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Knowledge Center » Economics » RUPEE DEPRECIATION
Rupee Depreciation:
The 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.Let us first understand the meaning of Rupee Depreciation:It is loss in the value of Rupee with respect to foreign currency US $, with which it is usually compared.The US$-INR value is determined by the supply-demand for each of these currencies in the currency markets. This supply-demand is based on 2 factors –
1. Current Account = Exports - Imports + NRI Remittances
2. Capital Account = FDI + FII Equity + FII Debt
For the Indian Rupees value to be steady, any demand for the US$ due to one of the above factors has to be balanced by a proportionate demand for the INR. Currently this balance has been upset by the FII Debt component from the Capital Account Balance. Due to improving economic conditions in the US, a lot of FII debt is leaving India and causing a strain on the rupee. Hence the value of the rupee is depreciating.

What role does Supply and Demand Play?
Over the last few months, the demand for the US$ has gone up and a lot of that demand for US$ is coming out of India. Hence the same US$ which used to cost Rs.55 a few months back, costs Rs.63 today. More demand for the US$ means people are willing to pay more and hence driving up the price.Hence we say that the rupee is depreciating in value, because we need more rupees to buy the same amount of dollars This depreciation in the value of the rupee is not only restricted to India. Many other emerging economies are being hit. The Brazilian Real has lost 18% of its value in the last 7 months. The South African Rand has depreciated almost 20% this year.

How is the petrol we use affecting the Rupee-Dollar Rate?

Everytime India imports something from another country we pay in US$ since it’s the most widely used business currency. So what do we import – Oil, Coal, Gold, Electronic goods, Precious stones, Machinery, Chemicals, Metals etc - and we imported a lot – as much as US$400 billion of these products were imported in 2012. So we need $400 billion in US$ currency to pay for these imports. This generates the demand for the US$ - as Indian importers will have to sell Indian rupees to buy 400 billion worth of US$ to pay for all the imports. So the currency market is flooded with Indian Rupees to the tune of $400 billion and hence the value of the rupee drops (since there is a lot of INR supply). This in itself is not necessarily a bad thing if it’s compensated by other factors. The value of the rupee will remain stable if the demand for the US$ is compensated by equivalent demand for the INR. The other factor that determines this balance is Exports.India exported almost $310 billion worth of goods and services in 2012. Indian exports include Jewellery, Pharma, Garments, Electronics, Rubber, Cotton, Glass, Petroleum products, Equipment, Machinery etc. This will generate $310 billion worth of demand for Indian rupees. The Indian exporters who are getting paid in US$, will convert this US$ into INR using the currency markets (not very different from the stock market). So whatever rupees flooded the market due to the $400 billion of imports will be bought back due to the $310 billion of exports.

Oil, Gold, Electronics.......The Problem
The imports released $400 billion worth of INR but the exports compensated only for $310 billion worth of INR. This difference (Exports – Imports) is called the Trade Balance. If imports are larger it is called a trade deficit, if exports are larger it’s called a trade surplus. There is another factor that affects the Trade Balance. It is called “Invisibles” – this is the money the country receives from NRI’s living outside the country. So when a NRI wires US$100,000 into India, it creates demand for US$100,000 worth of INR. This is again a good thing for the rupee. The Trade Balance along with the Invisibles constitutes the Current Account.Current Account = Trade Balance – Invisibles = Exports – Imports + Invisibles If this number is negative we have a Current Account Deficit. If this number is positive we have a Current Account Surplus. Current Account Deficit results in a demand for more dollars and ends up depreciating the rupee. India had a Current Account deficit of US$18.10 billion in the first quarter of 2013. The average Current Account deficit was US$1.5 billion from 1949 until 2013, reaching the best surplus of US$ 7.36 billion in March 2004 and the worst deficit at US$32.6 billion in December 2012. The Current Account Deficit of India was 4.8% of 2012 GDP.A Current Account Deficit by itself is not that bad if it is balanced by other factors like foreign investment into India.

WalMart, Hyundai, Barclays and our Capital Account
There are 2 ways foreign investors invest in India –
FII – Foreign investors investing directly in the Indian Markets. If they invest equity they will invest into the stock markets. If they invest debt they will do it through the bond markets or lend directly to companies.FDI – Foreign investors investing directly into Indian companies. For example WalMart investing in its JV with Bharti, Hyundai investing into its plants, Barclays investing into its services etc.This FII + FDI inflows are together called the Capital Account. Historically, even though we have had a Current Account Deficit, the Capital Account inflows made up for this and kept the Rupee value steady.It’s obvious that foreign investments into India will generate demand for the rupee and keep its value steady. Since all the US$ being invested into Indian companies will first have to be converted into rupees.

The Culprit – FII Debt
The culprits for our sudden rupee depreciation are the Debt FII Investors. 4 years back, the US Federal Reserve (equivalent to India’s RBI) reduced interest rates in the US to revive the economy by making money easily available. So a lot of institutional investors would borrow money in the US for 2-3% and lend it to Indian Companies at 12-17% hence making a profit. Such a trade is called an arbitrage.However, earlier this year, the Federal Reserve started increasing interest rates in the US and hence this arbitrage trade is not as profitable anymore. Hence a flood of US$ is leaving India back to the US where the interest rates are getting better. In February 2012, we had about $2 billion in FII debt flowing into India. This dried up to $0.2 billion in November 2012 and in July 2013 it was negative $2 billion – means $2 billion left the country. When $2 billion leaves the country, rupee is being sold to buy US$ in the currency markets. Hence the same vicious cycle – more rupee flooding the market -> more supply -> rupee depreciates -> 1US$ = Rs.63!!

What if the Rupee Depreciates?
So what is the big deal if the rupee depreciates? How does this affect our daily lives – For starters, it will cause inflation and prices of everything will go up. This is how it happens – if the rupee depreciates, then imports become more expensive (since we have to now pay Rs. 63 for the same 1 US$ worth of goods). India’s largest import is Oil. So, if oil gets expensive then everything that depends on oil - transportation, machinery, vegetables, consumer goods, chemicals will also get more pricey Hence cost of living of the average citizen increases and our quality of life decreases. So this is how it impacts our day to day life
Impact of Rupee Depreciation
Effect on If Rupee DEPRECIATES (For example, when US$-INR moves from Rs.50/- to Rs55/ If Rupee APPRECIATES (For example, when US$-INR moves from Rs50/- to Rs 47/-
Importers Imports become costly as for each USD we have to pay Rs5/- more IMPORTS BECOME COSTLIER Imports become cheaper as for each USD we have to pay Rs3 lessIMPORTS BECOME CHEAPER
Exporters Exporters will have higher revenue.  For exports of each Dollar, the exporter will get Rs 5 higher EXPORTERS EARN MORE Exporters will earn lower revenue.  For exports of each dollar, now the exporter will get Rs 3 less.EXPORTERS EARN LESS
Indian Who Wish to Go on Holidays Abroad For each dollar taken abroad for spending, the traveller has to pay Rs 5 more and thus his trip will become costlier TRIP IS COSTLIER For each dollar he intends to take abroad for spending, the traveller has to pay Rs3 less and thus his trip will become cheaper.TRIP IS CHEAPER

Now we know why the Indian government is always very hesitant to open up their economy fully – it is to avoid situations such as this. Easier inflow of foreign money also means easier outflow of foreign money.

How do we fix this situation?
For the short-term, there is really not much we can do. Most bankers and economists believe that the worst of the FII Debt outflow is behind us and the rupee will stabilize soon. Most of this FII debt “Hot Money” has left the country and hence the pressure on the rupee will decrease.

Medium and Long Term
To get the rupee back to US$1 = Rs.55 levels we will have to strengthen our exports and reduce dependence on our oil imports. Both these can’t be done overnight and will take time.We can also provide more confidence to FII investors to invest more money into the Indian stock markets, hence increasing demand for the rupee and stabilizing it in the process. This will require stricter regulation for companies listed in the stock exchanges, reducing corruption and improving efficiencies in Indian companies.