# PROJECT REPORT On

“IFE between India and ten strongest currencies of world from September 2011 to September 2012”

Submitted for the fulfillment of the requirement for the award Of the Mid-term Assessment in Finance

Submitted by Surabhi Jain (40201030)

Under the supervision of Mrs. Uma Nagarajan Faculty Guide [Finance]

International Fisher Effect Theory
This theory tells the relation between nominal interest rate and inflation rate. IFE states that the nominal interest rates between two countries should be equal to their expected inflation differential. Thus if IFE holds, real interest rate remains constant. And investors would earn same interest at home and abroad. If a country’s nominal interest rate is high, there will be capital inflows. Increase in money supply, boosts up spending, i.e., aggregate demand rises. So, demand exceeds supply and inflation rate also rises. So, higher the nominal interest rate, higher will be the inflation. Also, currency of home country depreciates because of capital inflows.   Expected change in the exchange rate = (1 + real interest rate % of home country/1 + real interest rate % of foreign country) -1 Expected change in the exchange rate= (Future spot rate/Current spot rate) -1

This report analyses the IFE relation of Indian Rupee with ten other strongest currencies of the world during September 2011 to September 2012.

1. Indian Rupee and European Euro

Sep-12

Jun-12

Mar-12

Dec-11 60 62 Dec-11 Euro Actual spot rate 69.363423 Euro Expected spot rate 63.718071 64 Mar-12 65.334691 69.356423 66 68 Jun-12 69.372811 65.329491 70 Sep-12 70.939965 69.367611 72

IFE does not hold between INR and Euro during any of the quarters. CASE 1- INR depreciated as compared to Euro, more than was expected during December 2011, June 2012 and September 2012. It was because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become costlier and hence arbitrage is possible by investing in foreign assets by entering into forward
contract before the depreciation actually happened.

CASE 2- INR appreciated as compared to Euro during March 2012. It was because of higher inflation rates in India which resulted in capital outflows. Advantages: Foreign goods and services are cheap, including foreign travel. This helps the import sector of the economy and the companies that sell foreign goods; helps domestic companies buying foreign inputs; helps domestic consumers - imports are cheaper.

Disadvantages: Domestic exports are expensive, including tourism in India. This hurts the export sector, companies that sell abroad, makes them less competitive. Domestic goods become less competitive overseas and in the home county because of high prices as compared to imported goods. Impact on Indian investor: An Indian investor would have lost by investing in foreign assets during this period. Since INR is depreciating, foreign investment would become cheaper but it is not favorable for the investor in case the foreign currency further depreciates. Arbitrage is possible by selling of foreign assets by entering into forward contract before the depreciation actually happened.

2. India Rupee and US Dollar

Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 42 44 Dec-11 US Dollar Actual spot rate US Dollar Expected spot rate 51.885 46.632502 46 48 Mar-12 49.835132 51.8675 50 52 Jun-12 55.415001 49.834932 54 56 Sep-12 55.358002 55.414801 58

IFE holds between Indian and US dollar during September 2012 quarter. So, domestic and US goods would be available at the same rates and arbitrage is not possible.

IFE did not hold for December 2011, March 2012 and June 2012 quarters. CASE 1- INR depreciated as compared to USD, more than was expected during December 2011 and June 2012. It was because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become

costlier and hence arbitrage is possible by investing in foreign assets by entering into forward contract before the depreciation actually happened. CASE 2- INR appreciated as compared to USD during March 2012. It was because of higher inflation rates in India which resulted in capital outflows. Advantages: Foreign goods and services are cheap, including foreign travel. This helps the import sector of the economy and the companies that sell foreign goods; helps domestic companies buying foreign inputs; helps domestic consumers - imports are cheaper. Disadvantages: Domestic exports are expensive, including tourism in India. This hurts the export sector, companies that sell abroad, makes them less competitive. Domestic goods become less competitive overseas and in the home county because of high prices as compared to imported goods. Impact on Indian investor: An Indian investor would have lost by investing in foreign assets during this period. Since INR is depreciating, foreign investment would become cheaper but it is not favorable for the investor in case the foreign currency further depreciates. Arbitrage is possible by selling of foreign assets by entering into forward contract before the depreciation actually happened.

3. India Rupee and United Kingdom’s British Pound

Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 65 Dec-11 British Pound Actual spot rate British Pound Expected spot rate 81.150376 73.997434 70 75 Mar-12 78.131682 81.123376 80 Jun-12 85.699298 78.121982 85 Sep-12 88.625393 85.689598 90

IFE does not hold between INR and British Pound during any of the quarters. CASE 1- INR depreciated as compared to British Pound, more than was expected during December 2011, June 2012 and September 2012. It was because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become costlier
and hence arbitrage is possible by investing in foreign assets by entering into forward contract before the depreciation actually happened.

CASE 2- INR appreciated as compared to British Pound during March 2012. It was because of higher inflation rates in India which resulted in capital outflows. Advantages: Foreign goods and services are cheap, including foreign travel. This helps the import sector of the economy and the companies that sell foreign goods; helps domestic companies buying foreign inputs; helps domestic consumers - imports are cheaper. Disadvantages: Domestic exports are expensive, including tourism in India. This hurts the export sector, companies that sell abroad, makes them less competitive. Domestic goods become less competitive overseas and in the home county because of high prices as compared to imported goods. Impact on Indian investor: An Indian investor would have lost by investing in foreign assets during this period. Since INR is depreciating, foreign investment would become cheaper but it is not favorable for the investor in case the foreign currency further depreciates. Arbitrage is possible by selling of foreign assets by entering into forward contract before the depreciation actually happened.

4. India Rupee and Australian Dollar

Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 44 46 Dec-11 Australian Dollar Actual spot rate 52.868734 48 50 Mar-12 52.783701 52.890234 52 54 Jun-12 54.943975 52.818001 56 58 Sep-12 57.494821 54.978275 60

Australian Dollar Expected 48.736602 spot rate

IFE holds between Indian and Australian dollar during March 2012 quarter. So, domestic and Australian goods would be available at the same rates and arbitrage is not possible. IFE did not hold for December 2011, June 2012 and September 2012 quarters. INR depreciated as compared to Australian dollar, more than was expected during December 2011, June and September 2012. It was because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become costlier and hence arbitrage is possible by investing in foreign assets by entering into forward contract before the depreciation actually happened.

5. India Rupee and Canadian Dollar

Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 0 10 Dec-11 Canadian Dollar Actual spot rate Canadian Dollar Expected spot rate 50.839371 46.77869 20 Mar-12 50.365042 50.836371 30 40 Jun-12 53.984415 50.373342 50 Sep-12 56.5599 53.992715 60

IFE holds between Indian and Canadian dollar during March 2012 quarter. So, domestic and Canadian goods would be available at the same rates and arbitrage is not possible. IFE did not hold for December 2011, June 2012 and September quarters. INR depreciated as compared to Canadian dollar, more than was expected during December 2011, June and September 2012. It was because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become costlier and hence arbitrage is possible by investing in foreign assets by entering into forward contract before the depreciation actually happened.

6. India Rupee and Emirati Dirham

Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 11.5 12 Dec-11 Emirati Dirham Actual spot rate 14.125208 12.5 13 13.5 14 14.5 15 15.5

Mar-12 13.567595 14.143208

Jun-12 15.087944 13.584895

Sep-12 15.071194 15.105244

Emirati Dirham Expected 12.719101 spot rate

IFE holds between Indian and Emirati Dirham during September 2012 quarter. So, domestic and Emirati goods would be available at the same rates and arbitrage is not possible. IFE did not hold for December 2011, March 2012 and June 2012 quarters. CASE 1: INR depreciated as compared to Emirati Dirham, more than was expected during December 2011 and June 2012. It was because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become costlier and hence arbitrage is possible by investing in foreign assets by entering into forward contract before the depreciation actually happened.

CASE 2- INR appreciated as compared to Emirati Dirham during March 2012. It was because of higher inflation rates in India which resulted in capital outflows. Advantages: Foreign goods and services are cheap, including foreign travel. This helps the import sector of the economy and the companies that sell foreign goods; helps domestic companies buying foreign inputs; helps domestic consumers - imports are cheaper. Disadvantages: Domestic exports are expensive, including tourism in India. This hurts the export sector, companies that sell abroad, makes them less competitive. Domestic goods become less competitive overseas and in the home county because of high prices as compared to imported goods. Impact on Indian investor: An Indian investor would have lost by investing in foreign assets during this period. Since INR is depreciating, foreign investment would become cheaper but it is not favorable for the investor in case the foreign currency further depreciates. Arbitrage is possible by selling of foreign assets by entering into forward contract before the depreciation actually happened.

7. India Rupee and Swiss Francs

Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 48 50 Dec-11 Swiss Franc Actual spot 56.132892 rate Swiss Franc Expected spot rate 52.788436 52 Mar-12 54.174329 56.149892 54 56 Jun-12 57.726966 54.190629 58 Sep-12 58.623321 57.743266 60

IFE does not hold between INR and Swiss Francs during any of the quarters. CASE 1- INR depreciated as compared to Swiss Francs, more than was expected during December 2011, June 2012 and September 2012. It was because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become costlier and hence arbitrage is possible by investing in foreign assets by entering into forward
contract before the depreciation actually happened.

CASE 2- INR appreciated as compared to Swiss Francs during March 2012. It was because of higher inflation rates in India which resulted in capital outflows.

Advantages: Foreign goods and services are cheap, including foreign travel. This helps the import sector of the economy and the companies that sell foreign goods; helps domestic companies buying foreign inputs; helps domestic consumers - imports are cheaper. Disadvantages: Domestic exports are expensive, including tourism in India. This hurts the export sector, companies that sell abroad, makes them less competitive. Domestic goods become less competitive overseas and in the home county because of high prices as compared to imported goods. Impact on Indian investor: An Indian investor would have lost by investing in foreign assets during this period. Since INR is depreciating, foreign investment would become cheaper but it is not favorable for the investor in case the foreign currency further depreciates. Arbitrage is possible by selling of foreign assets by entering into forward contract before the depreciation actually happened.

8. India Rupee and Chinese Yuan

Chart Title
Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 6.5 7 Dec-11 Chinese Yuan Renminbi Actual spot rate Chinese Yuan Renminbi Expected spot rate 8.187666 7.332957 7.5 Mar-12 7.89055 8.222266 8 Jun-12 8.692413 7.94385 8.5 Sep-12 8.726453 8.745713 9

IFE holds between Indian and Chinese Yuan during September 2012 quarter. So, domestic and Chinese goods would be available at the same rates and arbitrage is not possible. IFE does not hold between INR and Chinese Yuan during December 2011, March 2012 and June 2012 quarters. CASE 1- INR depreciated as compared to Chinese Yuan more than was expected during December 2011, June 2012 and September 2012. It was because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become costlier and hence arbitrage is possible by investing in foreign assets by entering into forward
contract before the depreciation actually happened.

CASE 2- INR appreciated as compared to Chinese Yuan during March 2012. It was because of higher inflation rates in India which resulted in capital outflows. Advantages: Foreign goods and services are cheap, including foreign travel. This helps the import sector of the economy and the companies that sell foreign goods; helps domestic companies buying foreign inputs; helps domestic consumers - imports are cheaper. Disadvantages: Domestic exports are expensive, including tourism in India. This hurts the export sector, companies that sell abroad, makes them less competitive. Domestic goods become less competitive overseas and in the home county because of high prices as compared to imported goods. Impact on Indian investor: An Indian investor would have lost by investing in foreign assets during this period. Since INR is depreciating, foreign investment would become cheaper but it is not favorable for the investor in case the foreign currency further depreciates. Arbitrage is possible by selling of foreign assets by entering into forward contract before the depreciation actually happened.

9. India Rupee and Malaysian Ringitt

Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 14 14.5 Dec-11 Malaysian Ringgit Actual 16.451332 spot rate Malaysian Ringgit Expected spot rate 15.521222 15 15.5 Mar-12 16.553773 16.461332 16 16.5 Jun-12 17.409676 16.581073 17 17.5 Sep-12 17.800001 17.436976 18

IFE does not hold between INR and Malaysian Ringitt during any of the quarters. INR has continuously depreciated as compared to Malaysian Ringitt, more than was expected during every quarter. It is because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become costlier and hence arbitrage is possible by investing in foreign assets by entering into forward
contract before the depreciation actually happened.

10. India Rupee and New Zealand dollar

Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 34 36 Dec-11 New Zealand Dollar Actual 40.116368 spot rate New Zealand Dollar Expected spot rate 38.315958 38 Mar-12 40.946792 40.133368 40 42 Jun-12 42.691717 40.973092 44 Sep-12 44.981144 42.718017 46

IFE does not hold between INR and New Zealand dollar during any of the quarters. INR has continuously depreciated as compared to New Zealand dollar, more than was expected during every quarter. It is because of higher interest rates in India which resulted in capital inflows. Advantages to country: Helps the Indian export sector. Our goods and services are cheap overseas, including tourism in India. It helps the import-competing sector as domestic goods become more competitive. Disadvantages to country: Hurts the import sector of the economy. It hurts domestic companies buying foreign inputs. Hurts Indian consumers - imports are more expensive, e.g. petroleum, gold. Impact on Indian investor: An Indian investor would have gained by investing in foreign assets during this period. However, since INR is depreciating, foreign investment would become costlier and hence arbitrage is possible by investing in foreign assets by entering into forward
contract before the depreciation actually happened.