The Rupee Depreciation

Written By Monoram Roy Chowdhury

1. Introduction
"We invented money and we use it, yet we cannot understand its laws or control its actions. It has a
life of its own." - Lionel Trilling, American literary critic.

Reserve Bank of Indias (RBI) Governor, Mr. D. Subbarao, knows the fickle nature of money better than
anyone else in the country. As the rupee went on a free fall in the last few months spooking businesses
and investors alike and prompting the RBI to take measures to stem the slide, most people were left
wondering what this ado was about. With the rupee crashing to a record low of nearly 59 against the
dollar, it has become one of the worst performing currencies in Asia. The rupee on 11 th June 2011 fell
by a whopping 74 paisa to hit a new all-time low of 58.92. The rupee has fallen by more than 8% since
May this year. Having a currency at an all-time low is not a great advertisement for the government's
management of the economy ahead of elections.

2. The Changing Face

Money is not an organic creature but its value keeps changing with the society and its economic
conditions. One rupee in 1947 is not the same as one rupee today, both in terms of appearance and
purchasing power. The value of a country's currency is linked with its economic conditions and
policies.
The value of a countrys currency depends on factors that affect the economy such as imports and
exports, inflation, employment rates, interest rates, growth rate, trade deficit, performance of equity
markets, foreign exchange reserves, macroeconomic policies, foreign investment inflows, banking
capital, commodity prices and geopolitical conditions.
Income levels influence currencies through consumer spending. When incomes increase, people spend
more. Higher demand for imported goods increases demand for foreign currencies and thus weakens
the local currency.
Balance of payments, which comprises trade balance (net inflow/outflow of money) and flow of capital,
also affect the value of a country's currency. A country that sells more goods and services in overseas
markets than it buys from them has a trade surplus. This means more foreign currency comes into the
country than what is paid for imports. This strengthens the local currency.
Another factor is the difference in interest rates between countries. Let us consider the recent RBI
move to deregulate interest rates on savings deposits and fixed deposits held by non-resident Indians

(NRIs). The move was part of a series of steps to stem the fall in the rupee. By allowing banks to
increase rates on NRI rupee accounts and bringing them on a par with domestic term deposit rates, the
RBI expects fund inflows from NRIs, triggering a rise in demand for rupees and an increase in the value
of the local currency.
The RBI manages the value of the rupee with several tools, which involve controlling its supply in the
market and, thus, making it cheap or expensive. RBI controls the movement of the rupee through (or,
by way of) changes in interest rates, relaxation or tightening of rules for fund flows, tweaking the cash
reserve ratio (the proportion of money banks have to keep with the central bank) and selling or buying
of dollars in the open market; it also fixes the statutory liquidity ratio, that is, the proportion of money
banks have to invest in government bonds, and the repo rate, at which it lends to banks.
While an increase in interest rates makes a currency expensive, changes in cash reserve and statutory
liquidity ratios increase or decrease the quantity of money available, impacting its value .
Interest Rate Differentials
This is based on interest rate parity theory. This says that countries which have higher interest rates
will have their currencies depreciate. If this does not happen, there will be cases for arbitrage for
foreign investors till the arbitrage opportunity disappears from the market. The reality is far more
complex as higher interest rates could actually bring in higher capital inflows putting further
appreciating pressure on the currency. In such a scenario, foreign investors earn both higher interest
rates and also gain on the appreciating currency. This could lead to a herd mentality by foreign
investors posing macroeconomic problems for the monetary authority.
Inflationary Pressure
Every generation complains about price rise. Prices shoot up when goods and services are scarce or
money is in excess supply. If prices increase, it means that the value of the currency has eroded and
that its purchasing power has fallen.
Let us say the central bank of a country increases money flow in the economy by 4%, while economic
growth is 3%. The difference causes inflation. If the growth in money supply is 10%, inflation will surge
because of the mismatch between economic growth and money supply. In such a scenario, loan
repayments will be a lesser burden if interest rates are fixed, as one has to pay the same amount but
with a lower valuation.
A fall in purchasing power due to inflation reduces consumption, hurting industries. Imports also
become costlier. Exporters, of course, earn more in terms of local currency.
However, if the increase in money supply lags economic growth, the economy will face deflation, or
negative inflation. The purchasing power of money will increase when the economy enters the

deflationary state. If one were to think that deflation would help one to consume more and enjoy life
more, that would be a wrong presumption.
Unless the fall in prices of goods is because of improved production efficiencies, one would have less
money to spend. If one were to have a fixed-interest loan to repay, that debt would have a higher
valuation. Yields from fixed-income investments made before deflation set in will, of course, increase in
value.
Minting Money
A fantasy world where trees have banknotes and bear coins instead of fruits might sound like a dream
come true. Economists will be the devil's messenger in that world when they break the news that ones
money is as good as dry leaves.
If one was looking for a machine that can print money, one would have to meet someone who actually
owns one - the government. Money is printed by governments, but they cannot print all the money
they need. When a government prints money to meet its needs without the economy growing at the
same pace, the result can be catastrophic. Zimbabwe is a recent example.
After the 1990s land reforms in free Zimbabwe, farm production as well as manufacturing declined
drastically. However, the government continued to print money for its expenses. Zimbabweans started
losing faith in the local currency. As inflation surged drastically, the Zimbabwean dollars were printed
in denominations as high as 100 trillion. After the currency lost its value, people started using US
dollars. In April 2009, the country put its currency on hold and switched to US dollars.
In the past, governments used to back their currencies with gold reserves or a foreign currency such as
the US dollar that could be converted into gold on demand. The gold standard currency system was
abandoned as there was not enough gold to issue money and currency valuations fluctuated with the
supply

and

demand

of

gold.

In the modern economy, governments print money based on their assessment of future economic
growth and demand. The purchasing power of the currency remains constant if the increase in money
supply is equal to the rise in gross domestic product and other factors influencing the currency remain
unchanged.
Forex Demand
Though international trade and movement of people are increasing rapidly, there is no currency that is
acceptable across the globe. Whether one goes for higher studies to the US or flies to Rio for a
vacation, one has to pay for services and goods in the currency that is accepted in the country. Even
while shopping online on stores run by foreign companies, one has to pay in foreign exchange.
The foreign exchange rate for conversion of currencies depends on the market scenario and the
exchange rate being followed by the countries. Floating exchange rates or flexible exchange rates are

determined by market forces without active intervention of central governments. For instance, due to
heavy imports, the supply of the rupee may go up and its value fall. In contrast, when exports increase
and

dollar

inflows

are

high,

the

rupee

strengthens.

Earlier, most countries had fixed exchange rates. This system has been abandoned by most countries
due to the risk of devaluation of currencies owing to active government intervention. Most countries
now adopt a mixed system of exchange rates where central banks intervene in the market to buy or
sell the different currencies to control the movement of their own currencies.
Not everyone loses in a weak currency scenario. Exporters across the 17-country euro zone, for
instance, are benefiting from a weak local currency. Sometimes, countries use various ways to keep
their currencies undervalued to promote exports. Chinese Renminbi is one such currency that several
economists say is undervalued.
Now that we know the factors that determine the value of a currency, how does the rupee in
someones bank account and purse stand at present? Over the past few months, since May 2013, the
rupee has been weakening against the dollar.

3. Rupee Depreciation - Meaning

It simply means that if earlier we had to pay 49 for a dollar, now we have to pay 50 for the same.
In simple words, there is a loss of 1 against every US$ 1 transaction, with the fall of every rupee
against the dollar. So, if we buy a thing worth say, US$ 1000, then earlier we would have had to pay
49,000 and now we have to pay 50000. So, there is a 1000 loss in just 1 day.

4. Rupee Depreciation - Probable Causes

Well, there are many reasons for it. But a few of the many reasons, why the rupee hits a record low
against the dollar are discussed below.
Difference in Balance of Payment
Indias imports are increasing and exports are decreasing due to a large population. This simply means
that much more dollars are being spent, as compared to its earnings. It is another big factor for the
declining value of the rupee as against the US dollar.
It is the sum of current account and capital account of a country and is an external account of a
country with other countries. Both current account and capital account play a role in determining the
movement of the currency:
Current Account Surplus/Deficit: Current account surplus means exports are more than imports. In
economics, we assume prices to be in equilibrium and hence to balance the surplus, the currency
should appreciate. Likewise, for current account deficit countries, the currency should depreciate.
Capital Account flows: As currency adjustments do not happen immediately to adjust current
account surpluses and deficits, capital flows play a role. Deficit countries need capital flows and

surplus countries generate capital outflows. On a global level, we assume that deficits will be
cancelled by surpluses generated in other countries. In theory, we assume current account deficits
will be equal to capital inflows, but in the real world we could easily have a situation of excessive
flows. So, some countries can have current account deficits and also a balance of payments surplus
as capital inflows are higher than current account deficits. In this case, the currency does not
depreciate but actually appreciates as in the case of India (explained below). Only when capital
inflows are not enough, there will be depreciating pressure on the currency.
Widening Trade Deficit
Rising deficit is bad for India as it exposes the economy to the risk of a sudden stop and reversal of
capital flows. This would be so in the case of an event shock. For example, if the U.S. Fed withdraws its
bond buying programs, there might be a sudden outward flow of money, leaving India scrambling for
dollars. The slowdown in the Indian economy has made the current situation even more volatile
because the government is unable to generate heavy capital inflow. India's current account deficit was
equivalent to a record 6.7% of the gross domestic product in December.
Weakness in Domestic Equities
Due to the falling rupee rate as against the US dollar, the FIIs started pulling out their investments
from the Indian market. Why was this so? Suppose an investor invests US$ 500 in the Indian market. If
the market grows by 10%, his valuation would be US$ 550. But, talking in rupee terms, for that
investment of US$ 500 (i.e. ` 25,000 for ` 50 per dollar), a 10% increase would become ` 25000+ `
2500 = ` 27,500. But, with the falling rate of the rupee, the rate becomes, say ` 55 per dollar. Now,
when he wants his money back in dollars, he would get 27500/55=US$ 500. That means, there are no
profits for the foreign investor.
That is why; the FIIs (Foreign Institutional Investors) are withdrawing their money from the Indian
markets and investing in more attractive destinations like china. This has lead to more decline of the
US dollars in the Indian economy.
Foreign institutional investors have been selling index futures in the First week of June 2013. This is a
hedging move as FIIs expect stocks (cash segment) to fall in the near term, traders have said. FIIs
have been a key support for markets (and the rupee) after buying over US$ 1538 crores ( 90000
crores) worth of shares this year, as of First week of June 2013.
Restricted FDI Policies
There are many sectors in which FDI is restricted such as retail, insurance, defense, etc. Records show
that our FDI inflows fell from US$ 4000 crores (2008) to US$ 2500 crores (in 2011). Due to the relaxed
FDI policies in China, FDI inflows in China are always above the US$ 10000 crores mark.
Rising Import Bills

Oil and gold imports account for 35% and 11% of India's trade bill respectively. Traders say there has
been continuous demand for the greenback from oil importers, the biggest buyers of dollars in the
domestic currency market, pushing the rupee lower. Similarly, falling gold prices have offset the
governments and the central bank's moves to reduce gold imports, which increases current account
deficit and weighs on the currency.

Weak Economic Fundamentals

Moses Harding of Indus land Bank told NDTV on 8th June 2013, that a weak economy and no signs of a
quick fix solution are weighing on the rupee. The UPA government is unlikely to deliver far reaching
reforms to generate heavy capital inflows, as it did last September to stave off the loss of India's
investment grade credit rating, experts say.

Eurozone Crisis
Dollar inflows into the Indian economy are falling because of global troubles such as the Eurozone
crisis (Greece with a debt more than its economy, making dollar strong) and the high valuation of
Indian companies.

The Dollars Strength

The dollar index has been rising on signs of growing economic momentum and talk of an early end to
the Fed's stimulus effort. Thio Chin Loo, senior currency strategist at BNP Paribas told NDTV on 8th June
2013, that there has been a general dollar rebound in markets on the back of rising U.S. yields as a
result of slightly better than expected payroll data in the U.S. The US dollar is riding high across the
board including the rupee, she added.

5. Rupee Depreciation Impact

5.1. Introduction
Primarily, the consequences of a weak rupee are felt through:
Increase in the Import Bill
A depreciation of the local currency results in higher import costs for the country. Failure of a similar
rise being experienced in the prices of exportable commodities results in a widening of the current
account deficit of the country.
Higher Inflation
Increase in import prices of essential commodities such as crude oil, fertilizer, pulses, edible oils, coal
and other industrial raw materials are bound to increase the prices of the final goods. This makes these
goods costlier for the consumers and hence inflation might be pushed up further.

Fiscal Slippage
The central governments fiscal burden might increase as the hike in the prices of imported crude oil
and fertilizer might warrant a higher subsidy provision to be made for these commodities .

Increase in the Cost of Borrowings

Interest rate differentials in the domestic and global markets encourage the industry to raise money
through foreign markets; however, a fall in the rupee value would negate the benefits of doing so .

5.2. Impact on the Indian Market

Companies with foreign debt would have to pay more for the same debt.
Oil companies would pay more for a lesser valued barrel. About 70% of oil needs of India are imported.
And, if we continue to pay more for the unending oil needs, it would adversely affect the Indian
market and increase inflation.
With each international transaction, India suffers mammoth losses. Till now, we have seen very smallscale losses with the falling rupee. But, international trades are in values of lakhs of crores. With
every falling rupee, India loses ` 100 crores in International trade .The loss of ` 100 crores are
explained below through an example.
Just a small example would suffice. In 1947, US$ 1 was equivalent to 1. So, for a transaction worth
50 billion, we would have to pay US$ 50 billion. Now, the current rate is, say, 50 per dollar. So, now
for the same purchase worth 5000 crores, we would have to pay US$ 2500 billion. Just think of how
the rupee has weakened with respect to the UD dollar.
The impact of rupee depreciation on Crude Oil imports suggests:

The dollar price of crude oil has increased, while the exchange rate is depreciating.
Due to the depreciation of the domestic currency, i.e. the rupee, the domestic price of crude oil

has become more costly.

Expenditure on power and fuel for industry has increased.

The impact of rupee depreciation on Thermal Coal imports suggests:

The benefit of falling commodity prices is not being transferred to the industry due to rupee
depreciation.
Rupee depreciation coupled with an inflexible tariff structure means that the power companies will
have to suffer huge losses.
The impact of rupee depreciation on Fertilizer imports suggests:
There has been an increase in the global prices of DAP fertilizer.
The depreciation of rupee has further aggravated the cost pressures on the industry.
Continuous increase in the prices of imported fertilizer can also adversely impact the subsidy burden of
the government.

The impact of rupee depreciation on Vegetable Oil imports suggests:

Global prices have increased.

Increase in import costs of palm oil increases the cost of production for the FMCG industry and puts
pressure on their profit margin.

5.3. Gainers of Rupee Depreciation

When a currency depreciates, the exporters rejoice because they get more of the local currency for
every unit of foreign currency though the quantum of trade remains unchanged. But this time, many
exporters were caught off guard. For one, there is little dollar supply in the market as most exporters
seem to have covered themselves in the 45-46 range. Sudden changes in the position of the rupee
do not really matter much. Exporters these days resort to hedging against such risks (of volatility).
Besides, the buyers overseas also renegotiate and push rates down.
The depreciating rupee will be positive for the Indian IT sector, which generates more than 80-90% of
its US$ 70 billion revenue from the overseas markets and this kind of appreciation in foreign currency
will enhance their actual realization of revenue in dollar terms. Every 1% change in rupee-dollar rate
has a 40 basis points impact on the margins on the net profit numbers of IT services companies such
as TCS, Infosys, HCL, etc. to mention a few.
Individually, expatriates living outside India too gain by rupee depreciation. In fact, the expat Indians
understand the currency movement a lot better than the resident Indians.
Indians in the UAE usually accumulate dirham with an eye on the exchange rates and remit funds as
soon as the rupee falls. India was the worlds largest remittance recipient in 2010 with US$ 55 billion
transferred to the country by expatriates.

5.4. Negative Impact

When a currency loses its value it creates many problems for the economy. It 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 be able to easily pass on the
increased prices to the consumers. Further, this higher import bill will lead to a rise in fiscal deficit for
the government and will push the inflation, which is already hovering around the double-digit mark.
On the other hand, Indian companies will also have to pay more in rupee terms for procuring their raw
materials, despite a drop in global commodity prices, only because of a depreciating rupee against
dollar. Already, oil companies cited the fall in the rupee value to the dollar to increase petrol prices

recently. For oil marketing companies, with every fall in the rupee, the under-recovery on account of
petroleum products goes up by 95 billion per year on the price-controlled items, said an HPCL official.
Just like oil, many products and commodities are more expensive to import now. Corporates who have
foreign currency loans on their books also take a view that despite a depreciating rupee, keeping the
beginning interest rates in developed markets would be a lot better to hold on to foreign currency
debt, as one gets 0-2% interest on dollar debt as compared with 12-14% on rupee debt.
Individually, traveling abroad becomes more expensive as travel costs can go up by at least 10%.
Students studying abroad too will be hit as more rupees will go out to pay for the courses and for
staying there.
The depreciation of rupee also affects the money flow in the Indian stock markets. FIIs, the main
investors in the Indian equity markets also start withdrawing their investments from the markets
fearing loss of value. In terms of portfolios, if one holds stocks in oil and gas, infrastructure, fertilizer or
the tire business, the returns will take a hit as the shares of these companies will fall when the rupee
falls as these companies procure their raw materials from abroad. On the other hand, stocks of
Information Technology (IT) companies and export-oriented units should do better.

6.1. Exchange Rate of the Indian Rupee Trends

With the rupee crashing to a record low of nearly 59/dollar, it has become one of the worst performing
currencies in Asia. The rupee on 11th June 2013 fell by a whopping 74 paisa to hit a new all-time low of
58.92. The rupee has fallen by more than 8% since May this year. The below table illustrates how the
rupee has fared against the dollar in the last two decades.
Table Showing the Exchange Rate of INR against various Foreign Currencies:
Date

US Dollar

Pound Sterling

Euro

Japanese Yen

31/12/1998

42.48

70.70

----

37.46

30/12/1999

43.51

70.47

43.81

42.61

29/12/2000

46.75

69.76

43.41

40.74

31/12/2001

48.18

69.90

42.66

36.68

31/12/2002

48.03

77.04

50.34

40.53

31/12/2003

45.61

81.17

57.31

42.68

31/12/2004

43.58

84.08

59.40

42.49

30/12/2005

45.07

77.89

53.55

38.44

29/12/2006

44.23

86.91

58.26

37.21

31/12/2007

39.41

78.74

58.12

35.21

31/12/2008

48.45

70.01

68.22

53.68

31/12/2009

46.68

75.03

67.07

50.51

30/12/2010

44.90

69.69

59.47

55.16

30/12/2011

53.26

82.09

68.90

68.68

31/12/2012

54.77

88.50

72.26

63.66

31/01/2013

53.29

84.22

72.23

58.66

28/02/2013

53.77

81.57

70.68

58.24

28/03/2013

54.39

82.32

69.54

57.76

30/04/2013

54.22

84.00

70.98

55.47

31/05/2013

56.50

86.00

73.68

56.03

11/06/2013

58.93

91.81

78.18

59.94

Source: RBI
Exchange rate of the Indian Rupee - Trends

300.00
250.00
200.00
150.00
100.00
50.00
0.00

US Dollar

Pound Sterling

Euro

Japanese yen

Source: RBI

6.2. Rupee Movement since 1991

If one looks at Indias Balance of Payments since 1970-71, one observes that the external account
mostly balances in 1970s. In fact in the second half of 1970s, there is a current account surplus. This
was a period of import substitution strategy and India followed a closed economy model. In the 1980s,
current account deficits started to rise culminating into a BOP crisis in 1991. It was in the 1991 Union
Budget that the Indian rupee was devalued and the government also opened up the economy. This was
followed by several reforms liberalizing the economy and the exchange rate regime shifted from the

10

fixed to manage a floating one. Hence, we need to analyze the current account and rupee
movement from 1991 onwards.
India has always had current account deficit barring the initial years in 2000s (Figure 1). The deficit has
been financed by capital flows and mostly capital flows have been higher than current account deficit
resulting in a balance of payments surplus. The surplus has in turn led to a rise in Forex reserves from
US$ 580 crores in 1990-91 to US$ 30480 crores by 2010-11 (Figure 2). In 1990-91, gold contributed
around 60% of Forex reserves and Forex currency assets were around 38%. This percentage has
changed to 1.5% and 90% respectively, by 2010-11 .

(Figure -1)
Balance of Payments - Trends
150,000
100,000
50,000
0
(50,000)
(100,000)

C urrent Account

C apital Account

Source: RBI

(Figure 2)

11

BoP

Foreign Exchange Reserves - Trends

350.00
300.00
250.00
200.00
150.00
100.00
50.00
0.00

Foreign exchange res erve

Source: RBI
What is even more stunning to note are the changes in BoP post- 2005. In the 1990s, the Balance of
Payments surplus was just about US$ 410 crores and it increased to US$ 2200 crores in the 2000s.
However, if we were to divide the 2000s period into 2000-05 and 2005-11, we would see a sharp rise in
both the current account deficit and the capital account surplus. The rise in Forex reserves is also
mainly seen in 2005-11.
Based on this, if we look at the rupee movement, we would broadly observe that it has depreciated
since 1991. In above (Para 6.1), discuss about the rupee movement against the major currencies. A
better way to understand the rupee movement is to track the real effective exchange rate. Real
effective exchange rate (REER) is based on a basket of currencies against which a country trades and
is adjusted for inflation. A rise in index means appreciation of the currency against the basket and a
decline indicates depreciation. RBI has been releasing REER for 6 currency and 36 currency trade
baskets since 1993-94 and we can observe that the currency did depreciate in the 1990s, but has
appreciated post-2005. It has depreciated following the Lehman crisis but has again appreciated in
2010-11.
In the 1990s, the rupee depreciated against its major trading currencies, as the average REER was less
than 100. However, in the 2000s, we can observe that the rupee appreciated against the major trading
currencies. If we divide the 2000s period further into 2000-05 and 2005-11, we can see that there is
depreciation in the first phase and a large appreciation in the second half of the decade.
Hence, overall, we can observe that the rupee has been following the path that the economic theories
highlighted above have suggested.
1.

As India opened up its economy post-1991, the rupee depreciated as it had current account
deficits. Earlier current account deficits were mainly on account of merchandise trade deficits.
However, as services exports picked up, this helped lower the pressure on current account deficit

12

in a major way. Without the services exports, the current account deficit would have been much
2.

higher.
There was a blip during the South East Asian crisis when the current account deficit increased from
US$ 460 crores to US$ 550 crores in 1997-98. Capital inflows declined from US$ 1140 crores to US$
1010 crores leading to a decline in the BoP surplus and the depreciation of the rupee. However,
given the scale of the crisis, the depreciation pressure on the rupee was much lesser. There was
active monetary management by RBI during that period. Similar measures have been taken up by

3.

the RBI in the current phase of rupee depreciation as well.

Till around 2005, India received capital inflows which were just enough to balance the current
account deficit. The situation changed after 2005 as India started receiving capital inflows which
were much higher than current account deficit. The capital inflow composition also changed where
external financing dominated in the early 1990s, and now most of the capital inflows have come
via foreign investment. Within foreign investment, the share of portfolio flows has been much
higher. As capital inflows were higher than the current account deficit, the rupee appreciated

4.

against the major currencies.

Other factors have also led to the appreciation of the rupee. First, India entered a favorable growth
phase registering growth rates of 9% and above since 2003. This surprised investors as few had
imagined India could grow at that rate consistently. The high growth led to a surge in capital
inflows mainly in portfolio inflows. Secondly, Indias inflation started rising around 2007 leading to
the RBI to tighten its policy rates. This led to higher interest rate differential between India and
other countries leading to additional capital inflows as highlighted above. It is important to
understand that at that time investors did not feel that inflation would remain persistent and

5.

thought that it would be a transitory phase and that it could be tackled by monetary policy.
During the Lehman crisis, capital flows shrunk sharply from a high of US$ 10700 crores in 2007-08
to just US$ 780 crores in 2008-09 and this led to a sharp depreciation of the currency. The rupee
plunged from around 39 per dollar to . 50 per dollar. The REER moved from 112.76 in 2007-08
to 102.97 in 2008- 09, depreciating sharply by 9.3%. The current account deficit also declined
sharply as well, tracking the decline in oil prices from US$ 12 billion in Jul-Sep 08 to US$ 30 crores
in Jan-Mar 09. The currency also depreciated tracking the global crisis which led to a preference for
dollar assets compared to the other countries currency assets.

6.

The Indian economy recovered much quicker and much more sharply from the global crisis. The
capital inflows increased from US$ 780 crores to US$ 5180 crores in 2009-10 and to US$ 5700
crores in 2010-11. The higher capital inflows were on account of both FDI and FII. External
Commercial Borrowings also picked up in 2010-11. The current account deficit also increased from
US$ 2790 crores in 2008-09 to US$ 4420 crores in 2010-11. REER (6 currency) appreciated by 13%
in 2010-11 and 36 REER by 7.7%.

7. Rupee Depreciation Casts Shadow over PE Exits

13

The private equity (PE) sector, already struggling for good returns from India now has another problem
to deal with the depreciation of the rupee. Apart from bringing the margins down, the rupees fall is
likely to hit the sentiments of global PE investors regarding India.
The Indian industry had witnessed the largest size of PE investments during the 2006-2008 periods.
Although a majority of the five-to-seven-year-old investments are ripe for an exit, the weakening of the
rupee, which will provide lower returns in dollar terms, has cast a shadow on exit plans.
Typically, these investors would like to make 20-25% plus an internal rate of return (IRR) on their
investments. If one were to really look at the rupee movement over the last three to four years, it has
lost more than 25% of its value. That is like adding at least one to one-and-a-half years of the
investment horizon.
According to data from VCC Edge, 2007 had seen the largest size of PE/venture capital (VC)
investments in India, worth US$ 2000 crores, while 2008 saw deals worth US$ 1460 crores.
With the flow of large investments, the rupee had appreciated by about 11% in 2007, at 39.33 from
44.49 in 2006. Compared with 127 exits worth US$ 3 billion in 2011, the country witnessed 162 exits
worth US$ 370 crores last year. The past five months in 2013 have seen large exits such as TPGs from
Shriram Transport Finance, Apaxs from Apollo Hospitals and Warburg Pincus from Havells. In 2013, till
date, about 65 PE/VC exits worth us$ 160 crores have taken place.

8. Outlook and Policy Measures

8.1. Introduction
The above analysis shows that the rupee has depreciated amidst a mix of economic developments in
India. Apart from the lower capital inflows, the uncertainty over the domestic economy has also made
investors nervous over the Indian economy which has further fuelled depreciation pressures. India was
receiving capital inflows even amidst continued global uncertainty in 2009-13, as its domestic outlook
was positive. With domestic outlook also turning negative, rupee depreciation was a natural outcome.
Depreciation leads to imports becoming costlier which is a worry for India as it meets most of its oil
demand via imports. Apart from oil, prices of other imported commodities such as metals, gold, etc.
will also rise pushing the overall inflation higher. Even if prices of global oil and commodities decline,
the Indian consumers might not benefit as depreciation will negate the impact. Inflation was expected
to decline from Dec-13 onwards, but rupee depreciation has played a spoilsport. Inflation may still
decline (as there is a huge base effect) but rupee depreciation is likely to lower the scale of decline.

8.2. Policy Options for RBI

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Raising Policy Rates:

This measure was used by countries like Iceland and Denmark in the initial phase of the crisis. The
rationale was to prevent sudden capital outflows and prevent meltdown of their currencies. In Indias
case, this cannot be done as the RBI has already tightened policy rates significantly since Mar-10 to
tame inflationary expectations. Higher interest rates along with domestic and global factors have
pushed growth levels much lower than expectations. In its Dec-11 monetary policy review, the RBI has
mentioned that future monetary policy actions are likely to reverse the cycle which will be in response
to the risks posed. Indias interest rates are already higher than that of most countries anyway, but
this has not led to higher capital inflows. On the other hand, lower policy rates in the future could lead
to further capital outflows.
Using Forex Reserves:
RBI can sell Forex reserves and buy Indian Rupees leading to the demand for the rupee. RBIs Deputy
Governor Dr. Subir Gokarn in a recent speech (An assessment of recent macroeconomic
developments, Dec-11) said that using Forex reserves poses problems on both sides -Not using
reserves to prevent currency depreciation poses the risk that the exchange rate will spiral out of
control, reinforced by self-fulfilling expectations. On the other hand, using them up in large quantities
to prevent depreciation may result in a deterioration of confidence in the economy's ability to meet
even its short-term external obligations. Since both outcomes are undesirable, the appropriate policy
response is to find a balance that avoids either. Based on weekly Forex reserves data, RBI seems to
be selling Forex reserves selectively to support the Rupee. Its intervention has been limited as liquidity
in money markets has remained tight in recent months and further intervention only tightens liquidity
further.
Easing Capital Controls:
Dr Gokarn in the same speech said that capital controls could be eased to allow more capital inflows.
He added that resisting currency depreciation is best done by increasing the supply of foreign
currency by expanding market participation. This in essence, has been the RBIs response to a
depreciating Rupee. The following measures have been taken lately:

Increased the FII limit on investment in government and corporate debt instruments.
First, it raised the ceilings on interest rates payable on non-resident deposits. This was later

deregulated allowing banks to determine their own deposit rates.

The all-in-cost ceiling for External Commercial Borrowings was enhanced to allow more ECB
borrowings.

Administrative Measures:
Apart from easing capital controls, some administrative measures have been taken to curb market
speculation.

Earlier, entities that borrow abroad were liberally allowed to retain those funds overseas. They are
now required to bring the proportion of those funds to be used for domestic expenditure into the
country immediately.

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Earlier, people could rebook forward contracts after cancellation. This facility has been withdrawn

which will ensure that only hedgers book forward contracts and that volatility is curbed.
Net Overnight Open Position Limit (NOOPL) of Forex dealers has been reduced across the board
and revised limits in respect of individual banks are being advised to the Forex dealers separately.

9. Conclusion
The growing Indian economy has led to a widening of current account deficit as imports of both oil and
non-oil commodities have risen. Despite a dramatic rise in software exports, the current account
deficits have remained elevated. Apart from the rising CAD, the financing CAD has also been seen as a
concern as most of these capital inflows are short-term in nature. The PMs Economic Advisory Council
in particular has always mentioned this as a policy concern. Boosting exports and seeking more stable
longer-term foreign inflows has been suggested as a way to alleviate concerns on current account
deficit. The exports have risen but so have prices of crude oil leading to a further widening of current
account deficit.
Efforts have been made to invite FDI but much more needs to be done especially after the holdback of
retail FDI and the recent criticisms of policy paralysis. Without a more stable source of capital inflows,
the rupee is expected to remain highly volatile shifting gears from a currency with an appreciating
outlook to a depreciating one in quick time.

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