than can find an alternative to oil which is the highest contributor to

increase in import.• Their should be a limit on the imports of luxury products.• Promote aggressively exports of manufactured goods like China.

How a student can support our devaluated currency??

• Student can spread awareness through social media and other means.

• They can educate people about the condition of rupee.

• They can promote use of Indian goods as far as possible.

Conclusion

• Today’s scenario presents that even after some steps taken by govt. their is no stabilization in value of rupee.

• So, govt. should work on further remedies.

• General public should also support govt. in decreasing imports i.e. “Spirit of Sacrifice by the People”.