Basics explained: The fall of the rupee
courtesy: yahoo finance
While expats remitting money back home may be rejoicing, the plunge of the Rupee to its all-time low levels against the dollar spooked the markets on Thursday as well as compelled the country’s top financial leaders to vocally discuss the issue.
Here are a few things you must know about the fall of the rupee.
Why did the Rupee plunge this week?
This happened due to two factors.
The Indian currency fell a day after the US Federal Reserve Chairman Ben Bernanke confirmed that the Fed could begin rolling back its Quantitative Easing (QE) programme later this year.
QE is an unconventional monetary policy aimed to stimulate the national economy. This is achieved by buying financial assets from commercial banks and other private institutions to widen the country’s monetary base, thereby increasing money supply in the economy. Through QE, long-term interest rates remain low, resulting in higher borrowing and spending that boosts the economy.
But since the US economy is gradually recovering, the US Fed, which is similar to our Reserve Bank of India, is considering normalising back to a standard monetary policy.
The Fed move naturally means end of cheaper money, thereby raising the dollar’s ‘value’ against the Indian rupee.
With the US economy strengthening, foreign investment has begun to take flight from the Indian stock and the debt markets. The strong demand for the dollar vis-à-vis the rupee has seen the rupee fall.
Apart from this India’s high current account deficit makes the rupee very shaky. Thus global economic movements have a more significant impact on it. Nations that have a high current account deficit, like India does, see their currency getting depreciated as against the dollar. This is what has happened to the Indian rupee.
A weakening Chinese economy, as evidenced by the nation’s PMI hitting a nine-month low, also does not spell good news. With demand for China’s goods weakening, leading to a drop in exports, and the domestic markets too showing signs of sluggishness, global markets have been rudely shaken up. With Asian, European and the US markets reacting to the flagging Chinese economic engine, the Indian stock markets too have been hit.
With the rupee already being pounded by a strengthening dollar and the Indian stock markets shaky due to inclement global conditions, the Indian economy too is feeling the heat. Although this will likely be a temporary phase, unless some other bad event hits global markets, in the short-term it does not augur well for the Indian economy.
Why did the Stock Markets and Gold prices crash?
According to Reuters, stock market traders are concerned that an end to the US monetary stimulus could lead to portfolio outflows, pushing the rupee lower and, in turn, delaying any rate cuts from the central bank.
Gold price, on the other hand is inversely related to the value of the dollar. Since gold is globally seen as a hedge against inflation or uncertainties, investors park their money in gold whenever US dollar depreciates.
Conversely, they promptly shift their investments from gold to dollar once the American currency appreciates. Gold and similar precious metals are no more seen as a viable asset class to hold.
Is it time to panic?
India is not the only country where the markets reacted to the US Fed and China news. The US markets and most Asian markets dropped sharply a day after.
India’s Finance Minister P Chidambaram has said that there is no need to react and panic over the rupee’s fall, adding that the US Fed’s statement is misunderstood.
He is not the only one to believe so.
"The reaction to Fed is exaggerated, outflows may happen but with the rupee so cheap it may be time for new money to also come in," Paras Adenwala, managing director and principal portfolio manager at Capital Portfolio Advisors told Reuters.
So what can the Government, RBI, SEBI do?
When ANI asked Chief Economic Advisor Raghuram Rajan about steps the government is contemplating to check the rupee's slide which fell to an all-time low of 59.93 to a dollar on Thursday, he replied “The Union Finance Ministry, the Reserve Bank of India and the Securities and Exchange Board of India are watching the developments closely and would take action, as appropriate. We are not, let me emphasise, we are not short of actions and instruments, if and when the need arises.”
From urging exporters to buy more rupees to staggering import payments, here’s what the Reserve Bank of India and the government could consider doing in order to prevent the rupee from falling further.
Foreign Direct Investment
Will the government allow up to 100 percent FDI in selective sectors? Well, that’s something to watch out for. Hindustan Times reported that the committee, which submitted its report on Tuesday, has recommended further opening up of FDI in multi-brand retail to 74 percent from the current 49 percent, allowing upto 49 percent FDI in public sector banks and raising the ceiling in insurance and pension sectors to 74 percent.
There are currently four categories of FDI ceiling, in which, FDI of up to 20 percent is allowed in public sector banks. Foreign partners can pick up stakes in defence, TV channels, print media and insurance for up to 26 percent. Investment by a registered FII under the Portfolio Investment Scheme would be permitted up to 24% only in the CICs listed at the Stock Exchanges, within the overall limit of 49% for foreign investment, according to Government of India.
Currently, FDI of 49 percent is allowed on cable networks, scheduled air transport services, FDI on commodity exchange, credit information companies, infrastructure companies, power exchanges and 51 percent on multi-brand retail. On establishment and operation of satellites, teleports, certain air transport services, telecom services and private sector banks, FDI of 74 percent is allowed.
Exports
A falling rupee against the dollar will give exporters a reason to rejoice briefly in terms of profits. But this volatile situation may raise import bills which could affect their business. Hence, the government or RBI could take help from exporters by asking them to convert foreign currencies which could temporarily relieve the rupee crisis.
Interest rates
The Reserve Bank of India kept interest rates unchanged earlier this week. The government’s effort to boost investment did not bring out good results as investors worried about India’s current account deficit.
"The RBI was slightly hawkish but with the rupee under pressure to weaken, the tone was appropriate," said Suresh Kumar Ramanathan, head of regional interest rates and FX strategy at CIMB in Kuala Lumpur to Reuters. "As long the rupee is under pressure, RBI will hesitate to ease anytime soon," he added.
NRI remittances
NRIs are all smiles as the real estate sector is an attractive investment on a weak rupee. India is the largest recipient of global remittances in the world, receiving $69 billion in 2012, according to a World Bank report. The money that expatriates send will have more value now because of a depreciating rupee.
Non-resident Indians can not only send more money back home but also purchase a home for reasonable prices because a weak rupee means more value for every dollar they spend. The rupee’s dip against the dollar will help them purchase properties as they can buy more rupees.
Curb gold imports
Although the Reserve Bank of India has certain restrictions on gold imports, will the government decide to curb gold imports again? Since 2012, the government has hiked import duty on gold thrice. In order to curb demand, the government increased import duty from 2 percent to 8 percent this month.
Hindustan Times reported Renisha Chainani, commodity analyst, Edelweiss Financial Services, stating “Our view on gold is bearish and we expect the yellow metal to touch R26000 by the end of this month. Gold is likely to be in the range of R26000-28000 in the next six months. Fed announcement is bearish for all commodities.”
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