The story of the falling rupee: Why is the rupee so weak? And what can be done to pull it up?

Sep 02 2013, 14:51 IST
Comments 0
SummaryUnder a floating exchange rate regime, the market determines the value of the exchange rate.

Critiques argue that although development indicators have improved, money is not being spent well as the quality of service has not improved. Add corruption to this, and one finds the perfect recipe for inflation.

Inflation and a rise in fiscal deficit is bad news for the exchange rate. In foreign exchange markets, expectation plays a crucial role. High fiscal deficits and higher inflationary expectations make domestic assets (government bonds) less attractive. Currency depreciates (following the asset market approach) as foreigners pull out money from the domestic capital market. The stock market tanking every other day is an indication of this.

Optimists will say this depreciation of the rupee is good for our exports. Here also, data suggest otherwise. A look at our major export items suggests there is a change in the composition of India’s exports from price-sensitive items such as leather footwear, dairy products, beverages, textiles and apparel, to less price-sensitive items such as refined petroleum product, chemicals, mineral products, and machinery and transport equipment. It is to be noted that the share of petroleum products in India’s export basket increased dramatically from around 2% in 1993 to around 20% in 2012. The surge in exports in the case of petroleum items is because of India’s potential in oil-refining activities.

On the contrary, India’s CAD is likely to increase further as oil and precious metals still contribute to the bulk of our imports. Controlling CAD is an important factor from the perspective of sovereign rating—countries with higher fiscal deficits and CAD generally lose out in terms of investor attractiveness. For the last fiscal year, India’s fiscal deficit (Centre-states combined) was around 9%, the highest when compared with other BRIC economies—China’s 1%, Brazil’s 2.8%, and Russia’s negative 1% (or surplus). A lower sovereign rating is likely to reduce foreign capital inflow depreciating the rupee even further.

Adding to the effect of these factors is the US economy showing signs of revival. There is indication about quantitative tightening where the Federal Reserve is likely to reduce government bond purchase by $10 billion (from $85 billion per month to $75 billion). This has further strengthened the dollar against most Asian currencies. The likely attack by the US on Syria has already shot up the crude oil price to $113 per barrel. In fact, gold in the international market is now trading at $1,400 per ounce (around 28.3 gm). In India, gold is trading at R34,000 per

Single Page Format
Ads by Google
Reader´s Comments
| Post a Comment
Please Wait while comments are loading...