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 11th 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 fixedincome 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 small-scale 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

350.00
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 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.

10

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

Current Account

Capital Account

BoP

Source: RBI

(Figure 2)

Foreign Exchange Reserves - Trends

350.00
300.00
250.00
200.00
150.00
100.00
50.00
0.00

Foreign exchange reserve

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.

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

2.

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

3.

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 against the major currencies.

4.

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 thought that it would be a transitory phase and that it could be tackled by monetary
policy.

12

5.

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

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.

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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

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

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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.

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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