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A report on

Dollar Appreciation against Indian Rupees: Its Causes, Effects & Remedies.

Presented to: Prof. Ajgaonkar

By: Tripathi Shatrunjay Roll No. : M 2245 MMS 3rd Sem (Finance)

Overview:
Currency depreciation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system. It is most often used for the unofficial increase of the exchange rate due to market forces, though sometimes it appears interchangeably with devaluation. Its opposite, an increase of value of a currency, is currency appreciation. The depreciation of a country's currency refers to a decrease in the value of that country's currency. For instance, if the Canadian dollar depreciates relative to the euro, the exchange rate (the Canadian dollar price of euros) rises - it takes more Canadian dollars to purchase 1 euro (1 EUR=1.5CAD 1 EUR=1.7CAD). When the Canadian dollar depreciates relative to the Euro, the Canadian dollar becomes more competitive because the price of Canadian goods when exchanged to Euro will be cheaper leading to a larger Canadian export. On the other hand, European countries that denominate its goods and services in Euros will have lost competitiveness to the Canadian dollar. The price of European products denominated in Euros will thus become more expensive in Canada. The appreciation of a country's currency refers to an increase in the value of that country's currency. Continuing with the CAD/EUR example, if the Canadian dollar appreciates relative to the euro, the exchange rate falls - it takes fewer Canadian dollars to purchase 1 euro (1 EUR=1.5CAD 1 EUR=1.4CAD). When the Canadian dollar appreciates relative to the Euro, the Canadian dollar becomes less competitive. This will lead to larger imports of European goods and services, and lower exports of Canadian goods and services.

Causes for Appreciation of Dollar-:


The main reasons for dollar appreciation are as follows-: 1. Demand Supply Rule Rupee quotation follows the simple economic rule of Demand & Supply. If

there is more demand for dollars in India than the supply for it, Rupee would depreciate and viceversa. Demand of dollars may be created by Importers requiring more dollars to pay for their imports, FIIs withdrawing their investments and taking the dollars outside India, etc. On the other hand, supply is created by exporters bringing in more dollars from their revenues, NRIs remitting more funds, FIIs bringing more dollar in India to spur their investments.
2. Fiscal Deficit How would others feel of your financial position if you earn Rs. 100,000 a year, but

end up spending Rs. 110,000 ? The excess of your expenditures over your total income is called Fiscal Deficit. In order to bridge a Fiscal Deficit, you may end up taking a loan of Rs. 10,000. The more loan you take, the more riskier you would become in the eyes of lenders. This is exactly the case in India. India is currently spending more than it earns via taxes resulting in a mounting fiscal deficit. The major brunt of this spending is going into subsidies. With mounting fiscal deficit, foreign investors start feeling uncomfortable and pull their money out of India resulting in rupee depreciation.

If we were to simply analyse the import export figures of 2011-12, then against exports of $300 bn the imports were $ 450 bn (in round figures). Thus there is a trade deficit of $150 bn. Holding on to these figures and on an estimated 235 trading days annually, it means there is a shortage of app $ 0.64 bn ( Rs 3447 crore) per day only on import export activities. Taking other requirements into consideration, JP Morgan the financial firm has estimated that, India needs $ 340 million on each trading day in 2012, to bridge its current account deficit. Another report by the broking firm Enami Securities points out that India needs $ 800 million (nearly Rs 4300 crore) every day to bridge its trade deficit, which it rates as the highest in the world today. A decade ago, it says this figure was just $50 million. The continued high fiscal deficit in the central budget, presently around 5.9% and expected to go up, is also a cause of serious concern, as it leads to a regime of high borrowing interests and govt. is also required to resort to increased borrowings. Coupled with increasing burden of subsidies on account of fertilisers, cooking gas, petrol and diesel prices, NAREGA etc it is a mammoth task to reduce the overspending to reduce the fiscal deficit to manageable levels. 2. Oil Prices are another significant factor in putting pressure on the Rupee. Oil import contributes as the biggest percentage of Indias import. By quantity, the oil demand is increasing year on year. By prices, Oil is quoted in International Markets in US Dollars. Oil prices are current over $100 a barrel and have significantly jumped up from sub $40 levels in 2002. With the increasing price of Oil in international markets, India has to pay an increased amount of dollars to import the same quantity of oil. Further more, with an increase in the quantity of oil imported into India, a further pressure is imposed on the demand of dollars to pay to our suppliers from whom we import Oil. This increase in demand for dollars depreciates the Rupee further.

3. Weaker Capital Markets If the capital markets (share markets) are on a boom, there is a continuous

flow of dollars into India which adds to the overall supply of dollars in the country. Unfortunately, the current situation is opposite. Capital markets are at status-quo for a couple of years and hence not influencing the supply side of dollars in the country. All in all weaker supply and excessive demand is resulting in sharp depreciation of Rupee

4. Speculators Once a trend is set, speculators tend to punt against the rupee adding further to the

bearish tone of Rupee.


5. Gold Demand- Dollar hungry India has therefore to pay more for buying dollars in the international

market to finance its imports of essential crude oil and also the yellow metal to satisfy its demand in the local markets at any price levels, amongst other imports .If only Indians were to reduce their purchase of gold by say a factor of 50-60 % that would result in reducing the demand for dollars to the tune of 30-40 billion dollars annually.

Effects of Rupee Depreciation-:


In the globalised world where we are living today, we are no longer shielded from the global economics and product prices. Economies have started taking advantage of countries which are producing specialised products at a cheaper rate and instead of producing them locally, they have started importing them. Economies which have competitive advantage in producing a product at a cheaper price have become exporters, hence opening up the global trade exports & imports. With opening economies, currency exchange rates have started playing an important role in the cost of imports or competitive advantage in exports. Lets start on a positive note detailing upon some of the good effects of rupee depreciation in India. Benefits of Rupee Depreciation 1. For Exporters Exporters are perhaps the biggest beneficiaries of the Rupee depreciation as every dollar of their sale fetches them more Rupees. Hence if they dont reduce their prices, with the same quantity of sales, they earn more in terms of Indian Rupees. If they intend to capture market share, depreciating rupee gives them an opportunity to reduce the price of their products in dollar terms and still making the same amount of profits in Rupee terms. This makes their products more competitive in international markets and helps in selling more volume of products due to cheaper prices in dollar terms. For example, the cost of producing a product is Rs. 5000. When the Dollar was quoting 45 Rs. the dollar cost of producing this item was $111. The exporter wanted to make 50% margin and hence he priced his products at $166 or Rs. 7666 (at 45 levels). At this level he is making a margin of Rs. 2666. When Dollar is now quoting at 56 Rs, the exporter is now getting Rs. 9296 for the same product which is priced at $166. If the exporter wants, he can now reduce his product prices in international markets to $136 without losing his margin of Rs. 2666. With the reduced product prices, he would become more competitive in international markets and gain more customers / buyers. 2. NRIs become richer Believe it or not, where ever NRIs are, most of them count their net worth in Rupee terms and find depreciating Rupee to their advantage. For example, a NRI earning 100,000 dollars, when converts his earning in Indian Rupees would be earning equivalent of Rs. 56,00,000 (when USD is Rs. 56) compared to Rs. 45,00,000 (when USD was Rs. 46). This adds additional Rs. 11, 00,000 to their kitty due to currency movements. Depreciating Rupee hence gives NRIs a big incentive to remit more funds into India for investment purposes, adding to Indias forex reserves.

3. Tourism industry With a depreciating rupee, holidays in India become cheaper. Take for example, a holiday package in Kerela backwaters costs around Rs. 200,000 for 10 days stay. When Dollar was quoting Rs. 45, this holiday would cost around $4400. With Dollar quoting at Rs. 56, the same holiday package would cost $3500, a whopping $900 cheaper ! This promotes foreigners to visit India as India becomes an attractive Tourism spot owing to its financial competitiveness.

Negative Effects of Depreciating Rupee


The cons of a depreciating Rupee are perhaps more than its advantages and hence the government and RBI tends to focus their policies and energies to control the excessive fluctuations in the currency. To understand the aftermath of the current currency depreciation, lets visit through the following points : 1. Expensive Imports Quite opposite to exports, a depreciating Rupee would mean that every dollar which we have to pay for our imports, costs more. For example, if we have to pay $100K for an import, it would cost Rs. 45 lacs when dollar is at Rs. 45 and would cost Rs. 56 lacs when the dollar is Rs. 56. Though it means that the imported commodity / product would become costly in India and any product with elastic demand would result in lowering the demand for such imported products. However, in case of India most of our imports are of products which are inelastic, e.g. Oil, luxury products, etc. and hence despite of rising import prices, our imports dont come down. 2. Oil Contagion Oil prices in India are a subject of two factors - international crude oil prices and the currency factor. A barrel of oil costing in International market at $100 would cost Rs. 4500 in India when dollar is quoting at Rs. 45 and Rs. 5600 when dollar is quoting at Rs. 56. Hence even though oil prices may decline 10% in International markets, currency depreciation may offset this decline resulting in high oil prices in India. As a result, high oil prices creeps into the prices of almost every commodity and product in the economy. Oil plays a fundamental role in Indias economy as it supports the fundamental structure of all Industries by fuelling up the energy requirements. A higher oil price would result in higher cost of production and higher logistics / transportation costs. 3. Higher inflation This paragraph gels in perfectly with the above points which stresses upon imports becoming expensive with a depreciating Rupee. And a direct consequence of it, the inflation in the economy shoots up! Higher inflation results in commodities becoming more expensive. Countries which import their essential commodities suffer more than countries who are major exporters. Unfortunately, as mentioned in above paragraphs, India is a major importer of Oil which tends to hit the cost structure of the economy and fuelling the inflation scenario in the economy. 4. Poor returns for FIIs

When it comes to FIIs, they need to report returns on their Indian portfolio in their local currency. For example, FIIs from USA would need to convert their Indian portfolio in US Dollar terms. Lets assume that a particular FII has a portfolio of Rs. 70 million in India. When they value their portfolio in dollar terms (when dollar is at 45 Rs.), the value would be $1.55 million. However, the same portfolio would be valued at $1.25 when dollar is at Rs. 56, shaving off a neat $300K from their valuation owing to currency movements! This at times triggers FIIs to sell out of their holdings to prevent any further losses and exit from India resulting in large scale withdrawal of funds from the country. 5. Repayment of Loans A couple of years ago, the option of borrowing cheap money from overseas were the hottest and the most fashionable financial option which every capable company was exploring. No one even dreamed that a time may come that owing to Rupee depreciation, they may be messed up badly, making their cost of borrowing much more expensive than what they could have borrowed within India. Not that the interest rates on external borrowings went up, but the impact of currency depreciation meant that the borrowing companies had to pay more Rupees to repay their dollar denominated loan. This completely screwed up their financial computations, whereby some companies even ended up defaulting on their loan payments. 6. Foreign Education Believe it or not, there are more and more Indian students taking admission in foreign university. However, foreign education doesnt come cheap and on an average can cost over 40,000 dollars. When dollar was at 45 levels, the same foreign education used to cost around Rs. 18 lacs. Now it costs over Rs. 22.5 lacs. This is not a small difference for a student who has to take an education loan to sponsor his / her education and then repay it with interest. 7. Foreign Holidays This is last thing on my mind today. A holiday package to Swiss costing $3000 would increase from around Rs. 1.4 lacs to Rs. 1.7 lacs per person. For a family of two, it adds over Rs. 60K to the cost! However, foreign holiday is a luxury which not many can afford and the ones who can afford it, additional 60K perhaps may not be a big dent on their savings.

Remedial Methods to check Dollar Appreciation against INR-:


1. It has been decided to allow Indian companies in the manufacturing and infrastructure sector and earning foreign exchange to avail of external commercial borrowing (ECB) for repayment of outstanding rupee loans towards capital expenditure and/or fresh Rupee capital expenditure under the approval route, the RBI said. 2. Allowing foreigners to all investing in Indian shares directly they could earlier invest only through participatory notes, and this makes it easier for them to invest directly, and will help bring more dollars in the country. 3. The other such move is to liberalize the NRE interest rates, and allow banks to set their own NRE rates. As soon as they did that some banks increased the rates from as low as 3.8% to 9.5%! Since

the interest income from this account is tax free for NRIs this is a great incentive to open NRE accounts and deposit money in these accounts. 4. If FDI is allowed in multi brand retail that will also get companies to invest money in India and bring in some dollars in the country and that will ultimately help the exchange rate as well.

Conclusion-:
If we see these measures none of them will bring down the high dollar rate overnight or even in a few weeks even if foreign investors can invest directly in India they arent exactly queuing up to do that right now, and even if NRIs can open these accounts, it takes about 3 4 weeks to open an account and even then its a question mark on how much money they will actually transfer? If there were quick and easy solutions, they wouldve been already implemented, but like all other things the way to have a stronger rupee is to make fundamental improvements in the system that attracts foreign inflows, and boosts exports, and things like these can only be done over the long term with sustained efforts.

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