Sunday, 12 February 2012

Volatile currency, INR

What is Depreciation?

As per accounting term depreciation means decrease in asset value. In case of currency (rupee) or real estate deprecation means the same, for e.g. rupee depreciate against dollar. In case of rupee and dollar, rupee value is decreased against dollar value in currency market (forex market). In simple language a currency will tend to become less valuable when its demand is less than supply.

If we understood definition, next question would be the reasons behind INR (Indian rupee) depreciation.

First Reason - Dollar is in Demand

BRIC countries like India have emerging economy, so a huge percentage of investment in India is from outside the country, especially from US but due to recession in US, big institutions are collapsing and many of them are on the verge of breakdown. They are suffering huge losses in their country. They have to maintain their balance sheets and look strong on all statements, so to recover losses in their country, they are pulling out their investments from India. Due to this pulling out of investment by these big companies from India or in other terms disinvestment, demand of dollar is raising up and rupee is depreciating.

Global slowdown and global investors’ preference US$ for safe investments, poor returns from Indian stock market (BSE Sensex lost close to 25% in 2011).

Second reason - Collapse of International Trade 

Importers are trying to accumulate dollars, as they have to pay in terms of dollars and at the end demand is increasing against the rupee. Exporters have a very few orders from outside countries, so there is no matter of converting dollar into rupee thereby decreasing demand for rupee.

If there is any deficit in the current account, which means country is doing more trading outside the country then its actual earning inside the country. This situation is not good for a country because the country needs to buy more foreign currency to fulfill its need inside the country. A country needs to manage its deficit within control; otherwise it will lead to an economic problem.

Depreciation in rupee is only beneficial to exporters, like IT industry, handicrafts, gems, jewelry, textiles, ready-made garments, industrial machinery, leather products, chemicals and related products. Because if $1=50 INR and dollar appreciate with 10% then rupee becomes 55 INR against $1. So, in this case where exporters get 50 INR in case of $1, now they earn 55 INR from $1.

But it inversely impact importers, like petroleum products, capital goods, chemicals, dyes, plastics, pharmaceuticals, iron and steel, uncut precious stones, fertilizers, pulp paper etc. The most impact which India gets from depreciating INR is from oil imports. Oil imports consume the largest part of the forex reserves. Take for instance crude oil imports. Brent crude oil price was $118.46 per barrel on April 2011 when exchange rate for the rupee was Rs 44.4 to a dollar. Oil price had gone down to $109.03 per barrel and exchange rate was Rs 52.7 to a dollar. Thus, because of the rupee depreciation not much benefit can be derived out of the lower oil price.

This effect is directly affected on balance of payment. And it results in high debt.

A depreciating rupee is not only impacting the import bill it has also affected the cost of borrowings for the corporate sector. Total external debt has increased by Rs.2186.8 billion for the period June 2011 to November 2011.

Even, Students going abroad for further studies and Indians going to foreign travel will be pinched hard due to his movement in rupee.

What was the role of RBI, dose it met expectations?

  • ·         The Reserve Bank of India reduced trading limits for banks in the foreign exchange market.
  • ·      The RBI deregulated non-resident external (NRE) rupee deposits and ordinary non-resident (NRO) accounts.

The reasons behind these steps are to support dollar inflow in Indian economy. By reducing barriers on Indian banks, RBI wants more inflow of dollars in country. If dollar supply will increase rupee value would appreciate.

Now, take a look on global exchange rate, country wise. Let’s start with China. Chinese Yuan is constantly appreciated in last year against USD, which means it is not satisfying Chinese exports any more. In July, 2011 Chinese trade balance was near about 30 billion Yuan, and in January, 2012 it was around 16 billion Yuan. If you can use same appreciation logic, you can easily get the reasons behind decrease in trade balance.

Japanese Yen, especially Japanese economy suffers a lot on Yen depreciation against dollar in 2011-12. After tsunami and Fucushima disaster Japan faces structural imbalances in economy. Yen also depreciate against USD in 2011, and Japanese trade balances ends with negative figure in January, 2012 from positive in mid 2010. 

“Finance is the art of passing currency from hand to hand until it finally disappears” – Robert W. Samoff


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