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Thursday, May 24

UPSC GK: What does depreciating Rupee mean for Indian Economy? (ECONOMICS)


The rupee has fallen 5.2% in the current financial year, from close to 65 on March 28 to an 18-month low of 68.42 against the dollar on Wednesday. As worries for importers, travellers and even students rise steadily, analysts are watching the currency’s steady march towards the 70-mark as international crude oil prices continue to rally and foreign funds flow out.

Why has the rupee been falling?

There are three major reasons. The rise in crude prices, portfolio outflows from India due to the selling of stocks, especially by foreign portfolio investors (FPIs), and a growing anticipation of interest rates rising in the US.

Brent crude prices have increased from $70.30 to over $80 per barrel since the beginning of the new financial year in April. This is mainly due to concerns over supply disruptions after the rise in US tensions with Iran, which contributes 11-12% of OPEC production. As oil prices rise, India’s trade deficit — excess of imports over exports — will worsen, which can in turn impact the current account deficit.

Expecting US interest rates to go up, FPIs have taken out Rs 27,000 crore from India in April and May so far, which is over $4 billion in less than two months. As the US Federal Reserve raises rates further — which is bound to happen — FPIs will prefer to invest in their home country as the arbitrage gain while investing in India and emerging markets will decline. A weakening rupee will also lower returns, which will in turn impact future inflows.

What does this mean for imports?

Importers will be hit as the cost of getting goods or equipment into India will increase. When the rupee weakens, importers, especially oil companies and other import-intensive companies, have to shell out more rupees to buy an equivalent amount of dollars. In this sense, a weak rupee can act as a kind of import tax. For the oil sector, it is a double whammy, as the rise in crude prices and the decline in rupee value add to retail fuel prices. Margins of oil companies will come under pressure.

And what about exports, then?

Exporters, especially software exporters, stand to benefit, as they get more rupees while converting dollar export earnings into Indian currency. This is expected to boost exports, which have been showing single-digit growth. In FY18, exports grew 9.78%, and given exports in April 2018 showed only 5.17% growth, it appears that the issues with GST implementation are yet to be overcome. The twin impact of FII outflows and worsening trade balance can hit the rupee further; to keep external metrics stable, therefore, exports of both services and merchandise need a further push.

So how is this situation affecting the overall economy?

The fiscal and current account deficits are interlinked. When fiscal deficit is high, government borrowing rises, leading to higher interest rates. However, when foreign funds start flowing in, the rupee strengthens and exports become more expensive. Crude prices are expected to rise further this year, and imports are expected to grow by at least 14%, says a note from SBI Research. This is bound to enlarge the import bill and push up the trade deficit, which will in turn add to the CAD and push the FY19 figure to 2.5% of GDP. A widening CAD has macroeconomic implications. The best way to bridge the gap is by boosting inflows, but Indian markets have been witnessing FPI outflows, instead. Also, the rise in import costs as a result of a weak rupee can boost inflationary pressures.

Is the middle class affected as well?

A weak rupee is making overseas travel costlier this holiday season — a traveller will have to shell out more rupees to buy dollars. Students studying abroad too will see their costs rise. In 2017-18, Indian travellers spent $4 billion abroad; students spent $2 billion.

But these are good times for those who receive remittances from abroad. According to the World Bank, the Indian diaspora remitted about $69 billion in 2017, the most in the world. The value of these remittances in bank accounts in India rises as the rupee depreciates against the dollar. If non-resident Indians or their families were to receive an amount similar to 2017 this year, and if the rupee were to continue to trade at the current exchange rate, it would translate into an extra $3.5 billion.

How desirable is it then, to have the rupee “as strong as the dollar”?

On August 20, 2013, when the rupee fell by 98 paise to 64.11 in a day, Narendra Modi, who was then the Chief Minister of Gujarat, said, “If the rupee keeps falling like this, other countries will start taking advantage of India.” Politicians have on several occasions spoken of the need for a stronger rupee. The currency’s fall and rise can be both negative and positive, depending on the macroeconomic situation, inflows, crude prices, strength against other currencies, real effective exchange value, etc. A strong rupee can hurt exports, but a weak rupee can push up the import bill.

So, what is the ideal value of the rupee against the dollar?

It’s difficult to say. The RBI, which manages the rupee’s movement, says that it never fixes a value; rather, it facilitates the orderly movement of the currency. The RBI buys dollars from the market when the rupee strengthens, and sells the US currency when the rupee weakens. It tries to maintain a balance by taking into account all external and internal factors. India’s foreign currency assets fell by around $6 billion to around $394 billion recently as the RBI apparently sold dollars from its foreign exchange kitty to stabilise the currency. With the markets witnessing foreign outflows in April and May, the RBI recently took several measures to attract more capital flows. It enhanced investment limits, relaxed rules for foreign investors, and revised the minimum residual maturity requirement and cap on aggregate FPI investments in central government securities.


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