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INTRODUCTION

The rupee has been falling of late raising questions as to where will it eventually go? The rupee has been weak right since the financial year began, which was to begin with more on account of the policies announced relating to retrospective taxation and GAAR. US Economy is improving, with more jobs being created to provide easy liquidity to the economy with a process called Quantitative Easing (QE) pushing the US bond yield higher. Domestic factors are also not helping which are described belowFII FactorFII inflows have declined by $ 82 mn in November (up to 20th), which can be directly related to the falling rupee in recent times. This was primarily due to net outflows of $ 580 mn in equity while debt inflows were positive at $ 498 mn. The Trade BalanceThe trade deficit for April October, FY13 was estimated at $ 110 bn which was higher than the deficit of $ 106 bn in FY12. Exports were $ 167 bn as against $ 178 bn registering a negative growth of 6.2% while imports at $ 277 bn, declined by 2.7%. ECBsECB approvals (which would translate into flows in the course of the year) have been at the same level in the first half of the year at around $ 18 bn. This has lent a modicum of stability to the forex capital inflows. FDIsFDI flows during the first 5 months of the year were much lower at $ 8.2 bn as against $ 20.6 bn last year. This has been one of the negative factors which have driven the rupee down in terms of lower supply of dollars. The USDINR spot exchange rate appreciated 8.8905 or 15.00 percent during the last 30 days. From 1973 until 2013, the USDINR averaged 31.8200 reaching an all time high of 68.1700 in August of 2013 and a record low of 7.1900 in March of 1973.

REASONS FOR THE FALL OF RUPEE

Analysing the prime reasons for the drastic fall in the rupee 1. Falling foreign investment inflows 2. Strengthening of the dollar 3. Rising fiscal deficit 4. Untameable inflation

1. Trade Deficit and Capital Account DeficitSince India imports more goods (in value terms) than it exports, it results in a huge imbalance in trade called a trade deficit. In the financial year ending March 2012, the deficit zoomed to $185bn compared with the original estimate of $160bn.Additionally; India's export performance may prove to be a dampener this year. Experts suggest that although exports for India grew 21% in 2011-12, it may not manage to witness a growth rate of even 10-15% in 2012-13. It is

important for India to reduce it trade deficits as that means more foreign currency comes into the country than what is paid for imports. This strengthens the local currency. Furthermore the two additional risks of rising trade deficits are: 1. Sudden Stop 2. Reversal of Capital Flow

The slowdown in the Indian economy has made the current situation even more volatile because the government is unable to generate heavy capital inflow. India's current account deficit was equivalent to a record 6.7 per cent of gross domestic product in December. In 2011-12, this deficit was more than $74bn, a huge jump from less than $46bn a year ago. In 2012-13, it may be even higher at $77bn.It hit a record high 4.8 per cent of gross domestic product in fiscal year 2013. This deficit was being financed by foreign money for last many years, but as the U.S. economy gathers momentum, there is increasing likelihood that the Federal Reserve will taper its bond buying programme The result is that India's foreign exchange reserves have dropped from a peak of $320bn in September 2011 to $290bn now. Another reason for the strain on rupee is Oil and gold imports. They account for 35 per cent and 11 per cent of India's trade bill respectively. We import 80 per cent of our crude requirements and so dollars will anyhow go out of the country irrespective of whatever arrangement the RBI makes. Similarly, falling gold prices have offset the government's and the central bank's moves to reduce gold imports, which increases current account deficit and weighs on the currency. Infact, high oil prices inflated the import bill and resulted in further widening of the current account deficit, which accelerated the rupee fall.

2. Low Capital Inflows as compared to outflowIf trade deficits are so high and so much money is going out of the country, sufficient money needs to flow in through investments to compensate for the outflow.One major reason for this has been the falling of the credit rating of India Inc and policy paralysis of the government. In 2011-12, India received foreign direct investment of more than $30bn, in addition to a net inflow of $18bn from foreign institutional investors in stocks and bonds. Uncertainty about India's commitment to economic reforms, retrospective taxes, and policy paralysis within the government have forced foreigners to either postpone their investment decisions, or take money out of Indian stock markets. The corruption sagas unleashed in the 2G and the Coalgate scam hasnt done Indias image abroad any good. In fact in the 2G scam telecom licenses have been cancelled and the message that was sent to the foreign investors was that India as a country can

go back on policy decisions. This is something that no big investor who is willing to put a lot of money at stake, likes to hear. As a result, India still has a huge current account deficit but is not getting the constant inflow of dollars. The United Nations Conference on Trade and Development (UNCTAD) recently pointed out that the foreign direct investment in India fell by 29% to $26 billion in 2012. The fear of Fed pulling the plug the bonds has triggered a selloff by foreign institutional investors (FIIs), who have pumped almost $14 billion into India so far this year and $22.2 billion last year. Business Today reported today that overseas investors pulled out a record Rs 44,162 crore (over $7.5 billion) from the Indian capital market in June 2013. A weaker rupee further erodes the returns earned by the foreign investors in the Indian market. Certain economy boasting actions were taken by the government. It had allowed foreign investors to invest upto 51% in multi-brand retailing. However, not a single global retailing company has filed an application with the Foreign Investment Promotion Board (FIPB), which looks at FDI proposals. Also, weakness in domestic equities is another reason as foreign institutional investors have been selling index futures

3. Increasing demand for Dollar versus Rupee leading to strengthening of DollarThe demand for American dollars is more than that of the Indian rupee leading to the rupee rapidly losing value against the dollar. The dollar is expected to strengthen more as Federal Reserve will taper asset purchases. The dollar has been rising since fear of the Federal Reserve tapering its quantitative easing (QE) has hit all asset classes. The currencies of all emerging markets, such as Indonesia, Thailand, Brazil and India have depreciated. The falling investments and government policy paralysis are the main reasons. An additional reason for this is that in 2004, the central bank(i.e. RBI) had approved nearly $220 billion worth of external commercial borrowings and foreign currency convertible bonds (FCCB), at the rate of a little over $2 billion a month. Nearly two-thirds of this amount was approved in the past five years. Much of this ECB will come up for repayment this financial year, putting further pressure on the rupee. Additionally due to low interest rates outside, many companies raised foreign loans and will need dollars to repay the amount. The trouble is that if a lot of companies decide to prepay loans then it will add to the demand for the dollar and thus put further pressure on the rupee. Another aspect that increases demand for dollars is increase in coal imports. Indian coal imports shot up by 43% to 16.77 million tonnes in May 2013, in comparison to the same period last year. Importing coal again means a greater demand for dollars. Similiarly, the massive import for gold also has the same impact. Indias love for gold has been one reason behind significant demand for the dollar. Gold is bought and sold internationally in dollars. India produces very little gold of its own and hence has to import almost all the gold that is consumed in the country. When gold is imported into the country, it needs to be paid for in dollars, thus pushing up the demand for

dollars. Same way, we import crude oil from countries like Saudi Arabia, Iraq, Venezuela etc. and these countries dont accept the Indian Rupee for payments, they want us to pay them in an internationally accepted currency like the USD or Euro. So, conclusively, more people try to hedge currency risk by selling rupees and buying dollars. This demand-supply gap between the dollar and the rupee leads to devaluation as well.

4. Slow Growth and High InflationAfter annual economic growth of nearly 9% in 2009-10 and 2010-11, the country grew at 6.5% in 2011-12. Coupled with high inflation due to high food and fuel prices, the rate of inflation rose to 11% as the government is unable to curb its fiscal deficit. High crude oil prices and weak currency make for case high inflation. The depreciating rupee is also building up a case of imported inflation as increased cost of imported commodities and goods goes higher In this scenario, most foreigners as well as Indians tend to take money abroad, or keep it away from India.

This further leads to Global investors hesitating about investing in India which puts more selling pressure on the rupee.

STEPS TAKEN BY THE RESERVE BANK OF INDIA

Normally, RBI has two options on the table when it is faced with the problem of a declining currency. One is to increase the policy rate thereby attracting foreign inflows thus decreasing the demand for the US dollar. The other option is to squeeze the rupee liquidity thus artificially increasing the rupee demand. RBI opted for the latter option and implemented the following of measures to this end. With rupee loses its value by about 12% since the end of April 2013, RBI and market regulator SEBI got together and announced a set of measures on June 10 to address rupee volatility. These measures were aimed at making it costly to take speculative positions in the market towards a dip in the rupee value and grouping large buyers of dollars into a single window to ease pressure on the market. As part of these measures, RBI barred banks from trading in rupee currency futures and options except on behalf of their clients in order to ease the rupee volatility. It also directed oil companies who happen to be the largest domestic buyers of dollars in order to finance the oil imports to trade only with a single bank thus easing the visible pressure on the market. In addition, SEBI also tightened the exposure norms for currency derivatives thus limiting the speculation in the market which was considered a reason for the declining rupee value. RBI followed up with another set of measures on July 15. RBI restricted the borrowing limit thorugh Liquidity Adjustment Facility (LAF) to 1% of total deposits or Rs 75000 crore. This would limit the liquidity of rupee in the domestic market and deter banks from borrowing excess funds. RBI also increased the Marginal Standing Facility (MSF) interest rate by 100 basis points to 10.25%. This was implement keeping in view the banks which were bearish on the rupee and bought dollars from the forward markets and borrowed from call markets expecting the dollar to rise. Increase in MSF rate would make it costlier to borrow short-term money and reduce speculation thus easing the pressure on rupee. The third announcement was to conduct Open Market (Sales) Operation to the tune of Rs 12,000 crore on July 18. This was again a measure to soak excess rupee liquidity in the market leading to a fall in the bond prices and rise in yields. Higher yields would then attract foreign investment which had eroded since April. However, RBI was able to sell only Rs 2,500 crore worth of government securities in this auction.

On July 22, RBI made it mandatory for all nominated banks to reserve 20% of their gold imports for exports. A day later, it directed the banks to draw only 50% of their total deposits in overnight borrowings and made it mandatory to maintain a 99% average CRR daily. In spite of all the above measures, RBI was unable to arrest the downward slide of rupee forcing it to announce on August 8 that it will sell government bonds worth Rs 22,000 crore every Monday starting August 12 to check forex volatility in the market. The bonds were essentially Government of India Cash Management Bills. It was revealed on August 12 that RBI had sold $2.2 billion from its foreign reserves as well as $900 million in the forward market in an attempt to decrease the dollar demand.

STEPS TAKEN BY THE GOVERNMENT

To arrest the rupee depreciation, Indian Government has taken certain measures which have been explained below: 1. Liberalizing FDI LimitsOne of the major reasons of the rupee depreciation is the huge Current Account Deficit. The CAD for fiscal year 2012-13 had been $ 88 Billion. Hence one of the major steps the government has taken to reduce CAD is to allow more foreign investment. To allow more foreign investment, government has eased FDI caps in 13 sectors of the indian economy.

In Telecom sector, 100 % FDI is now allowed. Similarly in Defence, the FDI cap has been raised from 26% to 49% applicable to state of art technology transfer. In four sectors of Gas refineries, Commodity exchange, power trading and stock exchanges, FDI has been allowed via the automatic route. The break up per sector has been mentioned below

However, Liberalizing FDI limits at this stage is like digging a well while a fire is raging on. Because, even after easing the FDI limits, foreign investors are sceptical about investing in India

due to unstable economic and political conditions. Thus liberalizing FDI limits has not entailed any immediate relief for the falling rupee.

2. Curbing Imports of Precious MetalsOne of the major reasons for the increasing Current Account Deficit can be attributed to high imports of precious metals. Gold imports in year 2011-12 had been $ 40 Billion. Gold is the second largest contributor in the import bill after petroleum. Hence to curb the import of gold, government has increased the customs duty on Gold, platinum and silver to 10%. The Government has also increased the import Tariff of Gold to 459$ per 10 Gms and $ 737 for silver kg imports. However, due to restriction on the imports of Gold, smuggling of Gold has been on rise. 3. Increasing Interest SubventionIn order to reduce CAD, along with reducing imports, the government Is also looking at measures to increase the exports. To achieve this, the government has increased the rate of Subvention from 2% to 3% which will benefit exporters and small and medium enterprise owners. 4. Issuing Quasi Sovereign BondsThe Government in order to increase the inflows to reduce the CAD, has also planned to issue Quasi Sovereign bonds. These bonds would be issued by state owned financial companies. However, there are differing opinions on issuing quasi sovereign bonds, hence the implementation of this step might take some time. Major companies like Power Finance corporation, India Infrastructure Company Ltd and Indian railway Finance Corporation will opt for these bonds to fund the long term infra-structure needs this year. In all likelihood, $4 billion dollars would be gained through these proceedings.

IMPACTS

Impact on diesel, petrol and keroseneIn September 2012, government introduced fuel pricing reforms. These reforms are mentioned as under. 1. To allow oil selling and marketing companies to increase diesel prices by 50 paisa per litre per month. 2. The diesel which is sold in bulk will not be considered for subsidy which is about 16 percent of total volume. 3. LPG sold at subsidized rates will be limited. Government was incurring losses on diesel of about Rs 8.64 per liter. So government decided to reduce those losses by marginally increasing the prices of diesel by 50 per liter per month. That would reduce the losses to Rs. 2.62 per liter. But due to decline of rupee the losses on diesel have increased to Rs. 7.1 per liter. We can estimate the amount of losses that government is facing due to rupee decline from the following example. In 2012-13 the loss incurred by oil firms was Rs. 1, 61,029 crore for average crude price of $ 107.07 per barrel for an exchange rate of Rs 54.45 per USD. So for every 1 rupee depreciation for 1 USD there is a loss of Rs 9,000 crore. So oil companies are bound to increase their prices in order to cope up with the losses. This price hikes burden every other sector directly or indirectly effectively burdening common man.

Impact on common manIndia imports crude oil, medicines, iron ore and fertilizers in large amount. To import same amount we have to pay higher amount of dollars. Now to compensate this high cost of payment the price hike made to final goods. Also fuel cost being associated to transport cost, increase in transport cost causes increase in price of regular items. Crude oil and palm oil which is an input to soaps and detergents lead to increase in the prices of these items. We also import some pulses. So rupee depreciation causes increase in the price of pulses. Rupee decline also increases cost of foreign education. All the foreign college expenses are paid in dollars, so dollar conversion at such high rates causes a burden to people opting for foreign education. Also it increases cost of foreign travel. Air fares go up due to increase in cost of air turbine fuel. Hotel stay and eating out cause additional increase in the cost.

There is an increase in the price of automobiles and cars by nearly 2% to 5% by all auto companies. Electronic goods have also become costlier due to increase in the price of imported electronic components required in these goods.

Impact on sectors1. IT IT sector in India exports their services to lot of clients located abroad. So for every 1 percent decrease in the value of rupee PAT of these companies increases approximately by 0.5 to 1%. 2. Pharmaceuticals India houses many global pharmaceutical majors. For this sector 60 and 80 per cent of revenues come from exports. Hence this increases their revenues and ultimately profits by significant amount. 3. Metals Finished steel and metal are exported from India. So these companies earn in the form of dollars giving rise to their revenues. 4. FMCG The goods such as oils and other raw materials required in soap and toothpaste manufacturing are imported. So these companies lose a part of their revenues due to additional accost incurred due to rupee decline. 5. Power Import of coal from Australia required for thermal power plants adds up to the cost of power generation. So this sector gets affected negatively due to rupee decline. 6. Auto Engines and other chassis components are mostly imported by auto companies. This import adds to final cost of manufacturing in two, three and four wheelers. So this sector gets negatively affected by rupee decline. 7. Telecom Telecom majors like Bharti Airtel and Reliance have huge foreign debt. Due to rupee depreciation the value of this debt increases as this debt is reported in terms of dollars in turn affecting sector as a whole.

8. Capital goods In this sector also companies have huge foreign debt. Again adding additional costs to their balance sheets. Impact on NRIs1. A WindfallA US-based NRI who pays Rs 40,000 equal monthly installment, or EMI, on a home loan. On August 1, 2011, his monthly outgo was $908. On January 9, 2012, it was $758, a saving of $150 or Rs 7,909. The same applies if he sends money home. A $1,000 fetched him Rs 44,000 on August 1, but on January 9, 2012, it got him more than Rs 52,000. 2. The Reverse ImpactThe trend is not entirely in favour of people based abroad. If you repatriate your rupee investments to the country where you stay, you stand to lose. For instance, your mutual fund investments worth Rs 1,00,000 converted into US dollars would have got $1,896 on January 9, 2012, as against $2,270 in August 1, 2011. Rupee depreciation has eroded the value of NRI investments in India by nearly 20 per cent in dollar terms. 3. Reasons for Investing in IndiaTo increase dollar inflows and check the decline in the rupee, the RBI recently deregulated the interest rates offered by banks on non-resident external (NRE) and non-resident ordinary rupee (NRO) accounts. An NRE account is a rupee account from which money can be fully repatriated, that is, sent back to the country of your residence. An NRO account is also a rupee account, but one can repatriate only up to $1 million every year from this account. Foreign currency non-rupee account is the same as the NRE account except that the deposits are in foreign currencies. 4. Taxation on NRI DepositsThough interest earned on NRE and FCNR accounts is tax-free in India, the tax rate for interest income from NRO accounts is 30 per cent. However, NRIs living in countries with which India has a Double Taxation Avoidance Agreement (DTAA) can avail of lower tax rates. The increase in NRI deposit rates, the 20 per cent rupee depreciation against the dollar and tax benefits under DTA agreements are a once-in-a-lifetime investment opportunity for NRIs. We have illustrated the gains in the table Making Hay. Fixed deposits are not the only option for NRIs in India. The equity markets have fallen close 20 per cent since the beginning of 2011 and many large and mid-cap stocks are trading 30-50 per

cent below their year-ago prices. The net asset values of equity mutual funds are also much lower than last year, making it a good time to invest in Indian equities.

10 reasons to worry about the rupee depreciationThe over 13% depreciation of the rupee from the beginning of April has the markets jittery and the government worried, and rightly so. ET explains why the sharp decline of the Indian currency against the US dollar is cause for concern.

Impact on Indian EquitiesThe sharp depreciation of rupee has not only rattled Dalal Street but has hit India-focused foreign funds and exchange traded funds (ETFs), which are promoted by global funds based out of the US, Europe and other developed markets. Feeling the heat, leading global funds such as Fidelity, HSBC, JP Morgan, Wisdom-Tree, Franklin and others have sold Indian equities worth $1.4 billion during the quarter as they faced redemption pressure from overseas clients, according to data compiled by Morningstar, an independent investment research firm. Some of the India-dedicated funds have plunged up to 16% during the April-June quarter (Q2, CY13), while the MSCI India index slipped 5.7% and the BSE Sensex gained 3%. The rupee, which fell nearly 10%, has thrown the Indian capital markets in disarray. Apart from the rupee, foreign investors are particularly concerned about the widening current account deficit, which many expect to hover around 4.5% in FY14 due to the sharp fall in the currency along with a slowdown in exports and rise in the import bill.

FALL OF RUPEE: GLOBAL PERSPECTIVE

FALL OF RUPEE: GLOBAL PERSPECTIVE

Over the one month period starting May 2013 to June 2013, all global currencies have taken a hit. In fact this decline started well before the fall of the Indian Currency which meant that at a time when all global currencies were falling, the Rupee held strong and was able to withstand pressure from other currencies. However, now the Rupee has also been impacted adversely due to the global pressure and has hit a record low of Rs 66.075 against USD on 27/08/2013 with the Sensex falling 600 points within a day to 17,968. At such a time, when the world is facing slow growth rates and going through a tough face, one fix for all solutions isnt possible. Hence, we have looked at the way ahead in terms of dividing steps that the RBI should take in the Short Run, Medium Run as well as the Long run to arrive at a comprehensive set of measures that the RBI can choose from to boost the Indian economy.

RBI Approaches (Short Run)For the FY 2012-2013, Indias Current Account deficit stood at a record 4.8% of the GDP.In Q1,2013, Indias current Account deficit marginally recovered to 3.6% of the GDP bringing down the deficit to USD 18 billion in comparison to a USD 21 Billion deficit for the same quarter in 2012. The reason for this fall in the Current Account Deficit was attributed to a fall in the Non Oil and Non Gold Imports attributing to slow economic growth. Even Gold Imports declined, down 5.7% to about 215 tonnes in Q1 2013. To improve this Current Account Deficit (CAD) situation, the RBI has taken a ost of measures to curb Gold Imports in the Indian Economy. Here is a brief timeline: JANUARY 2013 : Gold import duty raised to 6% from 2%. Duty on raw gold import doubled to 5%. FEBRUARY 2013 : MARCH 2013 : RBI considers imposing value restrictions on Gold Imports by banks. RBI plans to introduce 3 gold linked products in the near future. RBI denies any possibility of increase in Gold Import duty any further.

APRIL- MAY 2013 :

All these measures were implemented to curb Gold Imports by the Indian Economy. However Indias Gold imports in July 2013 were USD 2.9 billion as compared to USD 2.45 Billion in June 2013. This meant that RBIs efforts were going in vain. Due to high import duties, Gold Smuggling and import of Gold through other illegal channels had increased significantly and this is what led to an increased total import of gold. Hence, in the Short Run, our biggets problem does seem to be the huge amounts of gold that we have been importing. Even though RBI has taken steps to curb imports, RBI needs to monitor all the illegal smuggling that is taking place to avoid facing a BOP crisis. If the RBI successfully curbs these rising Gold Imports, it would save Foreign Exchange of about USD 10-12 Billion. RBI Approaches (Medium Run)In the short run, curbing Gold Imports to improve the CAD is a good enough measure. However, India is the worlds top Gold Importer and these measures may not result in the desired outcomes in the medium to long run, specifically due to the presence of illegal channels to smuggle gold. We have narrowed down to 4 steps that the RBI can take, in the medium run, to ensure a turnaround of the economy.

1. Dollar Window for Oil CompaniesOne medium run step could be to open a separate dollar window only limited to oil companies so that they buy dollars from the Central Bank and not the market. This is so because state owned PSUs are in fact dollars biggest buyers needing almost USD 8-8.5 billion per month for an average of 7.5 million tonnes of crude oil. Opening a separate window though would ease the pressure in Rupee, however drain the Foreign Exchange Reserves by about USD 8-8.5 Billion per month. 2. Ask exporters to buy RupeeThe RBI could use its authority to ask all exporters to convert a part of whatever Foreign Reserves and currency they must have; providing instant ease on the Rupee.

3. RBI InterventionSome experts suggest that Indias Forex Reserves amounting to USD 280 billion is more than sufficient to cover up for shocks and should be used in the market right now. Currently, RBIs USD 280 Billion reserve is enough for 7 more months of Foreign Exchange Reserve, as mentioned in the report earlier. Some economics advocate that RBI needs to be more flexible in terms of when to decide on intervention. 4. Moral PersuasionRBI could use its power of Moral Persuasion to convince banks to raise money from abroad at attractive rates. This has also been done in the past. This is because NRIS already have more than USD 100 billion that they have invested in India. As of Sep 2012, NRI,s had USD 58 Billion in dollar deposits in India. The government could also consider asking IDFC Ltd. to raise approximately an amount of USD 4 billion in debt from foreign countries thereby reducing the quantity of dollar available in the market. RBI Approaches (Long Run)Long run approaches that the RBI takes must aim towards one thing. The fact that to achieve long run improvement in our CAD, we need to experience growth that is higher than all other currencies. This can happen in the following ways: 1. Changes in the Export Policy Zero Percent EPCG schemes should be broadened to include all industries. Reduction in minimum land requirement criteria as a necessary condition in setting up SEZs be reduced to its half amount of 50 acre to facilitate easy setting up of SEZs and bolster growth and exports.

2. Clearing up Investment frameworkIndia has recently increase FDI limits in various sectors including civil aviation. However, there are still certain restrictions that are imposed such as 2/3rd of the investees directors should be Indian Nationals and that the control of the investee never leaves Indian hands. These conditions only botch up the investment framework not only just in civil aviation but also across all sectors. The red tape associated with ensuring that these regulations are met takes much time and often ends up stalling the investment process.

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