A PROJECT REPORT ON
FALLING RUPEE ()
SUBMITTEDTO THE UNIVERSITY OF MUMBAIAS A PARTIAL REQUIREMENT FOR
COMPLETING THE DEGREE OF M.COM (BANKING AND FINANCE) SEMESTER
ISUBJECT: ECONOMICS OF GLOBAL TRADE & FINANCESUBMITTED BY:
PILLAI ANUJA SURESHROLL NO.: 42
UNDER THE GUIDANCE OFMRS. RAJAM RAJAGOPALAN SIES COLLEGE OF
COMMERCE AND ECONOMICS,PLOT NO. 71/72, SION MATUNGA ESTATET.V.
CHIDAMBARAM MARG,SION (EAST), MUMBAI 400022.
CERTIFICATEThis is to certify that
_____________________________________________________________________________________________of
M.Com (Banking and Finance) Semester I (academic year 2013-201) has
successfully completed the project on
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_________________ ___________________ (Project Guide) (Course
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DECLARATION
I, __________________________________________________Student
M.Com (Banking and Finance) Semester I (academic year 2013-2014)
hereby declare that, I have completed the project on
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information presented in this project is true and original to the
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___________________PILLAI ANUJA SURESH Roll No.: 42
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ACKNOWLEDGEMENT
I would like to thank the University of Mumbai, for introducing
M.Com( Banking and Finance) course, thereby giving its students a
platform to be abreast with changing business scenario, with the
help of theory as a base and practical as a solution.I am indebted
to the reviewer of the project Mrs.Rajam Rajagopalan,my project
guide for her support and guidance. I would sincerely like to thank
her for all her efforts.Last but not the least; I would like to
thank my parents for giving the best education and for their
support and contribution without which this project would not have
been possible.
______________________ PILLAI ANUJA SURESH ROLL NO.42
TABLE OF CONTENTSSr.NoContentsPg.No
1Introduction6-
(a) Overview6
(b) Rationale8
(c) Objective8
(d) Chapterization8
2Life line of rupee9
3How Rupee has moved against dollar12
4Causes of Rupee fall14
5Impact of Rupee fall19
6Belated steps taken by authorities21
7Policy options for India22
8RBI and ailing rupee24
9New prescriptions for ailing rupee28
10Conclusion30
11References32
OVERVIEW
We invented money and we use it, yet we cannot understand its
laws or control its actions. It has a life of its own.- lionell
trilling, american literary criticThe most concerning chapter for
India during last two years and specifically last two months is the
weakening of rupee against dollar. It is not only that rupee has
lost its value in the global context but also dollar has improved
its performance in the global trading markets. The outstanding
performance of US equities and the improvement in the labor market
has made Americans more optimistic about the US economy, thereby
stimulating greater hopes of QE(Quantitative Easing) tapering.The
government of India is still unable to generate heavy capital
inflows.If US Federal Reserve withdraws its bond buying programme;
there will be unexpected outward flow of money leaving India
clambering for dollars. The slowdown in the Indian economy has made
the situation more fickle.The government has a strong role in
controlling currency in the form of policy regulation and reforms.
The current UPA leadership has failed to strike with some heavy
reform to generate more cash inflows. As a result the government
has gradually lost its control over rupee depreciation. Investors
sentiment plays a pivotal role over hereOil and gold imports
account for 35 per cent and 11 per cent of Indias trade bill
respectively.There has been an uninterrupted demand for the dollar
from the oil importers pushing the rupee lower. Likewise the
falling gold prices have made the central bank to reduce imports,
which increases CAD and hits the currency directly. Indian economy
requires a strong structural reform to maintain a positive balance
of payment.Also, government spends excessively as election
approaches just to woo electorate votes. This causes the rupee to
depreciate. Then the government beats around the bush to control
the currency behaviour. Most of the times these measures worsen the
economic crisis to a great extent.The foreign institutional
investors have been selling index futures and Indian equity market
is weakening. As a result there is a heavy demand for dollar and
Indian currency as well as economic situation is looking too
gloomy.These worries, combined with a record high current account
deficit and now uncertainty over the central banks monetary policy
stance, have prompted foreign investors to sell more than $12
billion of Indian debt and equities since late May.Reserve Bank of
India has taken certain steps and some more to be followed to have
a control over rupee.But the Question comes here, What are the
implication? Is it that bad overall?The best business prototype
anyone can have is to spend in rupees and earn in dollars, which is
what the giants of India Inc, including the top IT companies, excel
in. Basically the sector which is targeting exports for its
industrial operations are the one wins the game.Dollar appreciation
would be positive for sectors such as IT, pharmaceuticals, hotel,
textiles and automobiles which have the total foreign exchange
earnings of these firms are far greater than their forex spends. As
much as the rupee weakens, the foreign exchange earners gain
provided the other factors remains constant.A sharply declining
rupee triggers inflation, broaden the current account deficit, hits
investor sentiment and creates burdens for organization with high
exposure to foreign debt. The government and the Reserve Bank of
India have taken several reform initiatives to resist the downturn,
but their success stories are looking gloomy.Buying imported
materials will become very costly. A weak rupee will create extra
stress on Oil Marketing Companies (OMC) and this will surely be
passed on to the consumers as the companies are allowed to do so
after the deregulation of petrol and partial deregulation of
diesel. If the OMCs increase fuel prices, there will be a
substantial increase in overall cost of transportation which will
trigger inflation.If the depreciation is steep and without control,
it will strike up inflation. As a result the Central bank would
have very less room to impose further rate cut and thats the burden
the borrower would have to bear.Indians who have gone to abroad for
tours or studies are highly affected in these times. The only
smiling people in this context are the NRIs who gain more on
sending money to their homeland.As a whole we can say that though
weakening rupee is the reason for someones smile it is a real
threat for the countrys overall fiscal health and increase the
current account deficit heavily. But in my opinion this huge
downgrade is a temporary phenomenon and the rupee is really
oversold. Now the Central bank and Government should work hand in
hand and find out the policy measures to stabilize the frightening
scenario. I personally hope a further cut in SLR to ease the
liquidity to save rupee and also import duty hike in gold and other
related materials. RBI can buy bonds to ease liquidity in the
market. Finally we can say that the situation is tight and
challenging for us, but we can not only hope for the best but also
should contribute the most to get back Indian economy in the
driving seat.RATIONALEThe purpose of undertaking this project is to
understand as to why the rupee has been the worst performer in Asia
since late May 2013, when the US Federal Reserve first signaled
that it may begin tapering its monetary stimulus this year,
sparking an exodus of cheap money from emerging markets
worldwide.
OBJECTIVEThe Main objective of this Project is to analyse and
incur as to how and which factors are contributing in ailing the
Rupee value. Thereby it also aims at discussing and bringing out
various solutions for Ailing Rupee. It also intends to bring to the
Note about the current and new RBI governor Raghu ram rajans entry
at this stage of crisis and what actions he plans to adopt will
also be shortly discussed.
CHAPTERIZATIONThe first part of the project takes back to the
performance of rupee against dollar in the past.Then it
concentrates on the current scenario thereby explaining its causes
and impacts. It also lays out various startegies adopted by
authorities to curb the fall which unfortunately couldnt do
well.The second part then deals With RBI, New governor and New
prescriptions for ailing rupee thereby listing the impacts of the
measures to be takenThis project then ends with a conclusion.
LIFELINE OF RUPEEYesteryear humanist Mehamood was morethan
symbolic when he crooned Na biwi na bachcha na baap buda na maiyya/
the whole thing is that ki sabse bada Ruppaiya in the 1976 movie
sabse bada rupaiyaThe movie released a few years after a
politically controversial move to devalue the rupee in the mid-60s,
mirrored the inescable importance of the currency note in Indias
socio economic milieuIndias currency history is a spectacular
continuum since the ancient ages to the current rough and tumble of
a globalized economy, with each eras coinage, and worth, broadly
imitating the prevailing political, social and economic
environmentEARLY DAYSPunch marked coins of the 6th-7th century are
believed to be the first documented use of currency in India-
called thus because of the peculiar technique to make them by
thumping bear symbols into silver planes.The Ruppaiya whish has
evolved into the modern day rupee, was first introduced as a silver
coin for transaction by emperor Sher shah Suri, Who built the grand
trunk road in the 16th century.It also perhaps , hold out lessons
on the role of currency and household savings in raising public
resources to build massive projects.Thrifty households could well
turn out to the primary financiers of highways and ports if Indias
savings sustains at high levels, primarily due to its armies of
young people entering workforce.POST INDEPENDENCEIn 1947, One could
change a Rupee-Worth a US dollar then-into 16 annas, but in value,
this was no loose change. Those days for an anna you could buy a
kilo of Ghee, now priced anywhere between Rs.300 and Rs.400-a
nearly 2000 fold jump.Indias exchange rate has developed from a
fixed regime where the government and RBI determined the rupees
value-similar to what China does for its yaun against the dollar-to
a market ruled system determined by the laws of demand and supply,
pretty much like other commodities.Between 1947-1971, India
followed a par value system where the rupees value was fixed at
4.15 grains of fine gold. The currencys devaluation in june 1966
reduced the par value of rupee to 1.83 grains of fine
gold.DEVALUATIONIn 1966, the Government announced its first major
intervention in the foreign exchange market announcing rupees
devaluation by 37.5% ( from rs.4.75 the dollar became expensive to
rs.7.50 in one single stroke).A devalued or depreciated currency
boosts exporters earnings in rupee terms. For every dollar,
devalued currency gives them more in rupees terms. This encourages
them to slash prices for their goods in the world market making
them more competitive than global peers.Two wars- with china in
1962 and with Pakistan in 1965- had crippled the Indian economy.
The broad objective of devaluing the rupee was to raise export
earnings, liberalise imports and boost Indias chances of securing
more foreign aid, underlying the importance of currency
administration as a policy tool.According to John P Lewis who was
the head of the USAID (united states agency for international
development) mission to India in the mid 60s: Devaluation was not
aid in itself. Devaluation was an instrument ;it was essential if
freeing the market was to work. Whether formally or de facto, it
had to come sooner or later, and in purely economic terms; it made
sense to get on with it.25yrs later, buffeted by a precarious BOP
crisis, Manmohan singh, who was the Finance minister between 1991
and 1996, again devalued the rupee in 1992 to encourage exports and
earn precious dollars. The rupees value fell sharply from just over
rs.25 to a dollar to near rs.32 to a dollar.That was the last time
India has used devaluation as an economic policy instrument. India
has since moved on to a fully market determined exchange rate
regime. Trans continental capital movements decided by the click of
a jumpy computer mouse play a key role in deciding the worth of the
rupee, which only three year ago joined the elite club of symbol
endowed national currencies that include the dollar, the pound, the
euro and the yen.PAIN AHEAD The rupee has had a sharp fall since
May 2013 and is menacingly threatening to canter past Rs.70 to a
dollar. If the countrys top economy managers have gone into a
huddle after the currencys recent slide, it is only symptomatic of
the anxiety inflicting Indias broader economy.Ever since the world
recovered from the doctom bust and found a new mantra-emerging
markets foreign investments, both direct direct and financial, has
been chasing on Indias story that deliver returns in igh double
digits a year. The tide has since turned, bringing the rupee and
other emerging markets, currencies down.Analyst warned of more pain
ahead as the world settles down to a new normal state of
economy.Taming Inflation or the currency(as in the case currently)
may require policies that result in increasing the economic misery
for people in the near term. Unfortunately, we see no short cuts
claims Sonal varma, economist at Nomura.Eventually, funds will
return to India and its peers, for these will remain the island of
global growth. As Herbert stein, a former economic adviser to US
president Richard Nixon and Gerald ford had presciently observed If
something cannot go on forever, it will stop. Indias policy makers,
and its people, will only be hoping the steins rule prove true for
halting the rupees free fall.
BOX 1Exchange rate? Whats that?Like any commodity, the exchange
rate or price of a commodity is determined by the laws of Demand
and SupplyStronger demand for the currency pushes its price up and
vice versa.An exchange rate of Rs.65 to a dollar simply means that
the value of one dollar is equivalent to Rs.65
BOX 2Currency Devaluation/Depreciation??If a currency is
depreciating, his implies that its value has fallen in relation to
another currency. In the current context, the value of the rupee
has fallen or depreciated from about rs.55 against the dollar to
about rs.65,over few months.Banks, Brokers, Individuals and
Government trade in currenciesThat explains the daily fluctuation
in currency prices.
HOW RUPEE HAS MOVED AGAINST DOLLAR1=$1(1947)-India gains
independence.6.35 (1966)-Government devalues rupee to encourage
exports.7.67 (1973)-Oil crisis breaks out; Government enacts FERA
to clamp down on illegal forex transactions8.41 (1975)- Government
inposes political emergency.12.36 (1985)- Rajiv Gandhi government
launches first stirrings of liberalization through long term fiscal
policy22.63 (1991)- India mortages gold to wriggle out of a BOP
crisis. Also, Finance minister Manmohan singh dismantles the
Industrial licensing regime in a budget that marks te beginning of
Indias economic reforms.25.92 (1992)- Government sets up SEBI to
regulate stock market in the wake of Harshad Mehta securities
scam.31.44 (1993)-India moves to a full market determined exchange
rate system after merging the dual rates of the transitional
liberalized exchange rate management system (LERMS) introduced by
RBI earlier.35.43 (1996)- Import licensing is abolished and tariffs
brought down substantially36.32 *(1997)- Finance minister P
Chidambaram presents Dream budget bringing down tax rates 41.27
(1998)-The Asian currency crisis hits;the rupee sinks to a new
low.48.60 (2002)- The prevention of money laundering act
(PMLA),2002, is enacted, forming the core of the legal framework to
combat illicit monetary transactions across the country. 45.32
(2004)- UPA government with Manmohan singh as PM comes to
power.43.31 (2006)- Indias growth rate hits a record of 9.8% on the
back of high domestic and global demand.43.50 (2008)- Wall street
icon Lehman Brothers collapses, pushing the world economy into its
worst crisis in eight decades.48.40 (2009)- UPA government returns
to power53.32 (2012)- Government announces retrospective taxation
of corporate deals, spooking investors.Rupee canters past 55,
touching 57.P.Chidambaram returns as Finance minister; shepherds in
a string of reformist moves, including plans to push india to the
path of fiscal consolidation. NOW:US Federal reserve chief Ben
Bernanke hints at withdrawing cheap money policy amid signs of
recovery in the US.The rupee plunges to a new low, breaching 65 to
a dollar despite a slew of measures including forex controls on
individuals and companiesThe government appoints Raghuram Rajan as
governor of the RBI.
BOX 3Why is the rupee falling-US Federal connection??The US
federal reserve has hinted at winding down the programme to pump in
billion of dollars, amid signs of recovery in the US.Part of this
money came in to Indian equities.Portfolio investors are now
withdrawing money from emerging markets, causing the demand for
dollars to rise, pulling down local currencies.
CAUSES OF RUPEE FALLThe Indian Rupee has depreciated to an all
time low with respect to the US Dollar. On 28th August 2013, the
Indian rupee had gone down to 68.825 against the Dollar but the
situation was somewhat revived by the Reserve Bank of India that
decided to open a special window for helping state owned oil
companies Indian Oil Corp Ltd., Bharat Petroleum Corp and Hindustan
Petroleum Corp.The beneficiaries will be able to buy dollars
through this window till further notice is provided. These
companies, together, require about 8.5 billion dollars every month
to import oil and it is expected that this will help them meet the
requirements. This has had an immediate effect as is evident from
the fact that the INR has started at 67 against the USD at the
early proceedings in the Interbank Foreign Exchange Market. The
question, however, is why this is happening. There are several
reasons that can be enumerated in such a scenario.WHAT BASIC LAW OF
ECONOMICS SAY??As per the rudimentary laws of economics if the
demand for USD in India exceeds its supply then its worth will go
up and that of the INR will come down in that respect. It may be
that importers are the major entities who are in need of the dollar
for making their payments. Another possibility here could be that
the Foreign Institutional Investors are withdrawing their
investments in the country and taking them elsewhere.This can
create a shortfall in supply of the dollar in India. In fact, of
late, the FIIs have been heading to greener pastures like Singapore
owing to the greater operational efficiency and lesser bureaucratic
problems that have unsettled the Indian business fraternity and
hampered its overall economic growth.This situation can only be
addressed by exporters who can bring in dollars in the system. If
somehow the FIIs can be wooed back, then this imbalance can also be
addressed to a certain extent. GOING FOR GOLDGold is a physical
asset and has been a traditional favourite for parking surplus
income. Gold is considered to be a safe harvest asset. In times of
high inflation and volatile stock markets, gold prices usually tend
to go up. It becomes costlier in rupee terms as the US dollar turns
expensive. High gold consumption ahead of the festival and wedding
season could see a rise in purchases despite recent import curbs,
further pushing down the rupee.
EUROPEAN RECOVERYThere are signs of recovery in Europe after
years of recession. Higher consumer spending in major European
economies such as Germany will nudge companies to expand
capacities. Additional production lines in factories to meet
greater demand or purchases will push up energy consumption in
Europe. This will lead to higher crude oil demand. This, coupled
with the Syrian crisis could push up oil prices further. For India,
the import bill could get even wider and could push down the rupee
further.0.2% estimated growth in euro zone during april-june,
making an end to recession.
US MONETARY EASINGThe US federal reserve is printing extra
dollar to pump in $85 billion every month to boost spending and
investment and help the economy turnaround. Part of this money came
into emerging markets including India. In may, Fed resereve chief
Ben Bernanke signaled winding down the stimulus amid recovery
signs. This has prompted foreign portfolio investors to withdrawing
money from India and other emerging markets. The resultant rise in
dollar demand has pulled the rupee down to record lows $85 billion,
US federal reserve has been injecting monthly into the system.
Since the beginning of QE program, much of the money has leaked
into emerging markets offering higher yields and better growth
prospects. The emerging markets have been the biggest beneficiaries
of Feds loose monetary policy, which has pumped extra liquidity
since the global financial crisis of 2008. According to the IMF,
emerging markets received nearly $4 trillion in capital flows from
2009 to early this year.The investors borrowed cheap short-term
money in the US and invested in higher yielding assets in India,
Indonesia, South Africa and other emerging markets. This resulted
in more money flowing into debt, equity and commodity markets in
these countries. In India, many companies resorted to heavy
borrowings overseas. The massive capital inflows also enabled India
to comfortably finance its trade and current account deficits
rather than addressing the structural aspects of CAD. However, this
money will quickly leave India and other emerging markets when the
tapering of QE program begins. Already, emerging markets are
witnessing a huge outflow of dollars as investors have started
pulling money out of bond and equity markets. The foreign investors
pulled out a record Rs.620 bn ($10 bn) from the Indian debt and
equity markets during June-July 2013. If the Federal Reserve
decides to taper the QE program, the liquidity withdrawal would
continue to put pressure on the rupee over the next 12 to 18
months. SYRIAN CRISISA possible millitary intervention by the US in
Syria has sparked off fear that a war would break out in the oil
rich asset area. This has pushed up oil prices fuelling a rebound
in US dollar as investors flocked towards the dollars safety. India
imports nearly 2/3rd of its crude oil requirements and global oil
prices is bad news as it will push up the oil import bill and
consequent higher dollar demand would further impact the rupee $117
per barrel, the price of crude as on 25/08/2013, highest in 6
months
BILLING THE CADThe rupees fall is symptomatic of a wider Current
account deficit(CAD) or the difference between dollar inflows and
outflow. In 2012-13 Indias CAD had touched an all time high of $88
billion or a record 4.8% of GDP. Foreign porfolios investors are
waiting for cues on the calendar for rolling back the monetary
stimulus. A spurt of dollar outflow could make india to rein in the
CAD. A wider CAD carries the risk of weakening the rupee further.
VOLATILE STOCK MARKETWhen the economy is performing well and the
stock market is performing better than other countries, overseas
investors will become heavy investors here. It is a known fact that
Indian stock market is dominated by overseas investors. To invest
here, they need rupee. This will increase the demand for rupee and
will result in higher value for rupee. On the other hand, when
these investors are pulling money out of Indian stock market, rupee
will be depreciated. Indian market is in a bad shape for the last 2
years. The sentiments after the US downgrade and the European
crisis etc. resulted in overseas investors selling rupee,buying
dollars and rupee depreciation. In a bad performing market, when
there is depreciation in rupee, it will bring down the overseas
investors real returns. So they will start selling, which will
again worsen the situation. The dollar is still the safest paper
currency in the world! So, there is more demand for dollar in
volatile condition like this. This will add to the rupee
depreciation. THE ROLE OF OFF SHORE NDF MARKETAmidst all these
developments, the critical role played by the offshore non-delivery
forward (NDF) market in determining the value of rupee should not
be overlooked. The rupee NDF market has mushroomed in key global
financial centers with the liberalization of trade and capital
flows since the 1990s. NDFs are over-the-counter (OTC) derivatives
instruments for trading in non-convertible currencies such as the
Indian rupee and the Korean won. The contracts are called
non-deliverable since no delivery of the underlying currency takes
place on maturity. The counterparties settle the contracts on
maturity by paying the difference between the spot rate (decided by
the RBI) and NDF rate, usually in US dollars. Since NDFs are the
OTC derivatives, the actual size of the market is not known but
various surveys suggest that the trading volumes in the NDF markets
are larger than the onshore markets. According to a study by the
Bank for International Settlements (BIS), the daily turnover in
offshore rupee NDF market was $10.8 bn in 2010, nearly 52 percent
of the total turnover ($20.8 bn) in foreign exchange forwards and
forex swaps. The NDF market for the rupee is mainly concentrated in
Singapore, Hong Kong, Dubai, London and New York. In recent years,
London has become a key centre for trading in the rupee NDFs.
According to FXJSC Semi-Annual FX Turnover Surveys, the average
daily trading in rupee NDFs in London increased from $1.5 bn in
2008 to $5.2 bn in 2012, a jump of 250 percent. Being an offshore
market, the Indian authorities have no powers to enforce
regulations on it. The domestic banks and companies are not allowed
to transact in the NDF markets. The main participants in the rupee
NDF market consist of commercial and investment banks, hedge funds,
currency speculators, international subsidiaries of Indian
companies and big diamond merchants. Although the NDF market is
primarily meant to provide a platform to companies to hedge their
foreign exchange risk and related exposures, the dominant players
in this market are the speculators (who bet on the movement of the
rupee) and arbitrageurs (who exploit the price differentials
between offshore and onshore markets). GROWING INFLUENCE OF NDF
MARKETBeing a 247 market, the offshore NDF market exerts
considerable pressure on onshore currency markets, particularly
when the market sentiment is fragile for the rupee. Before Indian
markets open for trading, the NDF markets in Hong Kong and
Singapore set the price movement of the rupee. A bearish or bullish
trend in the NDF market set the tone for trading in the domestic
rupee market. An empirical study by a RBI staff member found that
there are volatility spillovers from NDF market to spot and forward
markets in India. The study also found that the magnitude of
volatility spillover from NDF to spot and forward markets has
become higher after currency futures were introduced in India in
2008. This is probably due to large arbitrage taking place between
futures and NDF market, says the study.In its latest Annual Report
(2012-13), the RBI has acknowledged that there is a long-term
relationship between the spot and NDF markets for the rupee. During
the period of depreciation, shocks originating in the NDF market
may carry more information, which gets reflected in on-shore
segments of the market through mean and volatility spillovers,
states the Report. FOREIGN BANKS PLAYING THE ARBITAGE GAMESince
foreign banks and institutional investors are present in both
onshore and offshore markets, they profit from huge arbitrage
opportunities using the prevailing negative sentiments in the
market. Such entities buy dollar-rupee forwards in onshore market
and sell forwards in offshore NDF market. According to India Forex
Advisors (a foreign exchange consulting and treasury management
firm), a large demand for forward dollar pushes up forward rate and
thereby influences the spot exchange rate in India. As witnessed
during July-August 2013, the increased speculative trading in the
NDF market exacerbated volatility in both the spot and the forward
market in India.Primarily six foreign banks (namely Citibank, HSBC,
Deutsche Bank, UBS, J P Morgan, and Standard Chartered Bank) are
the key players arbitraging between the rupee NDF market and
domestic markets. Besides, a few international subsidiaries of big
Indian corporations and some diamond merchants are also engaged in
arbitrage practice.
INDIA NOT WORST HITIts not in India alone where stocks and
currencies have contracted a global flu after investors began
flocking to safer locations such as the US ever since Federal
reserve chief hinted about rolling back th quantative easing policy
to aid recovery in the worlds largest economy.
IMPACT FUELLING INFLATIONOur transport bill could go up further.
A weak rupee has widened oil firms crude import bill sharply over
the last few months. This will eventually force them to raise
retail fuel prices to cover for potential revenue losses. Thus
costlier transport fuel will knock up prices and stoke inflation.
SOVEREIGN DOWNGRADEIndia has been the target of unsparing criticism
by credit rating agencies for its precarious public finances.
Ratings agency standard & poor cautioned that India faces a
rocky road ahead a high CAD, Low rupee and a high fiscal deficit
can raise the chance of a downgrade of Indias sovereign ratings
spooking investors and currency and equity markets.5% is Indias GDP
growth in 2012-13, the slowest in a decade.
INTEREST RATESThe RBI had been forced to raise banks borrowing
costs to curb liquidity in the system. The central bank wants to
discourage banks lendable resources being used for taking
speculative positions on the rupee. But costly funds for banks
could force lenders to raise rates for final consumers. Already,
many banks have raised rates. This could keep your EMIs high. FOREX
RESERVESIndias forex reserves can fund just about 7 months of
imports. The possibility of import payment default may be still far
away, but lower reserves will limit the RBIs ability to prop up the
rupee by selling dollar outflow , in wake of the rolling back of
the US stimulus Package, can also deplete the reserve. INFLATION
GRAPH AND FISCAL DEFICIT TO SCALE UPCurrently, India is suffering
from a near two digit inflationary pressure. A depreciating rupee
would only add fuel to this. It would lead to high inflation, as
India imports around 70 per cent of its crude oil requirement and
the government would have to pay more for it in rupee terms. Due to
the control on oil prices, the government may not easily pass the
increased prices to the consumers. Further, this higher import bill
will lead to rise in fiscal deficit for the government and will
push the inflation.On November 21 alone, overseas funds sold more
than US$500 million worth of Indian-listed shares over the five
trading sessions, reducing net inflows for 2011 to under US$300
million. The rupee has lost more than 10 percent of its value this
year, making it one of the worst performing currencies in Asia. In
the light of uncertainty and fall in global stock market, FIIs are
supposed to be pulling out their money from various EMEs (Emerging
Market Economies) and taking them back to their home countries in
order to sustain themselves.
A BLOW TO INDIAN IMPORTERSThe Indian import industry would also
have to pay more in rupee terms for procuring their raw materials.
This would happen despite a drop in global commodity prices, only
because of a depreciating rupee against dollar. Corporate India is
a net borrower of dollars and to that extent a depreciating rupee
would impact its balance sheet adversely. Companies with foreign
debt on their books would also be impacted. With the rupee
depreciating against the dollar, these companies would need more
rupees to repay their loans in dollars. This will increase their
debt burden and lower their profits. Obviously, investors would do
better to stay away from companies with high foreign debt.The
depreciating rupee has pushed up the prices of electronic gadgets
and home appliances. Car makers who import 10 to 40 percent of the
components are contemplating increasing prices. This is an attempt
to offset the increased import costs owing to the depreciating
rupee. An increase in prices could span from Rs 10,000 for small
cars to Rs 50,000 for luxury vehicles. The rising interest rates
and fuel hikes have played spoilsport for the car industry that is
brimming with a wide array of choice for consumers. NEGATIVE IMPACT
ON INDIAN STUDENT AND TRAVELLERS ABROADIndividually, travelling
abroad becomes more expensive as travel cost could go up by around
10 per cent compared to last July figures. Students studying abroad
too will be hit as more rupees will go out to pay for the courses,
stay and other expenses.RUPEE FALL IS A BLESSING???As reported,
Policy makers are spending sleepless nights over the falling rupee,
but it spells a winfall for NRI, who are racing to park their maney
back home.Expatriates working in west asia are borrowing from
friends and colleagues and even taking personal loans to cash in on
the other side.And bankers in kerala (the state has got around 2.8
million people working abroad, most of them in gulf countries)
report a 30% surge in remittances in the last 3 months.Smart people
have approached their companies and sponsors to advance their
salaries to make maximum use of the rupee slide
BELATED STEPS TAKEN BY AUTHORITIESDuring July-August 2013,
following measures were announced by the Indian authorities to stem
the depreciation of rupee and contain the current account deficit:
The duties on the import of gold, silver and platinum were
increased to 10 percent. The limits on foreign ownership of
sensitive sectors (such as telecoms and insurance) were further
liberalized. New restrictions were imposed on Indian residents
seeking to send money abroad to buy property. In mid-August, the
existing limits on overseas direct investments by Indian companies
were substantially reduced. However, this policy was withdrawn by
the new governor of RBI on September 3. The interest rates limits
for deposits meant for non-resident Indians were liberalized. New
restrictions on open interest on USD-INR trades were imposed. Banks
have been banned from trading in domestic currency futures and the
exchange-traded options market on their own. Banks can only trade
on behalf of their clients. The margin requirement on the domestic
dollar-rupee forward trade was increased to 100 percent of the
traded amount, which means investors will have to give the entire
amount of the transaction upfront. The state-owned oil marketing
companies (OMCs) which buy dollars to finance their imports were
asked to trade only with a single state-owned bank. It is
surprising to note is that the above-mentioned policy measures
failed to arrest the sliding value of the rupee in the currency
markets.
POLICY OPTIONS FOR INDIASeveral episodes of financial crises in
the 1990s (from Mexico to Southeast Asia) highlight the eminent
role played by current account deficits in triggering a currency
crisis. An economic boom fueled by short-term capital inflows and
debt-driven consumption is a recipe for currency crash. Indias
external sector vulnerability is a symptom of a much deeper malaise
in overall development strategy and domestic policymaking. Despite
the deterioration in major indicators of external sector
vulnerability, the policymakers remain complacent in defending
Indias growth story. There are no quick fixes to countrys
imbalanced external sector and the Indian economy remains
vulnerable to external shocks and global liquidity conditions.Some
analysts believe that India can rely on its foreign exchange
(forex) reserves of $275 bn to arrest the currency fall. But Indias
short-term external debt (with a maturity of one year or less) has
already reached an alarming level. According to the official
statistics, Indias short-term external debt stood at $116 bn in
March 2013 and the ratio of volatile capital flows (consisting of
short-term debt and portfolio investments) to countrys forex
reserves was as high as 96 percent. At current levels, the forex
reserves can barely meet the countrys import bill for seven months.
Firstly, New Delhi should take urgent policy measures to curb
inessential imports. Since increasing exports may take considerable
time, it is desirable to impose more curbs on gold, silver and
non-essential items. In addition to higher custom duties, strict
quantitative restrictions on the import of gold, silver and
non-essential items should be imposed. The government should also
consider imposing higher custom duties on those consumer
electronics goods which are not part of Information Technology
Agreement of the WTO. Indeed, such a policy regime may encourage
smuggling but there are ways and means to check it.Since oil is the
biggest item in its import bill, India should immediately accept
Irans offer to sell crude oil entirely in rupees and at
concessional terms. By accepting this offer, India could
potentially save $8.5 bn in foreign exchange spending. Oil imports
from Iran have declined substantially in the last five years due to
unilateral sanctions imposed by the US and the European Union.
Secondly, India should immediately work out modalities for trading
of goods in local currencies. India could begin trading in local
currencies with BRICS partners and Asian countries. Russia,
Malaysia and some other countries have expressed interest in
trading in local currencies with India. Thirdly, issuing
dollar-denominated sovereign bonds in the midst of a crisis-like
situation is a risky proposition. Besides, India will have to offer
a higher rate of interest to attract investors which in turn would
further increase countrys external indebtedness. Instead of
approaching the IMF for a standby loan which comes with stiff
conditions, India could enter into currency swap agreements with
key trading partners. Recently, India and Japan expanded their
bilateral currency swap facility to $50 bn. On the sidelines of the
G20 Summit at St Petersburg in September 2013, BRICS countries
worked out operational details of launching a $100 bn Contingent
Reserve Arrangement (CRA) to ease balance of payment
difficulties.Fourthly, to rein in rampant speculation and
manipulative activities in the offshore NDF market, the RBI should
work out arrangements with other regulatory authorities in the form
of information sharing and the setting of general standards.
Currently, a new regulatory framework for OTC derivatives market is
under preparation following the Dodd-Frank Act in the US, the
European Market Infrastructure Regulation (EMIR) in Europe and the
Basel III standards. As a member of G20, India should engage in the
ongoing international initiatives aimed at increasing transparency
and reducing systemic risk posed by the $560 trillion global OTC
derivatives market.Lastly, the Indian authorities should not
hesitate to impose capital controls as a macroeconomic policy tool
to protect the domestic economy from a sudden capital flight. In
this regard, capital controls imposed by Malaysia and Iceland on
the capital outflows are worth examining.
RBI AND THE AILING RUPEEOutgoing Reserve bank of India governor
D Subbarao expressed hope that his successor Raghuram Rajan would
be like Arjuna and find his way out of the Chakravyuha that the
economy is in.So the question is CAN ARJUNA GET COUNTRY OUT OF
CHAKRAVYUHA??Raghuram Rajan had made his intentions clear a few
days before he took over as the 23rd governor of the Reserve Bank
of India on September 4. On his penultimate day as chief economic
adviser, the 50 yr old economist told an informal media gathering
at the North block that the governors allegiance , as per the RBI
act, lay with protecting the value of the rupee and curbing
inflation. So, his decision to hike Repo and Reverse repo rates,
Despite increasing government pressure to slash them, should have
been expected. It, however, surprised analysts, stock markets,
India inc and more importantly, the government.The government, led
by union finance minister P.chidambaram, had been pressing for a
reduction in the Interest rates to boost economic growth. Many
expected Rajan to toe the government line in a stark departure from
his hawkish predecessor Duvvuri Subbarao. Rajan however, showed
that he has his own plans.IN HIS MAIDEN POLICY REVIEW, Rajan hiked
Repo rates and Reverse Repo rates by 25 basis points to 7.5 per
cent and 6.5 percent, respectively. In a bid to tighten liquidity,
RBI lowered the marginal facility rate by 75 basis points to 9.5
per cent, and brought down the minimum daily maintenance of the
cash reserve ratio(CRR) from 99 percent to 95 percent of the
requiorement. The CRR rate remained untouched at 4%.The US federal
Reserves decision to postpone the tapering off of the Quantitative
easing(QE) also failed to change Rajans mind. He says, Let us
remember that the postponement of tapering is only that, a
postponement, a cautious Rajan said.According to me , Rajans
assessment that the tapering off of QE is inevitable. A country
like India which is funding its current account deficit(CAD)
primarily with the help of portfolio inflow cannot afford to
overlook structural factors that are driving CADWhat to expect in
future??Analysis forecast that Rajan might further increase
interest rates to rein in inflation . However, SREI infrastructure
finance said in a statement: India needs huge investment in
infrastructure and half of that is expected to come from the
private sector. It is difficult to foresee how private sector will
be able to mobilise resources from domestic sources inthis
scenario.The society for Indian Automobile manufacturers said that:
The industry had been hoping for a recovery through the ensuing
festive season, anticipating an improvement in markets. But this
move comes as a surprise dampener...Interestingly, Despite the
pain, everyone privately, at least- agrees that rajan made the
right choice, and that he is a strong and worthy successor to
subbarao.In short we can quote Raghurams move as PAINFUL WISDOM
Know your Guv Raghuram rajan SCHOLARLY CREDENTIALSMassachusetts
institute of technology, Ph.D.,may 1991; Thesis title:Essays on
banking, IIM Ahmedabad MBA 1987, IIT delhi, btech (electrical),
1985 BOOKSFault lines:How hidden fractures still threaten the world
economy and many more EMPLOYMENT Eric j.gleacher distinguished
service professor of finance, graduate school of business, univ of
ChicagoChief economic advisor, finance ministry,GOIEconomic advisor
to PM of indiaChairman of high level committee on financial sector
reforms,indiaChief economist,IMF
MULTIPLE RESPONSIBILITIES OF RBIRBI, unlike its peers, has many
critical duties: MONETARY AUTHORITY- It formulates and implements
the monetary policy, mainltains price stability and credit to
productive sectors BANKING REGULATOR- It is the main financial
sector watchdog tasked with the duty to protect depositors interest
CURRENCY ADMINISTRATOR-It prints money with the primary objective
to give the public adequate quantity of supplies of notes and coins
FOREX MANAGEMENT- It has the responsibility to facilitate external
trade and payment and also prevent volatility in the forex market
GOVERNMENTS BANKER- It performs merchant banking functions for the
central and the state governments; also acts as their banker
RAJANS TRILEMMA
STABILISING RUPEE-20% fall in rupees value since may 2013. More
liquidity tighteningmeasures can choke growth by companies
borrowing costs TAMING INFLATION-9.6% Indias retail inflation in
july 2013. A depreciating rupee has made imported goods costlier,
but raising interest rates to cool prices will hurt investment.
BOOSTING GROWTH-4.4% Indias real GDP growth during April-june 2013.
High lending costs have forced companies to defer investment. But a
rate cutcan weaken the rupeeas also push up inflation.
RATE RULES Cash reserve ratio(CRR):Proportion of deposits banks
have to park with RBI REPO RATE:Rate at which RBI lends to bank
REVERSE REPO RATE:Rate at which RBI sucks cash from the system by
borrowing from banks. STATUTARY LIQUIDITY RATIO:Minimum proportion
of deposits banks are have to maintain in the form of gold, cash or
governments bonds.
Whos Exposed to the risk of a sudden stop of easy money from
US??MOST EXPOSED: Brazil, Mexico, South Africa, Turkey,
UkraineBODERLINE: Argentina, Hungary, Indonesia and
PolandMODERATELY EXPOSED: Chile, Columbia, Czech republic, India,
Korea, Malaysia, ThailandLEAST EXPOSED: China, Israel, Peru and
Russia
NEW PRESCRIPTION FOR THE AILING RUPEERUPEE SUPPORTMEASURES
IMPACT
RBI will swap dollars raised by banks under longterm deposits at
fixed rate of 3.5% Will encourage banks to raise dollars overseas
without currency risk
Banks overseas borrowings limit doubled to 100% of Tier 1
capital; RBI to swap dollars at 100 bps discount Banks will bring
in more dollars as cost of hedging comes down
Bank provisions for cash reserve ratio and statutory liquidity
ratio to be cut RBI may ease liquidity in forthcoming monetary
policy
BANKING LICENSE Ex guv Bimal jalan to head panel to screen
applications for bank licenses, new licenses before end january
Removes uncertainity of delay due to elections
Liberalized branch licensing for banks which meet rural
obligations Increase availability of banks in rural areas
Roadmap for freeing the entry of new private banks and allowing
different types of banks More competition in banking
More leeway for foreign banks coupled with more regulation and
supervisory control Strengthening of financial system
MARKET CONFIDENCE Cap on a companys overseas buy at 100% of its
net worth relaxed Companies can freely acquire businesses upto 400%
of their net worth if funding through ECB
Limit for Rebooking cancelled forward exchange contract doubled
to 50% for exporters Almed at inspiring confidence, greater risk
management flexibility for exporters
Importers to be allowed to rebook cancelled forward contracts
upto 25% Will enable better risk management
BANKING REFORMS Panel headed by deputy guv Urjit patel to review
monetary policy frame work RBI may drop mid quarter review for
consistency
RBI director Nachiket Mor to look into direct lending
requirement under priority sector norms Improved efficiency in
ending
Liberalization of markets and allowing speculation Seen to be
hinting at removal of restriction on banks faking position in
currency futures
Aadhar to be used for collating an individuals credit history
Improved credit for individuals
FINANCIAL INFRASTRUCTURE Electronic bill factoring exchange for
MSMEs where bills against corporates can be auctioned More credit
options for MSMEs
Deputy guv Anand sinha and Guv to look at speeding up of working
of debt recovery tribunals and asset reconstruction companies
Speedy resolution of Bad loans
Deputy guv KC chakrabarty to review NPAs central registry to
record loans by large corporates across banks Reduce risks from
large accounts going bad
White label Pos(card swipe) machines and mini ATMs to be allowed
Increased penetration of electronic payments
At a time when every surprise from RBI has been unpleasant one,
new governor Rajan sought to assuage markets with his action list
for the next 6 months. The time frame for these measures is not
years but months and weeks in some cases Rajan said
CONCLUSIONThe rupee's recent decline might appear sudden but it
hasn't really come as a surprise to keen observers. This crisis has
been building up for a long time. For years, successive governments
have relied on capital inflows to balance the CAD and support the
rupee. In the past, fortunately, the capital has come in. During
2003-08, capital inflows averaging $45 billion per year easily
wiped out the up to $15 billion CAD and exerted upward pressure on
the rupee. But they have dried up since then, and the government is
now appearing powerless to rein in the CAD to its target of $70
billion for FY14. The global economic crisis hasn't helped. In
fact, the Indian economy has managed to hit the perfect storm: the
government has been twiddling its thumbs, so the courts have shown
an unprecedented inclination towards judicial activism.While
dithering on matters of economic policy, government has chosen to
focus on unaffordable doles and subsidies. The latest in that trend
is the rather ambitious food security Bill. Its cost is expected to
be in excess of Rs 100,000 crore. God alone knows if the intended
benefits will actually reach those for whom they are intended, as
the malfunctioning of the PDS scheme is well known. Meanwhile, the
prolonged regulatory process of environmental clearances and the
difficulties in land acquisition have made industry rethink new
projects. The economy has been drifting directionless, with many
delays in much needed economic reforms and without incentives for
FDI.Largely compelled by government lethargy, the Supreme Court has
been intervening in policymaking. This has resulted in further
regulatory uncertainties for investors. Sectors ranging from
telecom and mining to pharma and real estate have been left
shaken.In the coal sector, India has some of the largest reserves
in the world, of around 300 billion tonnes. Yet, it's expected to
import 82 million tonnes of coal in FY14. With an average price of
$100/t, the bill will total to around $8 billion. It was with the
very aim of tackling such shortages that successive governments had
chosen the policy of captive coal block allocations, instead of
taking the auction route. With Coalgate simmering inside SC, and
outside, it's now unlikely that coal production will rise in the
near future as both government and investors will dither in taking
initiatives. Why would an investor choose to develop a captive coal
block if the court or the government is likely to de-allocate the
same? And why would someone develop any power intensive project
associated with a coal block?In the case of natural gas, not only
is the KG-D6 basin producing only a fraction of the projections,
the matter of pricing this gas has also landed in SC now.Even the
star of India's rise in the last decade, the telecom industry, is
now in doldrums on account of the double whammy of ever-changing
regulations and consequent SC actions. Telecom received cumulative
FDI of Rs 58,782 crore in the last 13 years, which accounted for 7%
of the total FDI inflows into the country. FDI in the entire
telecom sector, which includes radio paging, cellular mobile and
basic telephone services, plunged 81.64% in 2012-13 to Rs 1,654
crore. Since SC's '2G scam' decision, only a very brave foreign
investor would venture to put his foot into what could be a legal
landmine.Lastly, FORGET POLITICS UNITE TO SAVE ECONOMY We can
ignore the economic crisis only at our peril. There is widespread
panic as the rupee depreciates sharply with every passing day and
there's no telling where it will stop. There are multiple factors
behind the free fall. Global issues are a big contributing factor,
the biggest at the moment being the fear of an impending US
intervention in Syria and the resultant hardening of oil prices.
Otherwise, the currencies of other emerging markets wouldn't also
be crumblingWhile we cannot fully control what happens beyond our
shores, we can at least change the growing perception of domestic
drift. There's a sense that no one's quite in control in Delhi,
that there's a deficit in decision-making, and that there's a lack
of clarity of thought. No wonder currency speculators are having a
field day and making a bad situation worse.What we need is a
bipartisan response to the crisis. While the burden lies primarily
with the government, the opposition too needs to throw its weight
behind a national effort to pull the economy back from the brink.
When the Prime Minister addresses Parliament on Friday, he should
take the initiative and call for a concerted effort by the entire
political class, setting aside for the moment any political
oneupmanship. The Pension Bill and the Insurance Bill need to
cleared; pending projects must be fast-tracked; the Supreme Court
should be approached for a review of the ban on iron ore imports.
The two sides should also resolve the obstacles to rolling out the
goods and services tax GSTAt the same time, there should be an
agreement to try and leave contentious policy decisions aside for
the time being. The last thing we need is a further deterioration
of sentiment. Also, it doesn't really help when BJP leaders say
that only the next government can save the economy. The next
election is eight months away. What do we do in the meantime? Play
politics and allow the situation to worsen?Will all this
immediately strengthen the rupee and put the economy back on track?
Perhaps not. But it will certainly send out a signal that all hands
are on deck. And that our politicians can set their differences
aside in the interest of the nation.Are we being naive in calling
for a bipartisan effort? We would like to believe we aren't. We
hope this appeal won't fall on deaf ears and that our political
leaders will rise to the occasion. If they do so, they can yet
prevent the economy from keeling over the edge. They can also, in
the process, redeem themselves in the eyes of the electorate they
are so keen to woo.
REFERENCES The Week Magazine Times Of India articles Hindustan
times articles Economic times articles www.rbi.org.in
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