Macro Economics Assignment

Impact of Rupee Depreciation

Group Members: Akanksha Kochhar(11BSP1270) Richa Mandhyan (11BSP0809) Mitisha Gaur (11BSP0553) Kasturi (11BSP0442) Gaurav Gupta (11BSP0327) Kunal Saxena (11BSP0480)

CONTENTS
Introduction Why rupee is depreciating? Impact on Indian Economy Advantages of rupee depreciation to Indian Economy. o o o o o Beneficial to the Exporters Good News for NRIs Benefits to the IT sector Benefits to Investors invested in International Funds Benefits to the Hotel Industry

Disadvantages of rupee depreciation to Indian Economy o o o o Impact on inflation graph & fiscal deficit. A blow to Indian importers. Negative impact on FII flows to Indian market. Negative impact on Indian students and travellers abroad.

Conclusion

Introduction

The outlook for the Indian currency (INR) has gone through a drastic change in the last few months. The Indian currency has depreciated by more than 20 per cent since April 2008 and breached its crucial 50-level against the greenback on sustained dollar purchases by foreign banks and stronger dollar overseas. The fall in the value of Indian rupee has several consequences which could have mixed effects on Indian economy. Indian Rupee nearly breached the Rs 50 per dollar mark and closed at 49.90 - its weakest since May 14, 2009. The rupee has depreciated by over 12 per cent to close to 50-a-dollar mark currently from its near 44-level against the US currency at the end of July due to sustained dollar demand from banks and importers in view of the firm dollar sentiment fuelled by Euro zone crisis. The weakening of Indian rupee against other foreign currencies, especially dollar, is not good news for Indian government and importers. A depreciating rupee may compound the macroeconomic problems as prices of imported goods will surge and worsen the current account deficit. India won't be able to take advantage even if commodity prices ease due to global slowdown.

WHY IS INDIAN RUPEE DEPRECIATING?

The Indian rupee has depreciated by about 12% since July and touched the psychological mark of Rs 50 recently. It is imperative to understand the factors contributing to depreciation of Indian rupee in the global market. We need to understand in the global economy terms, when the currency will have more demand and when it will have less demand. The reasons for the fallout of rupee are as follows: The euro economic crisis, led by default concerns of Greece and the downgrading of two French banks has led to a loss of confidence in the Euro resulting in its devaluation against the dollar. This has also led to the dollar appreciating against other currencies including the rupee. The global economic crisis has caused the investors in the developed markets to be wary of investments in emerging economies like India. And as a result FIIs have started selling thei r investments in Indian Markets and are converting their rupee investments back into dollar. This outflow of foreign capital has resulted in depreciating of Indian rupee against US dollar. (Net FII outflows in the months of Aug and Sept have been close to Rs. 14,000 cr.) Also, due to the recent increase in the price of gold over a very short period of time there are fears of a bubble building in gold and hence investors do not perceive gold as a safe investment alternative. Due to these events investors have started viewing dollar as a safe currency. Due to Risk Aversion on the part of Currency Investors, the Demand for the US Dollar has gone up world over. Major drawback of depreciation in the value of the rupee is that it will increase the burden of servicing and repaying of foreign debt of the Indian Government (which has dollar denominated debt) and those companies that have raised dollar denominated debt. This drawback is all the more amplified in the case of short-term debt as the burden is immediately felt. However, due to the prudent polices of the Indian government, short-term debt is only a fraction (3.7%) of the total external debt. Political uncertainty and corruption is one of the major factors for any country to stabilize the economy. In India, last one year we are seeing the series of corruptions and there is no good news from the ruling party (Congress) about the economic reforms and lot of agitation among the citizens including the veteran Gandhian Anna Hazares campaign of Fight for Second Freedom which took attention from global media. India needs political change to gain confidence among the investors.

IMPACT ON INDIAN ECONOMY

This kind of movement leads to high inflation, as India imports around 70% of its crude oil requirement and the government will have to pay more for it in rupee terms. Due to the control on oil prices, the government may not easily pass the increased prices to the consumers. Further, this higher import bill will lead to increase in fiscal deficit for the Govt and will push the inflation, which is already hovering around double-digit mark, which is not good for ordinary people as well. On the other hand, Indian corporate will also have to pay more in rupee terms for procuring their raw materials, despite drop in global commodity prices, only because of a depreciating rupee against dollar.

There are many costs and benefits attached to a stronger and a weaker currency. However, while deciding on a policy, the economic and political situation must also be factored in. In light of the current depreciation of the rupee, one must assign a weightage to the various costs and benefits and then decide whether the depreciation is desirable or not. It is most likely that there will be large support for both views.

Advantages of Rupee Depreciation

Beneficial to the Exporters
India is majorly involved in exports of handicrafts, gems, jewelry, textiles, readymade garments, industrial machinery, leather products, chemicals and related products. India has been the worlds largest processor of diamonds. The exports make a major contribution in foreign receipts. The companies that are export driven may benefit in terms of better prices for their products and services and be able to increase their profit margins.

For example: if the companies were exporting goods at $1= Rs 48 they would receive Rs 4800 for every $100. Whereas, now they would receive Rs 5135 at current rupee price for every dollar i.e. $1= Rs 51.35 Moreover the products of Indian exporters would be more competitive in the foreign market and will have an edge over other Asian countries. Therefore, rupee depreciation should boost the exports.

Good News for NRIs

The fall of Indian rupee is benefiting the NRIs remitting money to India. The salaried workforce abroad can send in more money to their loved ones and their families in India at the same dollar amount. Currently the Indian rupee is at a 32 month low of Rs. 51.35 against the US dollar in comparison to Rs. 44.1 per dollar during August 2011.

For example: An NRI who remitted $2000 to his family, in august was able to send Rs 88,000. Whereas, considering the current rupee depreciation he can send Rs 1, 02,700 for the same amount of dollars. Thus NRIs can enjoy huge benefits from this current rupee fall.

 Benefits to the IT sector

The IT sector being a major job creator in the Indian economy may actually benefit from depreciating rupee as it spells good news for the IT sector. For Information Technology companies, services are billed mainly in dollars or in other foreign currencies. Majorly the companies that hedge funds for a short duration are more likely to benefit from the depreciating rupee. Hedging of funds means to allocate certain amount of funds as investments in certain securities that are generally speculative in order to earn higher returns Thus, the companies with short duration hedge funds would benefit. Any depreciation of the rupee would peg up their realizations and increase their profit margins.

Benefits to Investors invested in International Funds

The impact of currency movements on an international fund depends on the type of fund and its underlying holdings. These funds will be impacted by the movement of individual currencies, trading and the stock prices, rather than the rupees behavior against the dollar alone. However the investors who have invested in funds that have done well despite the market downturn, such as global commodities and gold are more likely to be more beneficial. Like- Birla Sun Life Commodities Equities-Global Precious Metals is up 4.8 per cent.

Benefits to the Hotel Industry

Indian Hotels is a dominant player in the luxury and premium business travel space having presence across tier-1 and tier-2 cities, as well as 16 hotels outside the country. It is expected to do well on account of higher room demand, and high average room rates and occupancy rates. Moreover, with a depreciated rupee an increase in tourists from abroad can be expected as they would have to pay less in rupee terms for their dollars, thus resulting in an increased demand in the hospitality sector.

Disadvantages to Indian Economy

Inflation graph and Fiscal deficit to scale up:

India is suffering from a nearing two digit inflationary pressure. A depreciation rupee will add fuel to this. It leads to high inflation, as India imports around 70 per cent of its crude oil requirement and the government will have to pay more for it in rupee terms. Due to the control on oil prices, the government may not easily pass the increased prices to the consumers. Further, this higher import bill will lead to rise in fiscal deficit for the government and will push the inflation. It (rupee fall) will be definitely blunt the high base impact. We will have to rework the (inflation) numbers, as we had not taken this into account. We had expected December inflation at 8.2%, but now it could be 8.5% because of the rupee fall, said Abheek Barua, chief economist at HDFC Bank. Going by a Yes Bank report, every 10% fall in the rupee is likely to lift the inflation rate based on the wholesale price index (WPI) by 40 basis points. Since November 1, the rupee has declined 5.5% against the greenback. The rupee has depreciated by about 11% against the dollar during 2011 -12 so far. Indias imports account for about 22% of GDP and depreciation of the rupee raises the risk of imported inflation, the RBI had said in the October report. Rupee depreciation has already started to push up prices in some sectors like automobile, consumer goods, and mobile phones. For instance, makers of consumer durables have raised product prices by up to 10%, as their import costs have gone up because of the rupees depreciation. In the last few months, FMCG firms, including Hindustan Unilever, Dabur, GCPL and Emami have increased prices of their various products by 3 to 10 %. As a result, Indian FMCG firms are turning to efficient cost management and local procurement of raw materials to offset increasing pressure on margins due to the weakening of rupee that has spiked input costs. A depreciating rupee makes imports of component, capital goods and raw materials more expensive. As inputs and other equipment that are imported get costlier, margins get reduced to that extent. Companies with a high import component and those with foreign currency borrowings may be marked down in the stock market as the rupee depreciates. The worst affected will be the oil and gas companies and capital goods companies which are net importers. For these companies raw material is in $ terms and sales are in Rupee terms. So, depreciating rupee will have a very adverse impact as this will cause an increase in the cost of raw materials without any corresponding increase in the price of finished products.

A blow to Indian Importers:

India import industry will also have to pay more in rupee terms for procuring their raw materials, despite drop in global commodity prices, only because of a depreciating rupee against dollar. Corporate India is a net borrower of dollar and to that extent a depreciating rupee impacts its balance sheet adversely. Companies with foreign debt on their books are badly impacted. With the rupee depreciating against the dollar, these companies will need more rupees to repay their loans in dollar. This will increase their debt burden and lower their profits. Obviously, investors would do better to stay away from companies with high foreign debt.

Negative impact on FII flows to Indian market:

Rupee depreciation is a huge risk for FIIs who are planning to invest in India. If an FII invest $10000, it can buy stock worth Rs 500000 @ current market price. Consider a scenario where after 1 year, the stock of FII made no loss, no profit and rupee depreciated to 55 against dollar. On stock sale the FII would get Rs 500000, but while converting to dollars, it ends up in loss.

Negative impact on Indian students and travellers abroad:

Individually, travelling abroad becomes more expensive as travel cost can go up by around 10 per cent compared to last July figures. Students studying abroad too will be hit as more rupees will go out to pay for the courses, stay and other expenses.

Concluding Remarks
The fall in the value of currency not only hurts the national pride, but also carries other risks as well. Depreciation of rupee dampens the inflow of foreign capital, rise in the external debt burdens, and also mount Indias oil and fertilizer subsidy bills. The most positive impact of depreciation of rupee is the stimulation of merchandise exports and discouraging merchandise imports and thus improving the terms of trade. 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. India imports many essential goods like crude oil, fertilizers, pharmaceuticals and many capital goods. Thus, the argument that depreciation is good as it discourage Indias import does not make any sense. Further, software or other exports also do not depend on the rupee s value only, but most on the quality and reputation of the product. Therefore, while it is not possible to completely eliminate for-ex risks, those companies that adopt prudent hedging strategies will have that extra edge over their peers.

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