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“THE EFFECT OF RUPEE DEPRECIATION ON INDIAN ECONOMY”
Submitted to
MUMBAI UNIVERSITY
FOR THE PARTIAL FULFILLMEN T OF THE DEGREE OF
Masters of Comme rce
ECONOMICS
SESSION 2013-2014
DEPT. OF MANAGEMEN T STUDIES
MULUND COLLEGE OF COMMERCE
Under the guidance of: MR. PAWAR
Submitted by: RAVEENA UDASI
Roll: - 15051
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DECLARATION
I, Raveena Udasi, student of MCom here by declared that the research
report entit led “SUCCESS AND FAILURES OF EUROPEAN UNION” is
comple ted and submitted under the guidance of is my origina l work.
The imper ia l find ing in this report is based on the data collec ted by me. I have
not submitted this project report to any other Unive rs ity for the purpose of
compliance of any requirement of any examina tion or degree.
DATE: Raveena Udasi
M.Com Sem I
ROLL NO. 15051
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CERTIFICATE
I, Prof. Pawar, hereby certify that Miss Raveena Manoj Udasi ROLL. No 15051 of Mulund
College of Commerce, S. N. Road, Mulund (West), Mumbai -400080 of M.com Part I (Business
Management) has completed her project on “The effect of Rupee depreciation on Indian
Economy” during the academic year 2013-14. The information submitted is true and original to
the best of my knowledge.
____________________ ___________________
Project Guide Principal
_____________________ ___________________
Co-coordinator External guide
Date:
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ACKNOWLEDGEM EN TS
A research project is a golden
opportunity for learning and self development. I conside r myse lf very lucky and honored to have so many wonderful people lead me through in comple t ion of
this project.
My grate ful thanks to Mr. Pawar who in spite of being extraord ina r i ly busy with her/his duties , took time out to
hear, guide and keep me on the correct path. I do not know where I would have been without her/him. A humble ‘Thank you’ Sir.
I would also like to thank everyone who took active invo lvement in help ing me with my project report withou t whom, it would not have been possib le.
RAVEENA UDASI
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EXECUTIVE SUMMARY
Deprecia t ion refers to a fall in the value of the domestic currency which is
caused by the demand for foreign currency exceeding its supply in the market. In such a situa t ion one has to pay more than before to get units of foreign
currency. This fall takes place in the market and on its own. Market determined exchange rate serves the purpose of align ing the domestic economy with the world economy was the price route. As consequence s the domestic price gets
linked up with those of the world price. With the libera l izat ions and globa lizat ion of the economy in recent years, imports are bound to increase. The
lessening of restrict ions on imports and lowering of tariff on imports which the economic reform imp lies, an increase in imports has in fact taken place. Again with trade having become an importan t element of the new strategy of growth.
India being a develop ing economy with high inflat ion, depreciat ion of the
currency is quite natura l. Depreciat ion of rupee is good, so long as it is not volat ile. A random depreciat ion that we have seen in the last few months is bad and it has hurt the economy. Right from the beginning of year 2013, the value of
rupee has been deprecia t ing.
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TABLE OF CONTENT
SR. NO. TABLE OF CONTENTS
PG. NO.
1 INTRODUCTION 8
2 IMPACT OF RUPEE DEPRECIATION 14
3 ROLE OF RBI 16
4 NEGATIVE FEEDBACK MECHANISM 20
5 IMPOSSIBLE TRINITY 22
6 CAUSES OF THE DEPRECIATION 23
7 BAD NEWS / GOOD NEWS 25
8 ROLE OF THE GOVERNMEN T 26
9 CONCLUSIONS 30
10 RESEARC H DATA TABULATION & ANALYSIS 40
11 FINDINGS AND RECOMMENDATIONS 41
12 BIBLIOGRAP HY 42
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LIMITATION OF RESEARCH
Of all the living things in this world, Human Beings are the most unpred ic tab le
and sometimes may act in a most irrat iona l manner. Hence the research should not be conside red to have a unive rsa l applicat ion since a conside rab le degree of behavio ra l aspect is invo lved in making investment decisions.
The research is also a bit narrow in scope as it considers only the success and
failures of European Nation. It did not take into account a very important factor which is traveling to the European countr ies for data evalua t ion and find ings but limits to the data provided in the books and compute rs. However, the detailed
study with the same approach can be performed .
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INTRODUCTION RUPEE DEPRECIATION
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“We invented money and we use it, yet we cannot understand its laws or control
its actions. It has a life of its own.” - Lione l Trill ing, American lite ra ry critic.
The most concerning chapter for India during last two years and specifica l ly last two months is the weakening of rupee agains t dollar . It is not only that rupee
has lost its value in the globa l context but also dolla r has improved its performance in the globa l trading markets. The outstand ing performance of US equit ies and the improvement in the labor market has made America ns more
optimis t ic about the US economy, thereby stimula t ing greater hopes of QE(Quanti ta t ive Easing) tapering.
The government of India is still unab le to generate heavy capita l inflows. I f US
Federal Reserve withd raws its bond buying programme; there will be unexpec ted outward flow of money leaving India clambering for dolla rs . The slowdown in the Indian economy has made the situa t ion more fick le.
The government has a strong role in contro ll ing currency in the form of policy
regula t ion and reforms. The current UPA leadership has failed to strike with some heavy reform to generate more cash inflows . As a result the government
has gradua lly lost its control over rupee deprecia t ion. Inves to rs’ sentiment plays a pivota l role over here.
Oil and gold imports account for 35 per cent and 11 per cent of India ’s trade bill
respective ly.There has been an uninterrupted demand for the dollar from the oil importe rs pushing the rupee lower. Likewise the falling gold prices have made the centra l bank to reduce imports, which increases CAD and hits the currency
direct ly. Indian economy requires a strong structura l reform to mainta in a posit ive balance of payment.
Also, government spends excess ive ly as elect ion approaches just to woo
electora te votes. Thiscauses the rupee to depreciate. Then the government beats around the bush to contro l the currency behaviour. Most of the times these measures worsen the economic crisis to a great extent.
The foreign inst itut iona l inves to rs have been selling index futures and Indian
equity market is weakening. As a result there is a heavy demand for dollar and Indian currency as well as economic situa t ion is looking too gloomy.
These worrie s, combined with a record high current account defic it and now
uncerta inty over the centra l bank’s moneta ry policy stance, have prompted foreign inves to rs to sell more than $12 billion of Indian debt and equit ie s since
late May.
Reserve Bank of India has taken certain steps and some more to be followed to have a control over rupee. But the big question comes here.
what are the implica t ions?
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The best business prototype anyone can have is to spend in rupees and earn in dollars, which is what the giants of India Inc, includ ing the top IT companies,
excel in. Basica lly the sector which is target ing exports for its industr ia l operations are the one wins the game.
Dolla r apprecia t ion would be positive for sectors such as IT, pharmaceutica ls , hotel, textiles and automob iles which have the total foreign exchange earnings of these firms are far greater than their forex spends. As much as the rupee
weakens, the foreign exchange earners gain provided the other factors remains constant.
A sharply declining rupee triggers infla t ion, broaden the current account defic it,
hits inves to r sentiment and creates burdens for organizat ion with high exposure to foreign debt. The government and the Reserve Bank of India have taken
severa l reform init ia t ives to resist the downturn, but their success stories are looking gloomy.
Buying imported mater ia ls will become very costly. A weak rupee will create extra stress on Oil Marketing Companies (OMC) and this will surely be passed
on to the consumers as the companies are allowed to do so after the deregula t ion of petrol and partia l deregula t ion of diesel. If the OMCs increase fuel prices,
there will be a substantia l increase in overall cost of transpor ta t ion which will trigge r infla t ion.
If the depreciat ion is steep and without control, it will strike up infla t ion. As a result the Central bank would have very less room to impose further rate cut and
that’s the burden the borrower would have to bear.
Indians who have gone to abroad for tours or studies are highly affec ted in these times . The only smiling people in this context are the NRI’s who gain more on
sending money to their home land.
As a whole we can say that though weakening rupee is the reason for someone’s smile it is a real threat for the country’s overall fisca l health and increase the
current account defic i t heavily. But in my opinion this huge downgrade is a temporary phenomenon and the rupee is really oversold. Now the Central bank and Government should work hand in hand and find out the policy measures to
stabilize the frightening scenario. I persona lly hope a further cut in SLR to ease the liquid i ty to save rupee and also import duty hike in gold and other related
mater ia ls. RBI can buy bonds to ease liquid ity in the market. Fina lly we can say that the situat ion is tight and challenging for us, but we can not only hope for the best but also should contribute the most to get back Indian economy in the
driving seat.
With the rupee shedding over 10 per cent in value since the last week of July, there is a lot of attent ion on the volat i le nature of the Indian Currency vis-a-vis
the US dolla r. But, the current free fall in the domestic currency to Rs 49-50 leve ls is in a way mirror ing a histo r ica l trend. Two major rupee devalua t ions occurred in 1966 and the early 90s. The reasons for the two devaluat ions were
not too dissimila r ; twin defic i t (current account and fisca l), soaring infla t ion,
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insuffic ient foreign exchange reserves, and the developed world demand ing decontro l and libera liza t ion to allow them to do business in India.
The reason for the fall
The Indian rupee is under great stress as overseas inves to rs are paring their exposure to Asia’s third- la rges t economy amid the US and Euro-zone crisis and
mounting worrie s over the domestic economy. The globa l uncerta inty and various economy crisis has forced the investors, large banks, investors and fi-
nancia l inst itut ions to search for safe haven and they have now started selling Euros and buying dollars. Thus, the dollar has apprecia ted agains t all major
currenc ies inc lud ing rupee. These inves to rs are quick ly pulling out the money from Indian market and invest ing in other safe investments such as Gold or the
US dolla r.
The 3 major factors contr ibuting to the fall are:
1. Risk Avers ion on part of Currency Investors, which has caused the Demand
for the US Dollar to go up world over.
2. Uncerta in Economic Situa t ion around the globe
3. FII’s turning Net-Selle`rs and withd rawing funds from the Indian Market.
Comparisons with a wider basket of 36 currenc ies also ind ica te that the rupee
has indeed appreciated by almost 15 per cent in real terms. Hence, purely from an analyt ica l perspect ive, the deprecia t ion in the rupee is an overdue market
adjustmen t, result ing from the nexus between exchange rate, infla t ion and interes t rates in the economy.
Impact of Rupee Deprecia t ion on the Indian Economy
Infla t ion graph and Fisca l defic it to scale up
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Currently, India is suffe r ing from a near two digit infla t ionary pressure . A deprecia t ing rupee would only add fuel to this. It would lead to high infla t ion,
as India imports around 70 per cent of its crude oil requirement and the government would have to pay more for it in rupee terms. Due to the control on
oil prices, the government may not easily pass the increased prices to the consumers . Furthe r, this higher import bill will lead to rise in fisca l defic it for
the government and will push the infla t ion.
On November 21 alone, overseas funds sold more than US$500 mill ion worth of
Indian- listed shares over the five trading sessions, reducing net inflows for 2011 to under US$300 mill ion. The rupee has lost more than 10 percent of its value this year, making it one of the worst performing currenc ies in Asia. In the light
of uncerta inty and fall in globa l stock market, FII’s are supposed to be pulling out their money from various EME’s (Emerging Market Economies) and taking
them back to their home countr ies in order to susta in themse lves.
A blow to Indian Importers
The Indian import indus try would also have to pay more in rupee terms for procur ing their raw mater ia ls. This would happen despite a drop in globa l
commod ity prices, only because of a depreciat ing rupee against dollar. Corporate India is a net borrower of dollars and to that extent a depreciat ing
rupee would impact its balance sheet adverse ly. Companies with foreign debt on their books would also be impac ted. With the rupee deprecia t ing against the
dollar , these companies would need more rupees to repay their loans in dollars. This will increase their debt burden and lower their profits. Obvious ly, inves tors would do better to stay away from companies with high foreign debt.
The deprecia t ing rupee has pushed up the prices of electron ic gadgets and home appliances. Car makers who import 10 to 40 percent of the components are
contemp lat ing increas ing prices. This is an attempt to offset the increased import costs owing to the deprecia t ing rupee. An increase in prices could span
from Rs 10,000 for small cars to Rs 50,000 for luxury vehic les . The rising interes t rates and fuel hikes have played spoilspo rt for the car indus try
that is brimming with a wide array of choice for consumers.
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IMPACT OF RUPEE DEPRECIATION
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Negative impact on Indian students and travellers abroad
Individua lly, travell ing abroad becomes more expens ive as travel cost could go up by around 10 per cent compared to last July figures. Students studying
abroad too will be hit as more rupees will go out to pay for the courses, stay and other expenses .
Impact on Oil Imports
Oil imports consume the larges t part of the FOREX reserves. A deprecia t ing rupee is bound to offset the decrease in the internat iona l prices of commod it ie s
such as oil. As can be seen from the figure below although the oil price per barrel has fallen however the depreciat ing rupee has not given any respite to the
importe r as they actually have to shell out more money in order to purchase the same quantity of oil. Take for instance crude oil imports. Brent crude oil price
was $118.46 per barrel on April 2011 when exchange rate for the rupee was Rs 44.4 to a dollar . On November, oil price had gone down to $109.03 per barrel
and exchange rate was Rs 52.7 to a dollar. Thus, because of the rupee deprecia t ion not much benefit can be derived out of the lower oil price. Instead, the increase in price of import ing oil between April and November is to the tune
of Rs. 489.8 per barrel.
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Cheerful news for Exporters
When a currency depreciates , the exporters make more profit because they get
more of the local currency for every unit of foreign currency though the quantity of trade remains unchanged. The deprecia t ing rupee would be posit ive for the
Indian IT sector which generates more than 85 per cent of their $70 billion revenue from the overseas markets. This kind of apprecia t ion in foreign
currency will enhance their actual realisat ion of revenue in dolla r terms.
Role of RBI
RBI will interfere in this area because a steady value of rupee is essentia l for
the orderly growth of the economy. A depreciat ing rupee will harm oilmarketing companies, and other import oriented businesses. This may help
the software companies and other exporters, who get their payment in dollars.
RBI will be watching the posit ion and interfe re to stabilize the currency value . In case of deprecia t ion, RBI will sell foreign currency from the reserve and this
will help in arrest ing the fall of rupee to some extent .
Possib le Solut ions
Oil import demand could be staggered and purchases co-ordina ted so that at no
point there is undue bundling of imports .
The government can take init ia t ives which encourage and increase the flow of
foreign inves tments into India. Three recent steps taken by the government be it the pension fund FDI limit or the increase in the inves tment limit inves tors in government security and corporate bonds are the steps in the right direct ion.
The government can make investments attract ive and invites long term FDI debt funds in infras tructure sector.
Government can conside r tempora ry import compress ion.
FDI in the aviat ion indus try retail can also attract foreign inves to rs.
Exchange Rate Mechanism
Let us first try to unders tand how exchange rate is determined? All economies
that interact with internat iona l economy can be broadly class ified into three
categor ies on the basis of exchange rate policy of the country.
1. Fixed Exchange Rate: These economies peg the value of their currency with
some other prominent currency like US dollar. This system is simp le and
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provides stability to the economy (of course, if the economy of the country to
whose currency its currency is pegged is stable) . This type of exchange rate
regime is mainta ined by genera l ly smalle r economies like Nepal and Bhutan
(pegged to Indian Rupee) or several African nations. Rationa l behind such
regime is that in case of small economy – if the exchange rate
ismarke t determined – the sudden influx or outflux of even relat ive ly small
amount offore ign capita l will have large impac t on exchange rate and cause
instab i l ity to its economy. Notable exception is China which despite being large
economy has its currency pegged to US dollar . But then when it comes to China ,
its irrat iona l to talk about rationa li ty .
2. Floating (or free) Exchange Rate: Bigger and developed economies like US,
UK, Japan etc genera lly let market determine their exchange rate. In such
economy exchange rate is determined by demand and supply of the currency.
For example consider exchange rate of US dollar versus Japanese Yen. If US
wants to import certain item from Japan, it will have to pay the Japanese
company in Japanese yen. This is because in common market of Japan, dolla r
will not fetch you anything. But the American company will not have Yen, so it
will purchase Yen from the interna t iona l currency market. This will increase the
demand of Yen and supply of dolla r. Thus the value of Yen vis a vis dollar will
increase. Similar ly if Japanese company is import ing something from US, it will
increase value of dolla r as compared to Yen.
Export- import, though the major, is not the only source for currency exchange.
Capita l flow – Americans inves t ing in Japan and Japanese inves t ing in USA – is
also a signif icant source of currency exchange . Anothe r source of currency
exchange is remittance – that is the money sent home by Americans working in
Japan and vice versa. Cumula t ive of all these exchanges determine the exchange
rate. If net requiremen t of Dolla r by Japanese is more than net Yen required by
USA, dollar will apprecia te agains t Yen. You should also unders tand that this is
oversimp lified for the purpose of illus tra t ion. In real world, there will be
mult ilate ra l interac t ions and fina l exchange rate will be equilibr ium reached by
all those interac t ions.
3. Hybrid system: Most mid sized economy like India practices a mix of both
these regimes. It allows for the exchange rate to float in a range which it deems
comfortab le. Once the market determined rate tries to breach this range, centra l
bank (government) intervenes in the currency market and contro ls the exchange
rate.
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How does governme nt control exchange rate?
In fixed or hybrid exchange rate regime where governmen t contro ls exchange
rate, contro l is exercised by active ly partic ipa t ing in interna t iona l currency
market through its centra l bank (Reserve Bank of India or RBI in our case).
Suppose there is huge demand of rupee in India which is driving the value of
rupee. Also, lets assume that RBI is comfortab le only in range of Rs 50 to Rs.
60 per US dolla r. This rapid surge in the demand of rupee (which might be
because a. Indian export is far more than its import, b. foreign investors want to
inves t in India and c. large number of Indians earning abroad are remit t ing their
money back home) is pushing the exchange rate below Rs. 50 per dollar. The
RBI will then step in the market and will offer Rs. 50 for each dollar. Those
buying rupees agains t dollar will now purchase from RBI since its offer ing
better rate. Soon other traders will have to arrive at this rate, if they want to
partic ipa te . Since RBI has the ability to print currency notes, it can keep the
lower limit of exchange rate fixed at this value. When demand for rupee is
subsided, RBI will step back and let market determine the exchange rate. In the
process, RBI will have accumulated a pool of dollars; this is called forex
reserve or foreign exchange reserve.
Now let us move to other extreme. Suppose Indian exports have dwind led ,
imports are on surge, foreign inves to rs are flee ing Indian market and
remit tances are at all time low. Now, every one wants dollar but there is litt le
supply. This will drive the price of dolla r up. Its about to breach the upper limit
of Rs. 60/ USD. RBI will step in again and will put its dollar reserves on sale at
the rate of Rs. 60/ USD. This will stop the further depreciat ion of rupee.
As you can see, in order to be able to stop the currency from apprecia t ing, RBI
will have to print money and for preventing its depreciat ion it needs a reserve of
dollar . This constra in t has interest ing imp licat ions on the current predicament of
RBI in the context of depreciat ing rupee.
Effec t of exchange rate on Import and Export : Suppose US company wants to
buy Indian textile and suppose on T-Shir t costs Rs. 120 and exchange rate is Rs.
50/$. So for american company the cost of T-Shir t is $2.4. Now, if rupee
deprecia tes to Rs. 60/$ the price of T-shir t becomes $2 only. This will make
Indian T-shir t cheaper to buy and will increase its demand. Companies who were
import ing from other nations (may be China or Bangladesh) might shift to India
and Indian exports will increase.
Consider the opposite scenar io. Rupee appreciates to Rs. 40/$ making the cost
of one T-shir t $3. This will repel US importers and might drive them to other
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riva l exporters whose garments are cheaper. Thus, depreciat ing currency helps
exports while apprecia t ing currency has opposite effect .
Similar ly if India imports $ 1000 iPad from US, at exchange rate of Rs. 60, it
will cost Rs. 60000. If currency apprecia tes to Rs. 50/$ the price will reduce by
Rs. 10000. This might encourage many new people to by iPad which earlier
thought it to be too expens ive. Thus, the demand for imported products will
increase in apprecia t ing currency and will drive imports upward. Deprecia t ing
currency will have opposite effect.
Balance of Payment (BoP) Accounts
Internat iona l monetary transact ions of a nation is recorded in two accounts .
1. Current Account: This records all the trades (export- import), remittances,
interes ts and earnings on inves tments made into out side countr ie s and other
flows which is current in nature (meaning with no intention of future return). If
total inflows in the country (its export, remit tances and earning from its
inves tmen ts abroad) is more than its outflows (its import, remit tances out of the
country, payments of interests etc.) then the country is said to have current
account surplus. China, owing to its huge exports, is currently the nation with
larges t current account surplus . Simila r ly, if outflows exceeds inflows, the
country is said to be in current account defic it . USA has the larges t current
account defic i t. India too has huge current account defic it (about 1 20 billion
USD in FY 2012)
2. Capita l Account: This records all the flow (into or out of the country) made
for future return – inves tment in stocks, bond or companies , in real estate or
FDI (inves tment made for setting up of business or indus try) . It also includes
loans taken from abroad (which actually is inves tment by foreign lender into the
nation). Foreign Currency Reserves are also part of Capita l account but are
genera lly not reported. A country is said to be in Capita l account surplus if total
inflows into the country (FII, FDI and borrowing from foreign companies /banks)
exceeds total outflows (inves tments into foreign countr ies and lend ing to
foreign countr ie s or companies) . In case situat ion is reversed, country has
capita l account defic it.
Payments always get balanced : You can spend only as much money as you have.
Or in other words, total amount you spend and inves t must always be equal to
the money you have earned and loans you have taken. What this means in the
context of BoP is that current account surplus must always be balanced by
Capita l account defic i t and if a country is having current account defic it, it must
always get equiva lent money form of capita l account surplus.
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BoP and Forex Reserves : Countr ie s having float ing exchange rate and free
capita l flows do not have to build foreign currency reserves. But as we have
seen earlier , those who exercise some or full contro l over exchange rate, do so
by manipula t ing their Forex Reserves. The difference in current account surplus
and capita l account (exclud ing forex reserves) defic it is balanced by equal
increase in forex reserves (China) and if country is not able to meet current
account defic i t by capita l flows, then it will have to liquida te its forex reserve
(current situat ion of India ).
For example, China which has huge exports (current account surplus) as well
has huge inflows in FDI and FII, balances this by build ing up huge forex
reserves as well as by inves t ing in foreign countr ies . Chinese government parks
large percentage of its surplus into US governmen t bonds and encourages its
government backed and other companies to buy assets in foreign countr ies
(mostly US). So it delibe ra te ly runs huge capita l account defic it so that it can
export. Otherwise , it will have to let its artific ia l ly depre ciated currency
apprecia te. This is interest ing and perhaps topic for another future artic le.
Negative Feedback Mechanism
Example of negative feedback system
Wikiped ia defines negative feedback as following “Negative feedback occurs
when the result of a process inf luences the operation of the process itself in
such a way as to reduce changes.” In order to understand this concept look at
the adjacent diagram (Again taken from Wikiped ia ). As you can see in the
diagram, when water leve l in the reservo ir decreases, the piston stopping water
flow is lifted and water starts to pour in. When water is filled, the piston will
again come down to stop more water from pouring and this will mainta in the
water at desired leve l. The equilib r ium leve l of water will be determined by the
arrangement of the system rather than the flow of water.
Similar negative feedback system exists in economics . For example, conside r
exchange rate and export- import. Actua l situa t ion will be very complica ted
because of a large number of variab le interac t ing togethe r. To keep things
simp le, we will conside r only two variab les at a time – export- import and
exchange rate. As we have discussed above, apprecia t ion
currency causes increase in import while discourages export. This will lead to
increase in demand for foreign currency and simultaneous ly increase in supply
of local currency. This putting a downward pressure on exchange rate. If
government does not interfe re and there is no net capita l flow, then exchange
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rate will quick ly adjust such that values of imports and exports are perfect ly
matched.
Relat ion between interes t rate and exchange rate (Interes t Rate Parity)
Anothe r beautiful example of such feedback system is interes t rate parity. In
order to expla in it lets assume Interes t rate for borrowing in USA is 4% and
interes t one gets on government bond in India is 8%. It will make perfect
business sense if you borrowed $1000 from USA, purchased Indian government
bond and after a year you got interest of $80. Paid $40 as interest to the bank
you borrowed from, and made a profit of $40. That withou t inves t ing a single
penny of your own. Such situa t ion where you can make money without inves t ing
any capita l at all is called arbitrage (which in itse lf is fascina t ing financ ia l
concept and deserves a comple te artic le on itself ).
The only problem with this is it will not be only you who can think of this.
Other people too would want to make profit out of this opportunity and soon
there will be many dollars flowing from USA to India causing Indian Rupe e to
apprecia te in comparison to USD and whatever gains you could make from
excess interes t rate will be offset by the increase in exchange rate.
Self fulf i ll ing prophec ies or Posit ive Feedback
Direct ly opposite to the concept of Negative feedback is Self Fulfil l ing
Prophec ies or Posit ive feedback. For example suppose there is a rumor,
comple te ly unfounded , that the price of gold is going to increase to very high in
a week. People will want to profit from this info rmation and will buy some gold
to sold later at higher price. Init ia l ly, some people will be fooled by the rumor
and buy gold. This tempora ry surge in short term demand will lead to
momenta ry increase in price. This increase in price will give credence to the
rumor, and more people will flock in to buy gold. This will further increase the
price, pulling even more people. The rumor, which originated without any
analys is or “fundamenta l” cause, was the reason itself for the rumor becoming
true.
Such positive feedback are very common in our life , enginee r ing and economics .
In context of exchange rate, sometimes positive feedback plays a prominen t
role. Suppose, all the traders in foreign exchange market believe that rupee has
deprecia ted far below its ‘intr ins ic’ value and it will apprecia te in near fu ture.
In order to profit from this antic ipa ted gain, they will try to hoard the rupee,
thus increas ing its demand and causing it to appreciate.
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Opposite of this is also true. If traders believe that rupee (or for that matter any
currency) is about to deprecia te , they might actually trigger it by shorting the
currency.
The paradox of negative and posit ive feedback
What seems to be posit ive feedback in short term might actua lly be negative
feedback if looked broadly. For example, lets look at the currency example
again. The genera l belie f that currency has fallen far below its true value caused
it to apprecia te through posit ive feedback mechanism. But, at the same time it
also prevented currency to deprecia te furthe r and hence acted as negative
feedback.
Exis tence of negative and positive feedback loops give rise to severa l
interes t ing phenomena in economics and in other areas. But the artic le has
already surpassed 2600 words, so I can not give many examples. However , one
example very crucia l to our ongoin g discuss ion can not be omit ted. It is what
economis ts say Imposs ible Trinity .
Imposs ible Trinity
The concept of imposs ib le trinity states that a country (or an economy) can not
simultaneous ly have Fixed exchange rate, Free capita l flow and independen t
moneta ry policy (which roughly means contro l over interes t rate).
For example, suppose India pegs its currency to say Rs. 60/$ and intends to
mainta in free capita l flow. Now, if it sets interes t rate that is higher than that of
USA, then money will start flowing in from US to bank on this arbitrage
opportunity (as we discussed earlier ). So, in order to mainta in its exchange rate,
it will have to buy Dolla rs. But it will have a limit to how much it can buy.
Similar ly, if it sets interest rates lower than US, money will start flowing out.
To prevent rupee from falling, it will have to sell off its dollar reserve. But that
can last only till its reserves gets fully depleted. Thus government will have to
set interes t rate equal to that of US.
If you look closely, India, in recent times, has tried to achieve this imposs ib le
trinity to some extent. It kept currency underva lued , wanted foreign inves to rs to
come in, and had to increase interes t rate to contain infla t ion. What makes this
more ludic rous is that it was attempted when our premie r is a trained economis t!
Now let us look at the unpreceden ted devalua t ion of rupee more closely.
22
Causes
What is good for Economy is bad for Polit ic s : India’s trade balance is highly
unfavo rab le. What this means is India imports far more than it exports. In fact,
Indian export is only about 80% of its imports, a defic it of about $ 120 bn
(2011). This defic i t is large ly balanced by remit tances (which stood at $69 bn in
2012), FDIs and FIIs.
Economica lly it makes sense for India to let its currency apprecia te because it
will make imports cheaper and help reduce its trade imba lance. But,
apprecia t ing currency will have negative impac t on its exports. Now, India
mainly exports labor intens ive goods and services – Software services, polished
diamond , textile s, processed cashew nuts, leathe r goods. These sectors genera te
huge employment. Apprecia t ion of currency causes fall in the profitab i li ty in
these sectors, leading to many people loose their jobs. Looked from perspective
of polit ic ians, this is huge ly unpopula r.
Even though the overall gain from apprecia ted rupee is far more than the losses,
gains per individua l are small in magnitude and distributed over a large
populat ion ; whereas losses per ind ividua l is large and concentra ted in mino r ity
of the popula t ion. Such polic ie s are imposs ib le to pursue in a democracy like
India because those at loss will be far more vocal while people at gain will not
bother at all.
Under such polit ica l conside ra t ions, our government, a coalit ion of severa l
parties can not afford to be bold. So, in last 5 -6 years, driven by impress ive
economic growth of India, when foreign inves to rs flocked , there was upward
pressure on the rupee. Government was unwil l ing to let rupee apprecia te and
kept it artific ia l ly devalued. In the process it amassed huge foreign exchange
reserves (about $300bn). Where did the government bring this money from? It
simp ly printed the money!
Print ing of more money causes infla t ion, another polit ica l ly unpopula r thing.
So, in order to curb the money supply, government issued bonds under Market
Stabiliza t ion Scheme (MSS bonds). It did curb the infla t ion to some extent, b ut
when bond matures, governmen t has to pay the money along with the inte rest .
So, this scheme does not really curb infla t ion, it postpones it. When those bonds
matured, government made payments, again by print ing more money, as
government is running budget defic it and does not have income to pay. This
caused infla t ion which you might have noticed during recent times. How does
government curb infla t ion now? It increased interes t rate to reduce the supply of
money.
Increase in interes t rate caused a slowdown in growth. Also, globa l economic
slowdown reduced demand for India exports and exports fell too (about 30% in
23
last year). Import however , did not fall by that amount because Oil, the major
component of our imports, is essentia l commod ity. So the trade balance turned
more unfavo rab le. Also, looking at the slowing pace of growth new inves tor
abstained from inves t ing in India and older inves to r too started to get uneasy.
As they tried to pull back their money, it put downward pressure on rupee.
If foreign inves to r expects the currency of a country to fall, it will withdraw its
inves tmen ts because its inves tment value will fall with the currency. For
example suppose you inves ted $1000 at Rs.40/$. So your inves tment in India is
Rs. 40000. Tomorrow if rupee falls to Rs. 60/$ then value of your investment
has fallen to $667. Foreign inves to rs fearing further fall in rupee started to flee
Indian market and this put furthe r downward pressure on rupee (Posit ive
feedback). Government could interfe re , but owing to its huge budget defic i t, had
limited resources and rupee had a free fall. There is more to it, but the artic le
swelling like Dolla r.
Impact
Economists do not agree about impac t of nomina l exchange rate on real
economy. Many argue that Nomina l values do not have any impac t on real
economy while others claim that the effect nomina l variab les have on human
psycho logy and expectat ions of future does hamper real economy (applying
posit ive feedback, you can see how?).
Two very visib le impac ts are 1. increas ing oil pr ices and 2. India gaining
competit ive advantage in certain export. Why oil price is increas ing is quite
obvious. The later impac t needs some elaborat ion. What has made the
devalua t ion of rupee more problematic is globa l slowdown. Alterna t ive ly, it
might well be that this downfa l l was brought about by the globa l slowdown. But
in eithe r cases, the demand for goods and services in developed economy is
dwind ling. But demand in certain goods like textile will not be impacted that
much (people are not going to shun wearing cloths because of slowdown). Main
competito r of India in such sector is China. During the same period when Indian
rupee has been falling, salar ie s of labors in China has been on the rise. This had
made Indian export more favorab le.
Anothe r impac t, which may seem like silver lining in the dark cloud is that it
has forced government to bring certain economic reforms (FDI in retail and
other sectors) and has brought a near cris is like situa t ion which can force
unwil l ing governmen t to bring reforms (as it did in 90s).
24
In macroeconomics theory, when a country’s currency declines, its exporters should
soon get a boost as the lower currency makes their goods more competitive. By
that rule, India should be, right now, enjoying an export boom. Since the start of
May, the currency has dropped 23 percent, making it one of the world’s worst
performers. Sure enough, exports did go up in July, rising 11.6 percent year -on-
year, the best increase in more than 12 months.
Consumers worldwide shouldn’ t expect to see a surge in Made- in-India products in
the coming months , however. The July increase comes after a period of
weakness : India’s exports dropped 1.8 percent in the 2012 -13 fisca l year. And
while the currency has been steadily weakening for two years, the dec line of the
rupee hasn’t helped narrow India’s current- account defic it. Instead, the trade
gap has just gotten bigger , hitt ing 9 percent of gross domestic product in the
first quarter.
BAD NEWS:
One culpr it is rising prices inside India, with the consumer price index jump ing
9.6 percent in July. India’s high inflat ion undercuts the competit iveness gains
from depreciat ion. Any benefit [from the weak rupee] will be offse t by the fact
that there is a huge infla t ion problem in India, and the cost of manufac t ur ing is
very high forlocal companies .
The cost of India’s imports , which are domina ted by petroleum and gold, have
shot up, and the fall in the value of the rupee will push them higher still.Ris ing
costs of raw materialsa re making business challenging. A stronger and a stable
currency is always better for businesses .
25
For Indian exports to boom, local exporters need trading partners with healthy
economies . There aren’t many of those around, making an export - led recovery
difficult. India’s structura l problems also make it harder for local exporters to
cash in on the weak rupee.
The country’s manufac ture rs have suffe red from India’s sorry history of
under investing in ports, roads and other infras truc ture. The infras truc ture deficit,
lowers growth potential and discourages foreign direct investment.
In the corporate media there is widespread discuss ion of whether India could soon
confront a current account cris is akin to that in 1991, when India was forced to
seek an emergency bailout from the IMF.
In recent weeks foreigners have been selling Indian government debt and now
reported ly hold just 43 percent of a government limit of $30 billion. Nervous
overseas investors responded by pulling more than $11 billion dollars out of
Indian stocks and bonds.
Over the past severa l years, India has financed much of the current accounts
defic it through short- term debt. The total short term-debt due before March 31,
2014 now amounts to a stagger ing $172 billion. The payment of this debt will
consume over 62 percent of the foreign exchange reserves .
The timing is particula r ly tough for consumer companies that were counting on
India’s September- to- December holiday season to spur sales. India’s consumers ,
whose spending helped see the country through the global financial crisis in 2008,
are closing their walle ts, squeezing companies from carmakers to shampoo
selle rs .
Companies that import finished goods or raw mater ia ls are the worst hit as they
scramb le to hold onto margins while balanc ing the need to raise prices without
deterring buyers.
India’s total consumption expend iture, which inc ludes private and government
spending, grew 3.3 percent in Jan-March 2013 from 9.3 percent in the same
period a year earlier , according to government estima tes. Tota l consumption
expend iture as a share of the country’s gross domestic product fell to 65.9
percent in the fourth quarter of 2012/13 from 72.1 percent in the first quarter of
the same fiscal year. While many consumer companies have resorted to price hikes
to cope with the currency, long- te rm supplier contracts and hedging are help ing
some to bite the bulle t for now.
More fundamenta l ly, the crisis is rooted in a dramatic slowing in India’s
economic growth and its growing, massive dependence on inflows of foreign
capita l to meet its current account deficit. In the last fisca l year, which ended March
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31, India recorded growth of 5 percent, the lowest in a decade, and far less than
the minimum 8 percent needed to prevent a rapid rise in unemployment.
The government won a victory on Aug. 26 with the lower house of Parliament
approving a plan to provide subsid ized grain to two- third s of India’s 1.2 billion
people. That might help Congress stay in power next year, but it also increases
concerns that the government is backtrack ing on promises to cut the budget
defic it .
Few Good News
Information techno logy outsourcers such as Tata Consultancy
Services and Infosys have grown, thanks to low-cost workers in Banga lo re and
other Indian citie s,
The government is aware of the structura l problems and wants to make large
inves tmen ts to improve infras tructure in a manufac tur ing “indus tr ia l corridor”
between Delhi and Mumbai.
Higher costs in China , meanwhile, are leading some labor- intens ive
manufac turers to look for alternat ives in Asia, creating an opportunity for
India, To take advantage of the opening, India needs to revise rules that make it
difficul t for large employers to hire and fire workers.
Role of Governme nt
Over the past three months as the rupee has deprecia ted , the government has
announced a series of measures aimed at attract ing foreign capita l— inc lud ing
removing or lowering foreign inves tment caps and furthe r reducing government
spending at the expense of working people. But these have failed to arrest the
rupee’s slide.
Role of RBI
India’s centra l bank, the Reserve Bank of India, mounted a major intervention in
foreign exchange markets after the India rupee—which has depreciated by more
than 15 percent since May—crashed through more than 60 rupee per US dolla r
mark.
Sections of corporate India have been pressing for the Reserve Bank of India
(RBI) to abandon its reputed preoccupation with curbing infla t ion, which at the
retail leve l is currently close to 10 percent, and lower interest rates so as to
stimula te economic growth.
Instead, to stop the rupee’s slide, the RBI has tightened liquid i ty, thereby
driving up the cost of credit and furthe r undercutt ing economic growth, and has
27
sold off dolla rs , drawing down its foreign exchange reserves to about $277
billio n.
In a furthe r attemp t to stem the rupee’s slide and the deplet ion of its foreign
currency reserves especia l ly US dollars , the RBI imposed capita l contro ls on
Augus t 14. Hencefo r th Indian corporat ions— with the notable exception of large
government-owned enterpr ises or PSUs (Public Sector Units) —will not be
allowed to inves t more than 100 percent of their net worth (assets minus
liab il it ies ) outside the country in any year; individua ls will be restricted to a
maximum of $75,000. Prior to this, the annua l ce ilings were 400 percent and
$200,000 respective ly. The import of gold coins, which the government claims
has contributed to the current crisis, has been banned.
RBI vs .Governme nt
The crisis enve lop ing the Indian economy has caused increas ing frict ion
between the Congress- led Indian government and the RBI. While the former has
repeated ly made known its preference for interes t rate cuts aimed at boosting
growth, the RBI has resisted , arguing that infla t ion needs to be contained and
that a further erosion of the rupee’s value, will, by driving up energy
costs(Ind ia ’s imports three-quar te rs of its petroleum)severe ly dampen growth.
Also, it is acutely aware of the large foreign borrowing s India’s corporate giants
have contracted, seeking to take advantage of the much lower interes t rates that
have prevailed in the U.S. and Europe since 2008.
The conflic t between the RBI and the government reflec ts the fact the Indian
economy is now caught between a proverb ia l rock and a hard-place , with the
Indian elite facing a choice between trying to boost economic growth by letting
the rupee slide still furthe r, thereby fueling growth- sapp ing infla t ion or
defend ing the rupee by tighten ing credit and thereby further squeezing economic
growth. And in the background looms the threat of a rapid deplet ion of India’s
reserves as foreign capita l spurns a crisis- r idden economy
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Lacking Confide nce
BNP Paribas slashed its economic growth forecast for India for the fisca l year
to March 2014 to 3.7 percent from its previous 5.2 percent – the weakest growth
since 1991-92 when India buckled under a balance of payments crisis that
required a loan from the Internat iona l Monetary Fund.
“Ind ia ’s parliament remains toxica l ly dysfunc tiona l with litt le, if
any, businessconduc ted , ” BNP said.
The rupee has plunged more than 20 percent this year, by far the bigges t
decliner among the Asian currenc ies tracked by Reuters.
Yet the government has so far failed to provide a coherent response, analys ts
said. Its approva l of infras truc ture projects was trumped by concerns about the
fisca l defic it after India’s lower house of parliament approved in Augus t a 1.35
trill ion rupees plan to provide cheap gain to the poor.
In its latest init ia t ive , the governmen t proposed setting up a task force to look
into currency swap agreements , a measure analys ts said could bring some relie f
if carried out in time by reducing market demand for dollars or other major
currenc ies.
29
Conclus ion:
Though growth has slowed down in recent times, the fundamenta ls of our
economy remains strong. Steps are being taken to contain the fisca l defic i t and
boost indus tr ia l inves tments.
Farmers in selected cluste rs adopted good agricu l tura l practices and benefited
from the yield advantage of hybr id rice techno logy. Impact of good monsoon
will gradua lly put impetus for growth and consumption primari ly from rural
India. It will also help in reducing infla t ion as surplus food production will help
reduce price, assuming that rupee bounces back and stabilizes in near future.
Growth in exports should also pick up as other major economies revive growth
and a feeble rupee will be able to fetch dollars which in return will translate
into more rupees. Also, a comparat ive ly weak rupee will make Indian produce
more competit ive in globa l markets and this by itself should, over time , help to
reduce imports and increase exports.
Limite d Impact For Most: A sustained rupee deprecia t ion is unlike ly to have a
negative impac t on the credit ratings for most inves tment- grade issuers that come under the Fitch Ratings Indian Nationa l scale. Two hundred and seventy-
four (accounting for over 92% of outstand ing debt) of 302 public ly rated issuers are unlike ly to face a negative rating action should the rupee trade between INR55/USD1 to INR60/USD1.
Some Negative Actions; Defaults Unlike ly : The remain ing 28 issue rs may expect negative rating actions, such as a change in Outlook or downgrade of the
30
rating, in the event of susta ined rupee deprecia t ion. Fitch does not expect any of these issuers to default .
Benefit For Exporte rs Capped: The posit ive impact on operating margins and leverage for export-or iented companies, which typica lly benefit from currency deprecia t ion, is expected to be lower than histor ica l ly observed. Fitch expects
that lower demand in the globa l economy, aggress ive price renegotia t ions, hedging of foreign-currency exposures and the negative impact of foreign -
currency debt servic ing will act to cap the benefit to credit profile s of companies in the pharmaceutica l, techno logy, text ile, and mining sectors
Higher Prices Passed On: Some importe rs are able to pass on higher prices from depreciat ion because of import parity price (IPP) practices prevale nt in
their industr ie s, such as companies in the oil and gas, or metals industry. Companies in the auto ancilla ry sector typica l ly have contracts to pass on higher
costs to their origina l equipment manufac ture rs . However, the slowdown in end -user demand may force companies in the auto ancillary sector to absorb some of the price increases.
Bearing the Brunt: Companies in the chemica l, fertil ise r or paper indus tr ies tend to import a signif icant portion of their raw mater ia ls, as do cement manufac turers without adequate domestic coal links. They are unlike ly to be
able to pass on higher costs because of current low demand, which will hurt margins. The credit profile for these sectors will be, on a relat ive basis, most
affected by rupee deprecia t ion.
No Direct Forex Exposure: There is no direct operationa l exposure to foreign currency for 121 issue rs (35% of overall debt). The potentia l benefit of reduction in globa l commod ity prices to margins for companies in sectors
includ ing real estate, metal processors, chemica l processors and print media will be offse t to a large extent by the rupee deprecia t ion.
Impact on Sub-Investme nt Grade: The potentia l posit ive operationa l impac t on
sub- inves tment grade companies is like ly to be more limited than that of correspond ing investment grade peers in indus tr ie s such as textiles, techno logy
and pharmaceutica ls .
Worst-Hit Sector: Sub-inves tment grade companies in the chemica l, meta l processing and trading (in processed and unprocessed imported commodit ie s )
indus tr ie s are expected to face lower margins, higher invento ry leve ls and stretched working capita l. They may be the worst casualt ies of the rupee deprecia t ion, particular ly if they have limited financ ia l flexib il i ty.
31
Appreciat ion Unlike ly: The rupee is unlike ly to apprecia te in the short term
until globa l risk avers ion subsides, according to Fitch.
The primary focus of this analys is is to evalua te the impac t of rupee
deprecia t ion on the credit profile of those inves tment grade companies with direct exposure to foreign exchange risk. The analys is evalua tes the stress that these issuers will experience if the rupee trades between INR55/USD1 to
INR60/USD1 for a sustained period of more than six months. Fitch notes that a temporary fall to say INR60/USD1 for a very short per iod is unlike ly to impa ir
the balance sheet strength of such inves tment- grade issuers.
Fitch analysed 302 issue rs that are public ly rated at investment grade („Fitch BBB- (ind)‟ and above) according to Fitch‟s nationa l scale. The total outstand ing adjusted debt (gross debt plus lease adjustment minus equity credit
for hybrid instruments plus preferred stock) for this group is INR8,639bn, of which about 25% is denomina ted in foreign currency, based on latest availab le
data.
Over 92% of the of overall adjusted debt is rated „Fitch A−(ind )‟ or above. Over 97% of the forex debt is with companies currently rated at „Fitch A - (ind )‟ or above. As such, these companies are expected to weather any significant
economic downtown.
Direct Forex Exposure
89% of foreign currency debt is held by net importe rs . However within the net importe rs‟ group, 90% of the foreign currency debt is held by just nine
companies . Of them the lowest rating is „Fitch A−(ind)‟ . Five of them are at „Fitch AAA(ind )‟ and three are at „Fitch AA(ind)‟. These issuers have
significant cushion availab le in their respective ratings and they are comfo rtab ly placed to weather any financ ia l stress on account of signif icant rupee deprecia t ion.
Impact on Debt
Sector-Wise Credit Impact
The section of report focuses on the impact of on credits from a rupee deprecia t ion on sectors where the impact (both posit ive and negative ) is pronounced. These sectors are not only core to the economy but also have
significant representat ion in Fitch‟s inves tment grade nationa l rating universe .
These sectors form four groups :
metals)
ys to mit iga te deprecia t ion (chemica l, paper, cement)
-dr iven exposure.
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Net Exporte rs
This sector consists of either pure exporters (cotton textile, techno logy and
mining) or companies where exports are much higher than imports (synthe t ic
textile ,pharmaceutica ls and jewelle ry). Histor ica l data sugges ts that rupee
deprecia t ion may be an enabling factor but need not be a driving factor for
export growth.
Exports (in dollar terms) from India grew at rates higher than 20% (yoy) from
2003 to 2008. This period also coinc ided with histor ica l ly high globa l GDP growth levels (in excess of 4.8%) not observed since 1980 and correspond ingly
high globa l trade volumes. However over most of the period the rupee apprecia ted against the dollar.
Thus while rupee depreciat ion would have a posit ive impact on majority of
companies in these sectors, a fall in globa l demand from histor ica l leve ls may
significantly limit the degree of the posit ive impact . Addit iona lly, aggress ive
price negotia t ion from corporate clients of such exporters may potentia l ly
furthe r limit the benefits.
More established players in pharmaceutica ls and techno logy, which typica l ly
hedge in excess of 40% of their foreign currency exposure, may have a limited upside to credit profile s. Debt servic ing of foreign currency loans by a
significant number of pharmaceutica l and text ile companies is expected to limit improvement of credit profile s.
Pharmaceutica ls
Of the 11 pharmaceutica l companies rated inves tment grade, 10 are direct ly
exposed to foreign currency risk. In nine companies, the rupee depreciat ion is expected to have a posit ive impact .
The export data pertinent to this sector tend to sugges t that globa l demand has a
higher impac t on export volumes than the rupee exchange rate.
Techno logy
The impac t of forex deprecia t ion will be nomina l for four of 13 techno logy
companies rated by Fitch. Details of the remain ing nine are provided below:
Better-es tab l ished software companies tend to hedge a higher proportion of their forex exposure than relat ive ly smaller players . Those companies that expose a higher proportion of their cash flows to forex risk would temporar i ly enjoy
higher margins, though the long- te rm risk profile may not improve given the inherent higher volat il ity.
HCL Infosys tems Limited is the only company in this group which may have a
negative impac t on margins. The company imports significant proport ion of its components, while it has signif icant fixed cost contacts for systems integra t ion and computing. However, the company has been trying to convert dollar-
denomina ted purchases into rupee-denomina ted buying.
ITES segment has exhib i ted relat ive ly higher margin expans ion with respect to rupee depreciat ion than pure software players. The sector may benefit agains t
33
competito rs from countr ie s such as the Philipp ines whose currency has apprecia ted relat ive to the rupee (see Append ix 1).
Mining (Iron Ore)
Fitch‟s portfo lio of mining companies mainly comprises iron ore miners. These
companies derive about half of their revenues from exports. Of the six
companies in this sector, which are rated in inves tment grade, five are direct ly
impac ted by rupee deprecia t ion.
Textiles
The rupee depreciat ion would have a overall posit ive impact on the texit le
sector. However, the degree of positive impac t will be more limited than observed histor ica l ly given the muted demand in customer countr ies . Histor ica lly export volumes for segments such as cotton yarn/fab r ic and
synthe t ic yarn/fab r ic have benefit ted the most from rupee deprecia t ion. The export volumes of ready-made garments had limited benefit of rupee
deprecia t ion in the past. Incrementa l volume growth may not be expected, particula r ly in cotton textile (as it is relat ive ly less affordab le than synthe t ic s ) and ready-made garments.
Addit iona lly, the extent of margin benefit may be muted for more well
established players who tend to hedge substantia l portion of forex exposure. For
instance, Bhart iya Internat iona l Limited („Fitch A−(ind )‟ /S tab le‟ ) hedges up to
70% of its forex exposure . For Orient Fashions Exports Private Limited („Fitch
BBB−(ind) /S tab le‟ ), the forex gain has been negated by forward hedge posit ions
at a lower- than-p reva iling USD/INR exchange rate.
Gems and Jewellery
In Fitch‟s investment grade unive rse there are two co mpanies in the gems and
jewellery sector. Suashish Diamonds Limited („Fitch BBB‟/Stab le ) is an
exporter and would like ly be positive ly affected operationa lly. BC Sen &
Company Limited is a domestic jewelle ry retailer . Most gem and jewellery
exporters are expected to have a benefit operationa lly. However a lot of such
exporters were thus far genera t ing signif ican t „other income‟ because of the low
US dolla r Libor rate, a high domestic fixed-depos it rate and favourab le
dollar /rupee forward rates. This income was often 12% to 15% of the PBT of
such companies . However, this profit opportunity is like ly to diminish given the
reduction in domestic deposit rate and a rise in dollar /rupee forward rates. Thus
the observab le incrementa l benefit to margins (due to rup ee deprecia t ion) may
actually be negated in case of some companies .
Importe rs With Ways to Mitigate Depreciat ion
This group essentia l ly consis ts of indus tr ie s that are net importers. They are usually able to pass on cost hikes from the rupee deprecia t ion either due to IPP
34
norms followed in the industry (eg oil and gas, steel and non-ferrous metals) . However, there are sectors such as auto ancilla ry where the cost rise is passed
on to the origina l equipment manufacturer (OEM) as per contract .
Auto and Related
Of the 29 inves tment grade companies in this sector, for three companies the direct impact of foreign currenc y deprecia t ion will be ins ignif icant . The details
of 26 issue rs are provided below:
Fitch-ra ted auto supplie rs are like ly to remain large ly unaffec ted by current or
even sharper rupee deprecia t ion. Within this sector there is a subsector of
companies whic h would clearly benefit from export revenue ( assuming stable
demand in their export market) while the other subsector would consist of
companies that are net importe rs but would be able to pass through to the OEM
a significant portion of the price rise due to rupee depreciat ion.
Net exporters such as QH Talbros Limited , Ashok Leyland Ltd., Hi-Tech Gears Limited, Minda Corporat ion Limited and Beri Udyog Priva te Limited are
expected to be posit ive ly impac ted in terms of operating cash flow.
The second subcatego ry of companies has histo r ica l ly been able to pass on the cost rise to the OEM. However Fitch believes that the auto OEMs currently
experienc ing lower demand would be resistant to the past practise. Fitch believes that these price rises would be shared through the entire auto supply chain. Thus the benefits of rupee deprecia t ion on this sub -catego ry of auto
ancilla ry companies margin would be lower than would have been expected from histor ica l observat ions .
The auto and related sector has a relat ive ly higher proport ion of companies
having a hedging strategy. Within the 29 companies in this sector, 18 have a consis tent forex hedging strategy, where on an average 40% to 60% of the foreign currency exposure is hedged. This is expected to moderate the impac t of
rupee depreciat ion.
Negative impact on operating margins may be expected on companies inc lud ing Punch Ratna Fasteners Pvt Ltd, Sterling Tools Limited and Deltronix India,
which have significant imports. However, the rating headroom is suffic ient in most instances .
Fitch notes that the Indian subsid iar ies and joint ventures of globa l suppliers would be worst hit owing to very high dependence on parents for input mater ia ls
and componen ts. Emitec Emiss ion Control Techno logies Priva te Limited is one such example.
On a posit ive note, Fitch could see stepping up of effor ts to localise some of
these imported input mater ia ls as well as the componen ts by OEMs, which
would benefit the domestic auto suppliers in the medium term.
Oil and Gas
35
The impac t of INR deprecia t ion on Fitch rated oil and gas companies can diffe r across public sector entit ies (PSE) such as IOC, HPCL and priva te refiners like
RIL and Essar Oil Ltd . Priva te refiners that import the bulk of their raw mater ia l could see their operating profitab i l ity fall in the range of 1% to 3% if
an exchange rate of INR55/USD persists. Exports for RIL (50%-60% of revenue) and Essar Oil (20%-40% of revenue ) can only provide limited mit iga t ion. Though these companies export a large part of their refined petroleum products,
the prices of many of these crude deriva t ive or petrochemica ls is determined by the demand-supp ly situa t ion of end-produc ts. This makes the pass- through of
high input prices difficu lt .
Forex borrowings for most of Fitch-ra ted oil and gas companies are low (0-20% for Essar, HPCL) to moderate (20%-50% for IOC, Petronet) except for Reliance, which has about 90% of its borrowing denominated in forex. Since public sector
enterpr ises are rated based on their strong linkages with government of Ind ia, Fitch does not expect their ratings to be impac ted by currency movements .
Reliance‟s credit metrics could be weakened because of its signif icant forex borrowings and the like ly impact of a rupee deprecia t ion on its operating profitab i l ity. However it is still like ly to remain very comfortab le for its rating
leve l.
On the contrary, the impac t of susta ined rupee depreciat ion on Essar Oil‟s operating profitab i l ity and financ ia l leverage – despite low forex borrowings –
could stretch its credit metr ic s beyond the agency‟s comfort leve l.
Metals
Globa lly, the price has fallen for ferrous and key non-ferrous meta ls over the
last 12 months (steel about 14%, aluminium 25%, copper 19%). However , due to
IPP and rupee deprecia t ion the prices in Indian market have remained broadly
unchanged from leve ls seen a year ago. Thus operating margins of Indian meta l
producers are expected to get substantia l support from the rupee d eprecia t ion
agains t globa l fall in metal prices. The extent of a benefit would depend on
degree of backward integra t ion (with respect to ore mines and links to coal
mines), with more integra ted players like ly to receive a higher benefit . This
indus try has high dependence on imported coal/coke, and would be to the same
extent, adverse ly affec ted by rupee depreciat ion.
Ferrous - Primary Steel Producers
Among Fitch rated Primary Steel producers Tata Steel Ltd (TSL) and Steel
Author i ty of India Ltd (SAIL), which have relat ive ly higher levels of vertica l
integra t ion, are expected to receive more cushion from the rupee deprecia t ion
agains t a fall in margins. However, players with limited or no vertica l
integra t ion (such as RINL) would be more adverse ly affec ted. Not only do these
companies have to import coke but the iron ore from domestic market would be
more expens ive by 10%, given the hike of iron ore by NMDC Ltd, India's larges t
iron ore miner .
36
Fitch believes the ability of steel producers to increase prices is limited because of the current weak end-user demand. Foreign currency loans will also result in
higher financ ing charges and lower net profits. However in most cases the rating is unlike ly to be affected given the suffic ien t rating headroom. The exception is
BPSL. Its export business is expected to have a positive impac t on margin. However BPSL has low rating headroom given its exist ing high leverage on account of its capacity expans ion.
Alloy/Spec ia lty Steel and Steel Products
Alloy/spec ia l ity steel producers using electr ic arc furnace for steel making are
large ly dependent on steel scrap (mostly imported ) for their operations. Globa l
scrap prices have softened by 6% as of end-May 2012 (from end-March 2012) as
agains t a steeper fall of 10% in the USD/INR rate during the same period. Such
companies usually enjoy some sourcing flexib i l ity as scrap iron may (to an
extent) be replaced by sponge iron. However, their sourcing flexib i l i ty may be
limited because of the disruption in operations of many small sp onge iron
companies located around Karnataka and Goa due to problems relating to iron
ore mining.
Indirec t Impact of Rupee Depreciation
These are companies that would essentia l ly be purchase rs of commod it ies linked to IPP. Their business models are comparab le to net importe rs to the extent that the infla ted cost (due to rupee deprecia t ion) of their raw materia ls would not be
easily passed onto the customer. These are sectors such as real estate (steel and cement comprise close to half of construc t ion cost), print media (newsprin t and
Pulp), and meta l (both ferrous and non-fe rrous) processors. While the globa l reduction in commod ity prices would have actually benefit ted their cost structure and may have boosted demand, the more than commensura te rupee
deprecia t ion has snatched away the advantage .
Impact on Sub-Investme nt Grade Issuers
Sub- inves tment grade companies are always more vulne rab le to business cycles. The direct iona l impact on operating margins may be comparab le to the sectors
in which they belong. Thus textile, pharmaceutica l and techno logy companies are like ly to make an opportunis t ic gain due to their unhedged posit ion. However they are more like ly to face drastic price renegotia t ions from their
customers.
Companies in sectors such as chemica l and metal processing are more like ly to absorb significant price rises (due to depreciat ion, which would affec t their
margins and signif icantly stress their credit profile ). The impac t on traders of processed and unprocessed commodit ies (meta ls , chemica ls , papers, rubbers) is
expected to be similar ly stressed. In each of these cases, the higher cost of invento ry, along with a possible increase in the working capita l cycle, could stress their liquid ity positions in the absence of suitab le fund ing options.
What May Change the Projecte d Outcome
37
Most of the trigge rs - - both positive and negative - - in the short term (defined as the next 12 months) are factors externa l to India. Maintenance of the rupee at
around INR55/USD1 to IBR57/US D may depend on a relat ive ly orderly resolut ion of the euro crisis ( to moderate flight to dollar -asset), a smooth
rebalanc ing of China‟s growth (to prevent furthe r deteriora t ion of sentiment towards emerging markets) and avoid ing geopolit ica l flare - ups (to prevent a spike in oil prices) . An adverse change in any of these factors may furthe r
deprecia te the rupee. This, would, however , feed into the deteriora t ing domestic balance of payments situa t ion and aggrava te it furthe r.
Given negative real interes t rates and the pressure on the exchange range,
extremely limited scope remains for moneta ry policy to correct the situa t ion. Similar ly, fisca l tools have limited scope without further affect ing the sovereign credit profile, given the high domestic fisca l defic it. Furthermore , should
inadequa te rainfa l l affec t agricul tura l output, the government may be expected to provide a stimulus to the sector as has been observed histor ica l ly. This may
aggrava te the fisca l deterio ra t ion.
Domestic policy-d r iven solut ions to address structura l issues (such as
deregula t ion of various subsid ies ) may improve investor sentiment. But these
benefits take time and the immed ia te impac t is like ly to be a higher infla t ion or
furthe r demand destruc t ion.
An analys is was performed on a group of 18 countr ie s rep resenting prominent emerging nations or countr ies that compete with India on a specific export -
oriented sector (such as textile s from Bangladesh). The countr ies whose local currenc ies deprecia ted the most agains t dollar as a group have the highest current account balance as a proportion of respective GDP. However, there are
exceptions. Examples include Mongo lia (ranked 18th, worst CAB/GDP ) and Chile (ranked 12th), whose currenc ies have depreciated less than 10% agains t
USD.
If the countr ies are ranked in terms of deteriorat ion in CAB/GDP ratio from 2011 to 2012, then the ranking sugges ts that some of the countr ies that have shown the worst deterio ra t ion are also countr ie s (Mongo lia, Chile) that have
deprecia ted the least agains t dollar . (In fact some have apprecia ted , such as the Philipp ines and China.)
Among these paramete rs (particula r ly CAB and government fisca l defic i t
related ), on an aggrega ted basis, India along with Sri Lanka, Mongolia , South Africa and Turkey have the worst deteriora t ion. The direct ion of the movement
of local currenc ies agains t the US dolla r may be driven by the fundamen ta ls . However, this fully does not expla in the huge deprecia t ion on the domestic currency value against the dollar.
For instance, Brazil (whose currency deprecia ted the most agains t the dollar),
may be comparab le with Mexico , Mongo lia, Vietnam Argentina and Chile on the basis of relat ive deterio ra t ion of these select macroeconomic paramete rs .
However, each of these five countr ies has local currenc ies that have shown relat ive ly much lower depreciat ion.
38
Impact of Globa l Risk Avers ion
Some of the countr ie s (Brazil , India, South Africa ) whose currency have
deprecia ted the most in the last 12 months are tracked in Figure 29. These
countr ie s, along with China and Russia , have been among the highes t
benefic iar ies of capita l inflows in emerging nations during the period of 2004 to
2008. Risk aversion may have reversed a signif icant portion of such capita l
flows .
39
RESEARCH DATA TABULATION & ANALYS IS
Descript ive research: The research will provide data about the "who, what, when, where and how" of a situa t ion, not what caused it. Therefore, descrip t ive
research is used for a project.
Research Design calls for decisions on the Data sources, Research approaches , Research instruments, Sampling plan and Contact method .
Data Sources:
1>Primary Data: Questions, Persona l interv iew (Sample size of few), Conference conducted by reporters for research work.
2>Secondary Data: Data from the Social Media, Interne t, Books and few European delega tes on a visit to India.
Research Approaches:
1>Survey Research: Survey’s would be conducted to find out the information
about the life sty le and importa nce of European Union. 2>Behavio ra l Data: Behavio ra l Data can also be used by going through the
databases (if availab le ) of the financ ia l Inst itu t ions and Banks and find ing out the economic state of the European Union.
3>Exper imenta l Research: Experiment Research may be used to unders tand cause and effect relat ionship between two objective variab les.
Research Instrume nt
1>Questionna ire : Questionna ire will contain both open ended and closed ended questions .
2>Psycho logica l tools : Psycho log ica l tools such as ladder ing technique, depth interview
40
FINDINGS AND CONCLUSIONS
The rupee’s decline affects everyone in the economy because it feeds direct ly
and ind irec t ly into genera l infla t ion, which is a continu in g problem even as
output growth decelera tes, and therefo re hits common people hard. There are
severa l ways in which the falling rupee immed ia te ly has an infla t ionary impac t ,
one of the most important of which is the price of energy. Since the misguided
decontro l of oil prices, it is not only the globa lly traded price of fuel but also
the exchange rate that determines domestic oil prices. Going by the way the
economies in the euro zone and the US have been behaving, it would be naïve to
expect that the export earnings would be contr ibuting significantly to foreign
exchange inflows in the near future. The govt should concentra te
On correcting the economic fundamenta ls rather than indulge in soap operas in a
run up to the elect ion. A better co-ordina t ion with RBI is required rather than
blame game.
Apart from all the polit ica l parties should come togethe r in fixing the problem
and gett ing back the inves to rs confidence.
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BIBLIOGRAPHY
http:/ /www.academia.edu/4169109 /F ac to rs_a ffect ing_ the_ f luc tua t ions_ in_excha
nge_rate_o f_ the_ Ind ian_Rupee_Group_9_C2
http:/ / ind ia ra t ings .co . in /up load /resea rch/spec ia lReports/2012/7 /3 /fi tch03Rupee.pdf
http:/ / ileadko lkata.wordpress. com/2013 /11 /08 /rupee -deprec ia t ion-and- i ts-impac t/
http:/ /www. ind ias ta t. com/a rt ic le /59 /nik hil/ ful l%20 text .pd f
http:/ /www.the leg is t. ne t / li fea f/2012-05-19-12-44-16 /f inance /55-rupee-deprecia t ion
http:/ /www. ii tk .ac . in/ ime /MBA_IITK/avantgarde /?p=1203
http:/ /www.cac lub ind ia. com/a r t ic le s/rupee-dep rec ia t ion- and- its- impac t-on-economy-an-overview-17954.asp#.UuDDj9K6bIU
http:/ /omegagoons. com/2013 /08 /deva lua t io n-o f-rupee- its-causes- impact- and-remedy/
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