Currency fluctuation on international exchanges around the world can bring sleepless nights to any investor. Domestic currency volatility is a very fragile thing, and has impact on investors’ sentiments.
The USA dollar simply known as USD is the highest traded currency in the world. Euro takes second place in currency trading. In current weak global scenario, Indian Rupee known as INR, has depreciated more than 25% in a year, and has created deep impact on domestic and international investors’ sentiments.
Depreciation of INR against USD can invite mighty storm in Indian financial markets. The main reasons behind its depreciation are USD in demand, as investors thinking that it is a safe haven to park funds. Second reason is collapse of International trade; India’s current trade deficit is $ 13486 million, 4.3% of Indian GDP. Third is capital flows, Indian notices more capital outflows than inflows of foreign currency.
The major impact of INR appreciation or depreciation would be seen in Import – Export industry, corporate and organizations having large borrowing of foreign loans, students going abroad for study and travelers coming India for visit.
How INR depreciation against USD impact corporate?
When INR was at level 45 – 50 against USD, corporate have borrowed money from overseas, and in current situation where INR is at 56 per USD, cost of repayment of foreign loans and bonds are costly. Crisil Ltd. study shows that Indian firms are defaulting on loans as cost of repayment goes up. In meantime cost of borrowing too increased by 10%. In this scenario companies are losing cost advantage from ECB and Federal Reserve Bank, because their rates are at a record low than Reserve Bank of India’s benchmark rate. These events have direct impact on corporate net profits, and can lead in low dividend payments.
Companies such as Bharat Forge, Rural Electrification Corporation, Bharti Airtel and Adani Power are heavily depending on overseas borrowing for expansions. Sterling Biotech failed to pay $ 184 million of convertible bonds that matured on date. It shows that corporate interest coverage ratio is falling and interest payments are rising.
INR depreciation has also created doubt in foreign investors and FIIs. Fall in Indian Rupee would not give foreign investors expected returns, and they would start pulling their investments from Indian financial
markets. By this INR would depreciate further because it would create lack in foreign currency reserves.
Research done by economist concluded that there is no direct relation between Indian stock markets and exchange rate, foreign exchange reserve, value of trade balance. But event would affect firms’ overall profits and this could lead towards stock prices fluctuation.
One of the major impacts of INR volatility is on Import and Export businesses.
Major Export items in India: Live animals, milk products, wheat, rice, coffee, tea, spices, cumin seed, tamarind powder, sesame seed, sugar, henna, herbal extract, medicines, fertilizers, chemicals, salt, iron ores, minerals, books, leather products, textile, dyes and pigments, home furnishing, footwear, brass items, Aluminum items, sanitary wear, ceramic, glassware, flanges, fittings, embroidered and Zari items, pipe and pipe fittings, handicraft, cables, medical disposables, laboratory equipments, surgical equipments, sports goods, wooden furniture and various other engineering and electrical products.
Major Import items in India: Cereals and preparations, Fertilizers, Edible Oil, Sugar, Pulp and waste paper, Paper, Newsprint, Crude rubber, Non-ferrous Metals, Metalliferrous ores and metal scrap, Iron and Steel, Crude Petroleum and petroleum products, Pearls, Precious and Semi-Precious stones, Machinery, Project Goods, Pulses, Coal and its derivatives, Non-metallic, Organic & Inorganic chemicals, Dyeing, tanning material, Medicinal products and Pharma products, Artificial resins, yarn & fabrics including silk, wool and cotton, electronic goods, wood and wood products, gold and silver, essential oils, computer software, etc.
In this Crude Petroleum and related products are imported around, $ 73.7 billion or 32% of the total imports. Hence, depreciation in rupee will increase import payment bills.
What steps Reserve Bank of India can take to stop Indian Rupee depreciation?
- Reduce trading limits for banks in foreign currency.
- Increase in interest rate for NRI and NRE bank accounts.
- Open window for Oil import companies to do direct payments in USD.
- Issue special type bonds targeted to Indians who live in foreign, this will boost foreign currency reserve.
In INR depreciation or USD appreciation exports gets advantage, but in this scenario, international commodity prices would fall and exporters could not get advantage.
What if INR touch 48 per USD?
India would become cheap destination for foreigners and Indian tourism sector gets boost. It works inversely, as simple as, it gives advantage for importers. This event could take place if Government policies make India lucrative in investment and results in capital inflow.
But it has negative impact on Indian economy. Indian government and Reserve Bank of India maintain rupee value against basket of currencies, maintains level is around 50 per USD. In 2007-08, rupee appreciated by 13% over USD. Appreciation in INR has negative impact on exports and its industry margins. This has a little role to play in trade deficit, because India’s less export business will directly impact on trade. When INR appreciated in 2007-08, India’s FY 08 Q1 trade deficit was around $ 16,000 million. (In trade deficit case major role is played by import payments bills.)
Note: Study was done in July, 2012