Story Of The Week

INR On A Tightrope

Google says money is anything that can be used as a medium of exchange, a legal tender to settle debts, a unit of account and a means to save or store purchasing power.

If the above is true, then how come Indians are constantly losing their purchasing power?

The Forex market’s final bell closed at 71.029 for the exchange rate between US Dollar and Indian Rupee on 30th August 2018. With this, the exchange rate hit its record low which had been on a falling spree since January. The crossing of the 70th mark is a sign of INR losing its market share and with it, the purchasing power of its holders. The entire episode which began on 28th August, significantly highlights the weakness of Asian peers and a strong month-end Dollar demand.

Reflecting upon the fall of Rupee, Niti Aayog Vice Chairman Rajiv Kumar, on Wednesday opined that currency should be allowed to fluctuate according to the market forces and in fact termed the calls for a stronger rupee of, a ‘falsifiable belief’.

There are several reasons that have collectively impacted the value of Rupee against Dollar.

  • Adam Smith’s- INVISIBLE HANDS

The invisible hand refers to the self-regulating nature of the marketplace in determining the price of a commodity. Here the commodities at play are the two currencies and their respective demand and supply in the foreign exchange markets have determined their values.

The importers in India constitute the major proportion of demand for US Dollar.

Foreign Institutional Investors whose interests have divested because of the volatility in the Indian market have started to withdraw. These FIIs are a great source of supply of Dollar in the country. A greater level of operational efficiency and lesser bureaucratic problems, make countries like Singapore more attractive for investments than India.

Rising demand and falling supply of Dollars have collectively raised its price with respect to the Indian currency.

  • Crude Inflation

A country where at least 80% of the oil needs, that is approximately 1,93,000 barrels per day are settled via imports, a rise in the crude oil prices is bound to create an uproar.  Recent trends show that the demand and cost of crude oil are exhibiting strong positive relationship.

Rising crude oil prices exert pressure on finances. According to a report by Global broking firm Nomura, every 10 Dollar rise in the crude oil prices augments India’s fiscal deficit by approximately 0.1%.

The implication is that India will need more Dollars to meet its inelastic demand for oil, that is the rate of substitution between Rupee and Dollar increases with its demand for oil.

The above data shows that FPIs reduced by almost 80% for the past three months in comparison to the previous year.

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  • Capital Market- TOO VOLATILE

Capital markets are one of the most significant growth pillars for any economy. If this market performs well, vicious circles of trade deficits and rising foreign exchange rates can be broken. However, foreign investments in the Indian markets have also suffered a backlash from the foreign markets due to the persistent volatility in terms of the capital acquisition.

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  • Widening Trade Deficit

According to a report by ICRA, India’s merchandise exports expanded twice that of exports growth in the year ended March 2018.  In fact, the import bill is taking a toll at a time when the receipts from exports have hit a fourteen year low.

This imbalance might push the trade deficit of the country to 1.9% of the Gross Domestic Product in the financial year 2019, the report added. The predictions of such future possibilities affect the markets and various macroeconomic variables in the present form also.

With future possibilities of rising Dollar and falling Rupee, present demand and supply get impacted. Current demand for Dollars has risen along with the supply for Rupee. Consolidated effect of these activities is the rise in the exchange rate.

  • Rising Tensions Between The US and China

The trade war between the US and China has its effects spread across all the emerging Asian economies. INR is one of the worst hit currency because:

  1. a) Both are trading partners of India

With 89 Billion Dollar worth of trade, China tops the list of largest bilateral trading partners of India. The US is the second largest with trade worth 74 Billion Dollars. Tensions between two of the biggest business partners, Indian Rupee faces downward pressure due to turbulent capital and business markets.

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  1. b) Expectation of a FED hike                     

The Trump’s administration has imposed tariffs on goods worth 50 Billion Dollars that were being imported from China. This has raised the inflation in the US markets, paving way for FED interest rate hikes. This will induce investors to invest in Dollar markets. The bargain has a serious impact on Indian Rupee as Dollars value strengthens during this process.

  • The Turkish Crisis

Rupee depreciation is also an after effect of falling Turkish Lira. Lira has gone down by more than 40% this year on account of rising tensions with the United States and concerns over Tayyip Erdogan’s rising influence over the economy.

The cumulative effect of this has plunged the economy into crisis and may well trigger recession and banking crisis. The spillover effects are bound to impact the emerging markets at least in the short run.

Thus, there are innumerable factors that have a causal-effect relationship with the Indian Rupee. However, the impact is what causes spur amongst the citizens whose purchasing powers are getting affected. Following are few of the after-effects of this fall in INR.

  1. Net Asset Value

A depreciating rupee will induce the authorities to raise the interest rates and thus bond yields in order to attract the capital inflows. However, there exists an inverse relationship between bond yields and net asset value, especially in the case of debt funds. Thus, long-term returns, as well as the performance of these funds, will be impacted adversely.

  1. Inflation:

With the eroding Rupee value, inflationary pressure due to rising import bills will encircle the economy. The industries where imported goods constitute a major proportion of raw material will witness a splurge in their costs, most of which will be passed on to the consumers in the form of higher prices.

  1. Rising value of DEBT:

Depreciation in rupee will have its foremost effect on those sectors which high debts denominated in Dollar. With the rise in the value of a dollar, raises the liability of all those capital-intensive units which have foreign borrowings especially in USD.

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 Raghuram Rajan, in an interaction with CNBC, said that he was not too concerned about the domestic currency as “it is more a factor of dollar strength rather than necessarily rupee weakness”.

Thus, we can see from the above analysis that there is a multitude of exogenous and endogenous variables that affect the markets of foreign exchange. Some economists blame the crisis in Turkey while some other, the trade wars.

 

References

 

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