Meaning of Depreciation of rupee:
When the rupee moves from 45 per US dollar to 52 per US dollar, why do we call it ‘rupee depreciation’ and not ‘rupee appreciation’ given that the rupee has risen against the dollar?Let’s replace rupee with eggs. Today, one USD can buy 45 eggs. Tomorrow, 1 USD can buy 52 eggs. Doesn’t this means that eggs have become cheaper since you can buy more eggs for the same one USD? Alternatively, it means that eggs have depreciated in value.The same is true for the rupee. When one USD can buy 45 rupees today and 52 rupees tomorrow, it means that the value of the rupee has depreciated.
When the economy is performing well and stock market is performing better than other countries, overseas investors will become heavy investors here. To invest here, they require rupee. This will increase the demand for rupee and will result in higher value for rupee. On the other hand, when these investors are pulling money out of Indian stock market, rupee will be depreciated.
Reasons for the depreciation of Rupee(INR) in India:
Continued Global uncertainty: Owing to uncertainty prevailing in Europe and slump in international market, investors prefer to stay away from risky investments (flight to security). This has significantly affected the portfolio investment in India. Credit rating agency’s downgrade of India to BBB- with a negative outlook, the last of the investment grade has not helped the cause. Any outward flow of currency or decrease in investment will put a downward pressure on exchange rate.
Capital Account Outflows: India needs dollars to finance its current account deficit. Institutional investors investing in India are directly impacted by the global market uncertainty . A volatile currency is never good for a foreign investor as it increases the transaction risk. Thus the relation becomes a vicious cycle, thereby further magnifying the volatility.
Interest Rate Difference: Higher real interest rates generally attract foreign investment but due to slowdown in growth there is increasing pressure on RBI to decrease the policy rates. Under such conditions foreign investors tend to stay away from investing.
Lack of reforms: Key policy reforms like Direct Tax Code (DTC) and Goods and Service Tax (GST) have been in the pipe line for years. A retrospective tax law (GAAR) has already earned a lot of flak from the business community. Attempts are being made to control the subsidy bills but fiscal deficit continues to hover around 5% of GDP. The government announced FDI in retail but had to hold back amidst huge furore from both opposition and allies. This has further made investors sentiment negative over the Indian economy.
Effects of Depreciation:
For the consumer:Depreciation leads to imports becoming costlier.Since India is structurally an import intensive country(Either directly imported like crude oil,fertilisers or imported components), as reflected in the high and persistent CAD month after month, the domestic costs will rise.
For the borrower: Companies or individuals who have taken foreign currency loans (for example, students with loans for studying abroad) may find their repayment obligation swelling as the rupee depreciates. For instance, if a borrower borrows $100 when the exchange rate was Rs 45 to a $, his original borrowing stands at Rs 4,500. After rupee depreciation to Rs 48 to a $, the same loan amounts to Rs 4,800.
For the investor: 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.
If you are working abroad and is earning in dollars, you will get more rupees for the same dollar. So this is good for those, who are posted abroad and is earning in dollars. You have seen, there is rush from NRIs to send money to India now to take advantage.
If you are planning for a foreign vacation, postpone it, otherwise it will cost you more now.But we can expect lot of foreign tourists to India this season, because, their travel cost have come down with a depreciating rupee!
A depreciating rupee also reduces the returns that foreign investors earn from investing in Indian companies. Therefore a depreciating currency may be a trigger for FII outflows.
On the other hand, companies that are export-driven may benefit in the form of better prices for the products and services sold.But for a country such as India that imports essentials such as crude oil, natural resources and many capital goods, this results in a bigger current account deficit in the near term.However, a weaker rupee does make exports more competitive globally and higher exports may eventually help make up for the trade deficit.
For Information Technology companies, services are billed mainly in dollars or in other foreign currencies.So it helps companies like Infosys to expand profit margin.
When the rupee moves from 45 per US dollar to 52 per US dollar, why do we call it ‘rupee depreciation’ and not ‘rupee appreciation’ given that the rupee has risen against the dollar?Let’s replace rupee with eggs. Today, one USD can buy 45 eggs. Tomorrow, 1 USD can buy 52 eggs. Doesn’t this means that eggs have become cheaper since you can buy more eggs for the same one USD? Alternatively, it means that eggs have depreciated in value.The same is true for the rupee. When one USD can buy 45 rupees today and 52 rupees tomorrow, it means that the value of the rupee has depreciated.
When the economy is performing well and stock market is performing better than other countries, overseas investors will become heavy investors here. To invest here, they require rupee. This will increase the demand for rupee and will result in higher value for rupee. On the other hand, when these investors are pulling money out of Indian stock market, rupee will be depreciated.
Reasons for the depreciation of Rupee(INR) in India:
Continued Global uncertainty: Owing to uncertainty prevailing in Europe and slump in international market, investors prefer to stay away from risky investments (flight to security). This has significantly affected the portfolio investment in India. Credit rating agency’s downgrade of India to BBB- with a negative outlook, the last of the investment grade has not helped the cause. Any outward flow of currency or decrease in investment will put a downward pressure on exchange rate.
Capital Account Outflows: India needs dollars to finance its current account deficit. Institutional investors investing in India are directly impacted by the global market uncertainty . A volatile currency is never good for a foreign investor as it increases the transaction risk. Thus the relation becomes a vicious cycle, thereby further magnifying the volatility.
Interest Rate Difference: Higher real interest rates generally attract foreign investment but due to slowdown in growth there is increasing pressure on RBI to decrease the policy rates. Under such conditions foreign investors tend to stay away from investing.
Lack of reforms: Key policy reforms like Direct Tax Code (DTC) and Goods and Service Tax (GST) have been in the pipe line for years. A retrospective tax law (GAAR) has already earned a lot of flak from the business community. Attempts are being made to control the subsidy bills but fiscal deficit continues to hover around 5% of GDP. The government announced FDI in retail but had to hold back amidst huge furore from both opposition and allies. This has further made investors sentiment negative over the Indian economy.
Effects of Depreciation:
For the consumer:Depreciation leads to imports becoming costlier.Since India is structurally an import intensive country(Either directly imported like crude oil,fertilisers or imported components), as reflected in the high and persistent CAD month after month, the domestic costs will rise.
For the borrower: Companies or individuals who have taken foreign currency loans (for example, students with loans for studying abroad) may find their repayment obligation swelling as the rupee depreciates. For instance, if a borrower borrows $100 when the exchange rate was Rs 45 to a $, his original borrowing stands at Rs 4,500. After rupee depreciation to Rs 48 to a $, the same loan amounts to Rs 4,800.
For the investor: 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.
If you are working abroad and is earning in dollars, you will get more rupees for the same dollar. So this is good for those, who are posted abroad and is earning in dollars. You have seen, there is rush from NRIs to send money to India now to take advantage.
If you are planning for a foreign vacation, postpone it, otherwise it will cost you more now.But we can expect lot of foreign tourists to India this season, because, their travel cost have come down with a depreciating rupee!
A depreciating rupee also reduces the returns that foreign investors earn from investing in Indian companies. Therefore a depreciating currency may be a trigger for FII outflows.
On the other hand, companies that are export-driven may benefit in the form of better prices for the products and services sold.But for a country such as India that imports essentials such as crude oil, natural resources and many capital goods, this results in a bigger current account deficit in the near term.However, a weaker rupee does make exports more competitive globally and higher exports may eventually help make up for the trade deficit.
For Information Technology companies, services are billed mainly in dollars or in other foreign currencies.So it helps companies like Infosys to expand profit margin.
Steps to curtail the depreciation of INR:
Measures by RBI:
Using Forex Reserves: RBI can sell forex reserves and buy Indian Rupees leading to demand for rupee. But using forex reserves poses risk also, as 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
Raising Interest Rates:It will help in encouraging foreign investments into India.
Measures by Government: Government should take some measures to liberalise cap ie limit on FDI and create a healthy environment for economic growth. Key policy reforms that should be initiated includes rolling of Goods and Services Tax (GST), Direct Tax Code (DTC), FDI in aviation and retail, Companies Bill and diesel decontrol. The government should take steps to loosen rules for portfolio investment in the Indian market, indicating its desire to sustain external inflows.
Measures by RBI:
Using Forex Reserves: RBI can sell forex reserves and buy Indian Rupees leading to demand for rupee. But using forex reserves poses risk also, as 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
Raising Interest Rates:It will help in encouraging foreign investments into India.
Measures by Government: Government should take some measures to liberalise cap ie limit on FDI and create a healthy environment for economic growth. Key policy reforms that should be initiated includes rolling of Goods and Services Tax (GST), Direct Tax Code (DTC), FDI in aviation and retail, Companies Bill and diesel decontrol. The government should take steps to loosen rules for portfolio investment in the Indian market, indicating its desire to sustain external inflows.
Note:Higher interest rates attract foreign capital and cause the exchange rate to rise.(Initially 1 INR=(1/45)$ and now 1 INR=(1/55)$.That means the exchange rate has become lower,reason being lower interest rates.)
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