RUPEE DEPRECIATION AND ITS IMPACT ON INDIAN ECONOMY

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1 RUPEE DEPRECIATION AND ITS IMPACT ON INDIAN ECONOMY Dr.A.Saravanan, M.A., M.Phil., Ph.D., Assistant Professor in Economics, J.K.K.Nataraja College of Arts & Science, Komarapalayam , Namakkal Dt. Tamil Nadu. Abstract The present paper has to analyze the effects on Indian currency depreciation against the dollar. The data collected for the study is secondary one. The required data for the study were collected and compiled from the RBI Website and Bulletin. The study covers the area of currency growth, foreign investment and macro economic factors these are all the components to effect of currency depreciation in India during the study period from to In addition, the other required data were collected from various journals and magazines. The collected data have been used for analysis with the help of statistical tools. Namely Mean, Standard Deviation (SD), Co-efficient of Variance (CV), Compound Annual Growth Rate (CAGR), Correlation and Paired t statistics analysis. The study concluded that the exchange rate in Indian currency was highly depreciation of Post-liberalization period and also its impact on the Indian economy. So, in order to Indian government take necessary step in to introduce new economic policy to switch over this scenario. Key words: Rupee Depreciation, Indian Currency growth between pre and post Liberalization, Exchange Rate, Inflation, Interest Rate, External Debt, GDP, FDI I. INTRODUCTION Depreciation refers to a fall in the value of the domestic currency which is caused by the demand for foreign currency exceeding its supply in the market. In such a situation one has to pay more than before to get units of foreign currency. This fall takes place in the market and on its own. Market determined exchange rate serves the purpose of aligning the domestic economy with the world economy was the price route. As consequences the domestic price gets linked up with those of the world price. With the liberalizations and globalization of the economy in recent years, imports are bound to increase. The lessening of restrictions on imports and lowering of tariff on imports which the economic reform implies, an increase in imports has in fact taken place. Again with trade having become an important element of the new strategy of growth. 1

2 India got freedom from British rule on Aug 15, At that time the Indian rupee was linked to the British pound and its value was at par with the American dollar. There was no foreign borrowing on India's balance sheet. To finance welfare and development activities, especially with the introduction of the Five-Year Plan in 1951, the government started external borrowings. This required the devaluation of the rupee.- After independence, Indian choose to adopt a fixed rate currency regime. The rupee was pegged at 4.79 against a dollar between 1948 and India faced a serious balance of payment crisis in 1991 and was forced to sharply devalue its currency. The country was in the grip of high inflation, low growth and the foreign reserves were not even worth to meet three weeks of imports. Under this situation, the currency was devalued to against a dollar. India being a developing economy with high inflation, depreciation of the currency is quite natural. Depreciation of rupee is good, so long as it is not volatile. A random depreciation that we have seen in the last few months is bad and it has hurt the economy. Right from the beginning of year 2013, the value of rupee has been depreciating. High growth coupled with a market driven exchange rate bears well for the economy. However, when growth falters and macroeconomic parameters start appearing vulnerable, one of the first casualties is the exchange rate. Currently, there is no clarity on whether we have seen the worst of the storm or it is just the beginning. The problems are manifold. Persistent high inflation and fiscal deficit, increasing subsidies, faltering exports and slowing industrial production point towards an economy, which is moderating in growth. Monetary policy has so far been ineffective in reversing the inflation trajectory. Fiscal stimulus appears nonexistent, especially when the government has added to the subsidy bill by giving a go ahead to the food security bill. In this weakened environment, the rupee has depreciated by close to 20% in the past few months. Secondly, the extent of volatility in the global economy hasn t helped. Besides the Eurozone crisis, the downgrade of the US economy has led to flight of capital in order to boost the US home economy. The US dollar has become scarce and unlike its peers, India needs to attract sufficient foreign funds to close the fiscal and current account gap. The fact that a weakening of the Indian economy has happened at the same time as a global debt crisis has elevated the exchange problem. The appreciation in the US dollar has led to the decrease in the value of Indian rupee. The value of US dollar has been rising ever since the US Federal Reserve has announced quantitative easing. This has hit not only the emerging markets and assets of India but also of other countries like Thailand, Brazil and Indonesia. Just as in other countries, the foreign institutional investors (FIIs) have also started withdrawing their 2

3 Jan, 2013 Feb, 2013 Mar, 2013 Apr, 2013 May, 2013 Jun, 2013 Jul, 2013 Aug, 2013 Sep, 2013 Oct, 2013 Nov, 2013 Dec, 2013 Jan, 2014 Feb, 2014 Mar, 2014 Apr, 2014 May, 2014 Jun, 2014 Jul, 2014 Aug, 2014 Sep, 2014 Oct, 2014 investments in the Indian bond market. With growing concern for increasing risks in the global environment, massive redemptions through the global exchange traded funds (ETFs) are taking place. This has further initiated the selling by the FIIs in the equity market of India leading to depreciation in the Indian rupee. The Reserve Bank of India does not wish to intervene and control this depreciation as it is initiated by global factors that are beyond the control of RBI. Moreover, the trade deficit of India has also not escalated further decreasing any hope of appreciation in Indian rupee in close future. Meanwhile the Indian economy, like any bank facing a run on its resources, is under intense pressure. This is aggravated because our banking sector is both small and undercapitalised and not well configured to take on rapid outflows of this nature. The rupee, like the currency of any country nowadays, is underpinned by the working economy and its fundamentals. And all parameters of these assessments are also very weak at present. Indian officials and central bankers say their economy is only one of several emerging markets that are suffering from the flight of investors back towards the US, where the prospect of an end to the Federal Reserve s ultra-easy monetary policies has made dollar assets more attractive. The Evolution of Indian rupee per 1 US dollar Exchange rate (monthly average) can be traced from the chart given below Indian Rupee per 1 US $ Exchange Rate (Monthly Average) II. REVIEW OF LITERATURE Edwards (2000) investigated the dynamic association between exchange rate regimes, capital flows and currency crises in emerging economies. The study draws on lessons learned 3

4 during the1990s, and deals with some of the most important policy controversies that emerged after the Mexican, East Asian, Russian and Brazilian crises. He concludes that under the appropriate conditions and policies, floating exchange rates can be effective and efficient. Taylor (2001) discusses the failure of liberalized policies in Argentina. He says that Argentina has failed in maintaining the liberalized policies about capital flows and a firm currency. Argentina had anti-inflation program based on freezing the exchange rate in the early 1990s. This means that the money supply within the country and the supply of credit to firms are tied directly to international reserves. So if the country gets capital inflows, the supply of money and credit increases, leading to a substantial increase in domestic prices. Harberger (2003) studied the impact of economic growth on real exchange rate. He found that there is no systematic connection between economic growth and real exchange rate. Husain et al. (2004) found in their study that little access to international capital is available for the weaker and less developed countries, so low rate of inflation and higher level of durability is associated with fixed exchange rate regime in those countries. However, they found no robust relationship between economic performance and exchange rate regime in the developing economies. They also found that advanced economies may experience durable and slightly higher level of growth rate without higher level of inflation in flexible exchange rate regime. Kanika Arora (2014) studied the real implications of the depreciation of the rupee on the Indian economy and shows that in the long run, the Indian economy has more to lose and less to gain with weaker rupee. The study concluded that the Indian Rupee has depreciated significantly against the US Dollar marking a new risk for Indian economy. Grim global economic outlook along with high inflation, widening current account deficit and FII outflows have contributed to this fall. RBI has responded with timely interventions by selling dollars intermittently. But in times of global uncertainty, investors prefer USD as a safe haven. To attract investments, RBI can ease capital controls by increasing the FII limit on investment in government and corporate debt instruments and introduce higher ceilings in ECB s. Government can create a stable political and economic environment. However, a lot depends on the Global economic outlook and the future of Eurozone which will determine the future of INR. III. STATEMENT OF THE PROBLEM If we look at India s Balance of Payments since , we see that external account mostly balances in 1970s. Infect in second half of 1970s there is a current account surplus. 4

5 This was a period of import substitution strategy and India followed a growing economy model. In 1980s, current account deficits start into a BOP crisis in It was in the 1991 Union Budget where Indian Rupee was devalued and the government also opened up the FDI. India FX rate system was on the fixed rate model till the 90s, when it was switched to floating rate model. Fixed FX rate is the rate fixed by the central bank against major world currencies like US dollar, Euro etc. Floating FX rate is the rate determined by market forces based on demand and supply of a currency. If supply exceeds demand of a currency its value decreases, as is happening in the case of the US dollar against the rupee, since there is huge inflow of foreign capital into India in US dollar. (Sumeet Agrawa, 2012). The current scenario flow of foreign capital (Investment) to reduce when compare with last two decades. Lacking of inefficient market condition, highly dominating budget against the small traders, Balance of Payment (BOP) face the decreasing trend, high investment in gold and decreasing the revenue collection of existing foreign investors. These are all the factors to support decreasing rupee value against the dollar. With this backdrop, in the present study, the researcher has made an attempt to analyze the Indian currency growth when compare with other country currency and which factors highly influencing the currency fluctuation in India. Hence, this paper has to analyze the effects on Indian currency depreciation against the dollar. IV. OBJECTIVES OF THE STUDY The following are the objectives of the study: 1. To analyze the growth of exchange rate in Indian rupee compare between Pre and Post-Liberalization. 2. To examine the growth of foreign investments flow in the Indian capital market. V. SCOPE OF THE STUDY This paper aims to know the effects of Indian currency depreciation against the dollar, what are all the factors to influencing the currency devaluation against the dollar with the help of select tools. VI. RESEARCH DESIGN Sources of Data: The data collected for the study is secondary one. The required data for the study were collected and compiled from the RBI Website and Bulletin and the study 5

6 covers a period of 44 years from to In addition, the other required data were collected from various journals and magazines. Framework of Analysis: The collected data have been used for analysis with the help of statistical tools. Namely Mean, Standard Deviation (SD), Coefficient of Variance (CV), Compound Annual Growth Rate (CAGR), Correlation and Paired t statistics analysis. Hypotheses: The following hypotheses have been framed in the present paper: H01: There is no significant relationship between the Indian currency growth Pre and Post period of Liberalization. H02: There is no significant relationship between the exchange rate and macro economic variables. VII. RESULTS AND DISCUSSIONS The results of the present paper are presented in two main parts viz., (i) Growth of Exchange Rate in Indian Rupee and (ii) Macro-Economic Factors Compare with the Exchange Rate. Part-I: Growth of Exchange Rate in Indian Rupee This part is mainly devoted for the study of Growth of Exchange Rate in Indian Rupee Vs the Us Dollar of Pre-Liberalization from to and Post- Liberalization from to Table-1 Growth of Exchange Rate in Indian Rupee Vs the Us Dollar of Pre and Post- Liberalization from to (Per Rupee value) Pre-Liberalization from to Post-Liberalization from to Year US Dollar CAGR Year US Dollar CAGR

7 Mean Mean SD 3.95 SD 7.74 CV 0.37 CV 0.18 CAGR 0.05 CAGR 0.04 Source: Compiled and Calculated From RBI Report. From Table-1 observed that the growth of exchange rate in Indian rupee Vs the US Dollar of Pre-Liberalization from to and Post-Liberalization from to In Indian rupee growth compare with US Dollar growth shows the fluctuating trend during the study period. The tables shows that the positive growth on Indian rupee when compare with USD currency during the study period from to of the before liberalization. It was due to the efficient market power, no competition of large traders, Balance of Payment (BOP) to face the increasing trend these are all the reason the currency to grow equally in dollar value. The highest rupee value but lowest growth indicates that the to in Indian currency and to in US Dollar. It was due to proper irregular activities of Balance of Payment, Multinational Companies dominations, could not predict and uncontrollable factors of inflation in domestic product and slowly growth of GDP growth in India. These are all the cases the Indian rupee value depreciation against the USD currency for Post-Liberalization. Table 2 Paired t-test for Pre and Post Liberalization of Exchange Rate of the Indian Rupee Vs Variables Indian Rupee per 1 US $ Exchange Rate the US Dollar from to and to Mean ± S.D Pre- Liberalization ± 3.95 * Significant at 5 Per cent Level. Mean ± S.D Post - Liberalization Mean Diff. Std. Deviation Std. Error Mean t ratio ± * 7

8 It is observed from the table 3 that the pre and post liberalization of exchange rate of the Indian rupee Vs the US Dollar from to and to The calculated value is less than 0.05 at 5 per cent level of significance. Hence, the hypothesis is rejected. So, there is a significant relationship the Indian currency growth Pre and Post period of Liberalization. Part-II: Macro-Economic Factors Compare with the Exchange Rate The various Macro-Economic factors compare with the exchange rate from to is presented in table-3. Table-3 Various Macro-Economic Factors Compare with the Exchange Rate from to (Rs. In Millions) Exchange External Debt Interest Rate Year Inflation (Current US GDP FDI Rate (Lending Rate) Dollar)

9 Mean SD CV Source: Compiled and Calculated From RBI Report. Table-3 ravels that the various Macro-Economic factors compare with the exchange rate from to The average exchange rate shows the positive growth during the study period. This has been due to the surplus Balance of Payment in India. In has the lowest rate of exchange Rs. 22.3, when compare with is Rs The average inflation rate shows the fluctuating trend during the study period. The rate of inflation 13.9 per cent in , when compare with 3.7 percent It was due to the decreasing trend of GDP growth in India. The average interest rate shows the fluctuating trend during the study period. Interest rate from has the highest rate of 18.9 per cent, when compare with per cent in It was due to maintain unfavorable lending high loan to the industry and individual and less maintenance of cash reserve ratio (CRR). The average external debt shows the increasing trend during the study period. The lowest external debt was $ million in The highest external debt was increased $ million in It was due to reduce the foreign investment return and excess of export over the import. The average GDP growth rate shows the fluctuating trend during the study period. The highest GDP growth stands for 9.57 per cent in The lowest GDP growth stands for 3.1 per cent in The average rate of FDI is fluctuating trend during the study period. In India the highest investment of $43,406 million in , when compare the lowest investment of $ 74 million in beginning period. It s found that the India has been adopting traditional market system and un modernization infrastructure facilities compare with other developing countries. Table 4 Correlation Analysis of Various Macro-Economic Factors Compare with the Exchange Rate from to

10 H02: There is no significant relationship between the exchange rate and macro economic Macro- Economic Factors Exchange Rate Inflation variables. Interest Rate External Debt GDP Exchange Rate 1 Inflation Interest Rate * * 1 External Debt 0.508* GDP ** FDI ** 1 *. Correlation is significant at the 0.05 level (2-tailed). **. Correlation is significant at the 0.01 level (2-tailed). Table-4 reveals the correlation analysis of various macro-economic factors compare with the exchange rate from to The positive correlation was observed between External debt and Exchange rate (.508), FDI and GDP (.575). The negative correlation was observed between Interest rate and Exchange rate (.484), GDP and Interest rate (.567) which are significant at 5 and 1 percent levels. The positive correlation was observed between Interest rate and Inflation (.414) which are significant at 5 percent level. FDI VIII. POLICY FOR IMPLICATIONS In post-liberalization period of Indian currency exchange value growth is very low when comparing with dollar, pound, sterling, euro and yen values. It indicates that the export over the import, highly inflation and multinational companies dominations. So, in order to increase the appreciation of Indian currency value Central Government must control deficit in order to raising import taxes, restrict and regulate exports and imports. Foreign investment in Indian capital market shows the decreasing trend during from to So, in order to increase the foreign investment the government needs to control external foreign debt, GDP growth and raising the cap on foreign investment, remove traditional market conditions. Macro- Economic factors like interest rate is highly related with depreciation or appreciation of Indian currency against the dollar value. So, the Central Government must increase cash reserve ratio (CRR) along with interest rate. IX. CONCLUSION 10

11 This research paper helps to find out the empirical relationship among the various macroeconomic variables and foreign investment analysis to know the current scenario and currency depreciation against the dollar value in India. Post-liberalization period of Indian currency exchange rate is not satisfactory. However, foreign investment in Indian capital market shows the decreasing trend during the study period. Similarly, the analysis reveals that the exchange rate in Indian currency was highly depreciation of Post-liberalization period and also its impact on the Indian economy. So, in order to Indian government take necessary step in to introduce new economic policy to switch over this scenario. X. REFERENCE 1. Akinlo, E. A. (2003), Exchange Rate Deprecation and Currency Substitution in Nigeria, African Review of Money Finance Banking, Vol. 32, No. 3, pp Chellasamy P, Depreciation of Indian Currency and Its Impact on Indian Economy, Vidyaniketan Journal of Management and Research, Vol.1 Issue-2 July December Edwards, S. (2001) Exchange Rate Regimes, Capital Inflows and Crisis Prevention, NBER and 4. Harberger, A. (2004), Economic Adjustment and the Real Exchange Rate, University of Chicago Press, 10, Kanika Arora, Depreciation of Rupee, International journal of Emerging Trends in Science and Technology, Vol.01, No.3, pp , May Secondary Data retrieve from 7. Shelly., S, (2012). An Analytical study on Indian Currency Rupee Depreciation against the US Dollar and Its Economic Impact, Journal of Economic and Management, Vol.1, Issue-1, pp Sumanjeet (2007), Appreciation of the Indian Currency: Implications for the Indian Economy, World Affairs: The Journal of International Issues, Vol 11, No. 4, Winter, pp Sumeet., A, (2012). Effect of Devaluation on Indian Currency in Indian Economy, International Referred Research Journal, Vol.3, Issue-28, pp Taylor, L. (2001) Argentina: A Poster Child for Failure of Liberalized Policies? Challenge, November December. 44, 6, ******* 11