IMPACT OF INDIAN RUPEE AND FOREIGN EXCHANGE RATE

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1 IMPACT OF INDIAN RUPEE AND FOREIGN EXCHANGE RATE Dr. C. MANIKANDA MUTHUKUMAR, R.D. GEETHA, Assistant Professor, Ph. D Research Scholar (Full - Time), PG and Research Department of Commerce, PG & Research Department of Commerce, Government Arts College (Autonomous), Government Arts College (Autonomous), Salem Salem ABSTRACT This paper explores the Import of Indian Rupee and Foreign Exchange Rate. The circumstances which have been created for the economy due to the depreciation of rupee against dollar reveals that there has been a strong and significant negative impact of this currency volatility on many sectors. The relationship between the values of local currencies in terms of foreign currencies and export competitiveness of any country is very complex. This relationship will become more complex if there is the heavy dependence on imported resources in the exported products. During last the one year Indian rupee weakens many times and reached to a level of for a dollar in February Since January 2015, the local currency lost around 12 percent to the US currency. Indian economy which already suffered from large fiscal and current account deficit adversely affected by relatively exchange rate pressure. To track it again on the way many hard decisions were taken by Indian govt. This paper presents different challenges due to these fluctuation and steps triggered by the central bank and government to create stability. Keywords: Impact of Rupee, Dollar Fluctuations, Exchange Rate. Introduction Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies. The exchange rate between two currencies is that rate at which one currency will be exchanged with another currency. It is also known as a foreign-exchange rate, forex rate. Exchange rate of one currency versus the other is influenced by numerous fundamental and technical factors. These include relative supply and demand of the two currencies, economic performance, outlook for inflation, interest rate differentials, capital flows, technical support and resistance levels, and so on. As these factors are generally in a state of perpetual flux, currency values fluctuate from one moment to the next. But although a currency s level is largely supposed to be determined by the underlying economy, the tables are often turned, as huge movements in a currency can dictate the economy s fortunes 1. Objectives The main objective of this study is 1. To understand the concept of Exchange rate and currency fluctuation and understand the causes for decline of the rupee against dollar. 2. To study the real implications of the depreciation of the rupee on the Indian economy and also different stringent measures by Indian government to make rupee stronger. 1 46

2 Who Fix The Value Of Indian Rupee Against US Dollar? Interesting question. Do you think Indian government fix the value of Indian Rupee against US dollar? If not, who fixes it? RBI? No; at present none of these entities fix the value of Indian Rupee. Now the value of Indian Rupee (or any other currency) is determined by market. If the demand for Indian currency is high, Indian rupee will have high value, and if demand is low, it will depreciate. Also, understand that a high value for Indian currency means, the exchanged rate of Indian rupee against US dollar will be less. Fixed Rate System Vs Floating Rate System If government or RBI fix the exchange rate of a currency (and does not allow any variations according to demand and supply forces in market), such a system is called Fixed Rate system. It is also called Bretton Woods system or Pegged Currency System. India was following this kind of system till 1975 and partial controls till Since this currency valuation mechanism is artificial, most of the countries including India changed to Floating Rate System where currency market determines the value of a currency. Rupee Devaluation Vs Rupee Depreciation The term devaluation is used when the government reduces the value of a currency under Fixed Rate System. When the value of currency fall under Floating Rate System, it is called depreciation. Revaluation is a term which is used when there is a rise of currency to the relation with a foreign currency in a fixed exchange rate. In floating exchange rate correct term would be appreciation. Altering the face value of a currency without changing its foreign exchange rate is a redenomination, not a revaluation. History Of Indian Rupee : A comparison of Indian Rupee Value vs US dollar. Value Of Indian Rupee: Does It Matter? It should not be forgotten that exchange rate of a currency is not really an indicator of the economic strength of a country. There are many countries including China which favors devaluation of currency. Also, economic position of India in 2013 is far better than that of 1947, though there is fall in Rupee value. At present what worries Finance Minister and RBI governor is not the falling Indian Rupee, but the fluctuations in the currency market. What India needs is stabilization of Indian Rupee value, be in Rs. 50, Rs.60 or Rs.70 per 1 US dollar. But if rupee is Rs.60 one day and if it Rs. 65 the next day, it shows high volatility. Such a situation is not good for the economy and that will only trigger more fall in Indian rupee. 47

3 Depreciation and Appreciation of Indian Rupee: Relation with Exports and Imports UPSC has often asked this question directly and indirectly how does a fall in rupee affects exports and imports? Wait, before analyzing this topic let s see one more question Why do governments devalue their currencies? They do it mainly to improve the balance of trade (or in other words increase exports and decrease imports!). Fluctuations In India s Rupee Rate And Its Economic Impact The Indian rupee is under great stress as overseas investors are paring their exposure to Asia s third-largest economy amid international uncertainty and mount ing worries over the domestic economy. On November 21 alone, overseas funds sold more than US$500 million worth of Indian-listed shares over the five trading sessions, reducing net inflows for 2011 to under US$300 million a tiny sum compared with the record investments of more than US$29 billion experienced in The rupee has lost more than 10 percent of its value this year, making it one of the worst performing currencies in Asia. The RBI also intervenes in the currency markets to maintain low volatility in exchange rates and remove excess liquidity from the economy. The rupee is pegged by the Bhutanese ngultrum at par and with the Nepali rupee at INR1 to NPR1.6. India has a managed floating exchange rate system. This means that the Indian government intervenes only if the exchange rate gets out of hand by increasing or reducing the money supply as the circumstances demand. Price Of Crude Oil The worth of crude oil has been a major bane for India since it has to bring in the maj ority of its requirement from outside the country. The demand for oil in India has been going up every year and this has led to the present situation. All over the world, the price of oil is given in dollars. This implies that as and when the demand for oil increases in India or there is an increase in oil prices in the global market, there also arises a need for more dollars to pay the suppliers. This also results in a situation where the worth of the INR decreases significantly in comparison to the dollar. Performance Of Dollar With Respect To Other Currencies The central banks across Japan and countries in the Eurozone have been bringing out a lot of money and this has meant that both Yen and Euro have lost their value. Compared to this the US Federal Reserve is giving hints that it will end the fiscal stimulus so that the dollar becomes stronger with respect to other currencies such as the Indian Rupee at least for the time being. Till now in 2013, the US dollar index has become stronger by 1.91%. Poor Current Account Deficit One of the main reasons behind the Indian government s inability to arrest the fall of the national currency is the critical current account deficit. In the fiscal India s CAD was measured at 4.8 percent of the GDP. The government has been unable to come up with any new destinations for exporting its products and this has also hampered the growth in this sector. Downgrading Of Indian Stocks Goldman Sachs, one of the leading banks in the world, has rated Indian stocks as being underweight. It has also asked investors to be careful given the concerns surrounding the recovery of the growth of Indian economy. Contraction of Indian Economy The various important sectors of Indian economy such as manufacturing, mining and agriculture have seen poor growth in 2013 and this has made them less appealing propositions for the investors. During June 2013, the aggregate industrial production in India reduced by 2.2 per cent and in July 2013 the RBI predicted that in the present fiscal there would be a growth of 5.5% which was lesser than its previous prediction of 5.7%. India Foreign Exchange Reserves The Foreign exchange reserves of India are mainly composed of US dollar in the forms of US government bonds and institutional bonds. The main component is Foreign currency assets. As per the data furnished by the Reserve Bank of India in its weekly statistical supplement, India's total foreign exchange reserves stands at US$ billion for the week ended July 48

4 31, 2015.In this, Foreign currency assets(fcas) was US$ billion, while gold reserves was US$18.25 billion. Gold reserves in India constitute nearly 15 percent of forex. Purpose of Foreign Exchange Reserve Official international reserves assets allow a central bank to purchase the domestic currency, which is considered a liability for the central bank its print the money. A central bank that implements a fixed exchange rate policy may face a situation where supply and demand would tend to push the value of the currency lower or higher (an increase in demand for the currency would tend to push its value higher, and a decrease lower) and thus the central bank would have to use reserves to maintain its fixed exchange rate. Under perfect capital mobility, the change in reserves is a temporary measure, since the fixed exchange rate attaches the domestic monetary policy to that of the country of the base currency. Precautionary Aspect The traditional use of reserves is as savings for potential times of crises, especially balance of payments crises. Originally, the creation of the IMF was viewed as a response to the need of countries to accumulate reserves. If a specific country is suffering from a balance of payments crisis, it would be able to borrow from the IMF, as this would be a pool of resources, and so the need to accumulate reserves would be lowered. However, the process of obtaining resources from the Fund is not automatic, which can cause problematic delays especially when markets are stressed. External Trade As most countries engage in international trade, reserves would be important to assure that trade would not be interrupted in the event of a stop of the inflow of foreign exchange to the country, what could happen during a financial crisis for example. As imports grew, reserves should grow as well to maintain the ratio. Nonetheless, evidence suggests that reserve accumulation was faster than what would be explained by trade, since the ratio has increased to several months of imports. The external trade factor also explains why the ratio of reserves in months of imports is closely watched by credit risk agencies. Financial Openness Besides external trade, the other important trend of the last decades is the opening of the financial account of the balance of payments. Hence, financial flows, such as direct investment and portfolio investment became more important. Usually financial flows are more volatile, which enforces the necessity of higher reserves. The rule of thumb for holding reserves as a consequence of the increasing of financial flows is known as Guidotti Greenspan rule and it states that a country should hold liquid reserves equal to their foreign liabilities coming due within a year. 49

5 Exchange Rate Policy Reserve accumulation can be an instrument to interfere with the exchange rate. Since the first General Agreement on Tariffs and Trade (GATT) of 1948 to the foundation of the World Trade Organization (WTO) in 1995, the regulation of trade is a major concern for most countries throughout the world. Hence, commercial distortions such as subsides and taxes are strongly discouraged. However, there is no global framework to regulate financial flows. Costs There are costs in maintaining large currency reserves. Price fluctuations in exchange markets result in gains and losses in the purchasing power of reserves. In addition to fluctuations in exchange rates, the purchasing power of fiat money decreases constantly due to devaluation through inflation. Therefore, a central bank must continually increase the amount of its reserves to maintain the same power to manipulate exchange rates. Reserves of foreign currency provide a small return in interest. Several calculations have been attempted to measure the cost of reserves. The traditional one is the spread between government debt and the yield on reserves. The caveat is that higher reserves can decrease the perception of risk and thus the government bond interest rate, so this measures can overstate the cost. By this measure, the cost can reach 1% of GDP to developing countries. While this is high, it should be viewed as an insurance against a crisis that could easily cost 10% of GDP to a country. Results are mixed, since they depend on specific features of the models. Why Foreign Exchange Reserves Are Important Foreign exchange reserve can be defined as deposits of a foreign currency held by the central bank of a country. Here are some of the reasons why it is important for a country to have good amount of foreign exchange reserves 1. It increases the confidence in the monetary and exchange rate policies of the government. 2. It enhances the capacity of the central bank of the country to intervene in the foreign exchange market and control any adverse movement and stabilize the foreign exchange rates to provide a more favorable economic environment for the progress of the country. 3. During time of any crisis foreign exchange reserves come to the rescue of any country so as to absorb the distress related to such crisis. 4. It also adds to the comfort of market participants that domestic currency is backed by external assets and hence it also helps the equity markets of the country, because due to strong reserves many people from foreign countries are willing to invest in the country having strong foreign exchange reserves. Conclusion The fall in the value of currency affects a lot of economic growth indicators. Depreciation of rupee reduces the inflow of foreign capital, rise in the external debt pressure, and also grow India s oil and fertilizer subsidy bills. The most positive impact of depreciation of rupee is the stimulation of exports and discouraging imports and thus improving the current account deficit. But, even after significant increase in the exports and sales in this year, Indian companies are reporting huge foreign exchange losses due to the depreciation of Indian rupee. This declines the overall profitability of these companies. As far as imports are concerned, for a country such as India, imports are necessary. 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. References (1). Anshu Grewal (2013) Impact of Rupee- Dollar Fluctuations on Indian Economy: Challenges for Rbi & Indian Government, International Journal of Computer Science and Management Studies Vol. 13, Issue 06, August 2013 ISSN: (2).Anubha Dhasmana (2014) How exchange rate changes impact Indian manufacturing firms. (3). Bagella, M., L. Becchetti, and I. Hasan, 2006, Real Effective Exchange Rate Volatility and Growth: A Framework to Measure Advantages of Flexibility vs. Costs of Volatility, Journal of Banking and Finance, Vol

6 (4).Chanan Pal Chawla Understanding the Impact of Exchange Rate Fluctuation on the Competitiveness of Business. (5). Coric, B., Pugh, G. (2010). The Effect of Exchange Rate Variability on International Trade: A Meta-Regression Analysis, Applied Economics, 42(20), pp (6). Eichengreen, B. J. (2008), The Real Exchange Rate and Economic Growth, International Bank for Reconstruction and Development, The World Bank. (7).Investopedia (2013) The Effects Of Currency Fluctuations On The Economy economy. (8).Kenen, P., Rodrik, D. (1986). Measuring and Analyzing the Effects of Short-Term Volatility in Real Exchange Rates, Review of Economics and Statistics, 68(2), pp (9).Kenen, P., Rodrik, D. (1986). Measuring and Analyzing the Effects of Short-Term Volatility in Real Exchange Rates, Review of Economics and Statistics, 68(2), pp (10).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 (11).Zanna, F. Luis (2005), Fighting Against Currency Depreciation, Macroeconomic Instability and Sudden Stops, International Finance Discussion Paper, No 848, December, Board of Governance of Federal Reserve System. 51