On August 15th 2018, while the country was celebrating the Independence Day came a surprise fall in the value of Rupee. Rupee had hit an all-time low of ₹70.67 for 1$. The value of all the Asian currencies started falling down. However, India is the worst performing currency in Asia having surpassed the psychological barrier of ₹70. Earlier, on 20.1.2016, it crossed the value of the Rupee crossed ₹68 and on 4.9.2013 it touched ₹68.62 a dollar.
India is not the only country affected by such fall in the value of their currency. Argentina is one of the worse-hit countries, with its currency (Argentine Peso) losing more than half of its value in 2018. Though their Central Bank has increased the interest rates by 15% to restore the value and control the inflation, it has still not regained the confidence of its investors. This, along with the domestic crisis, has made the situation worse. The Turkish Lira had also lost almost half of its value from May to August of this year, and it is still on the downward slide. It has lost more than 40% against the US Dollar due to the deteriorating relations with USA. The continuing decline may send the country into a banking crisis and slow down the economic activities in the country drastically. Further, Indonesian Rupiah, South African Rand, Mexican Peso are a few other countries which are affected, among them Indonesian Rupiah is the worst affected. Some of the economists say that it is a very big and bad news, whereas some say it may not be as big of a problem as it is portrayed.
Reasons for the steep fall in the value of Rupee
• Trade war between China and USA between the two economic giants: USA and China have been slamming each other with tariff on a wide range of items running into billions. This not affects the trade between the two countries but also other countries. This war has weakened the Indian Rupee.
• Global economic slowdown
• Increase in the crude oil prices: With the break-down in the USA-Iran nuclear deal and the imposition of sanctions against Iran, the cost of crude oil has increased. The price of Indian crude oil imports has increased from $52.49 in April last year to $63 in March, 2018. India needs more dollars to meet the rising demand and to meet the cost of the crude oil. India being the third largest importer of crude oil is badly affected by the increasing oil prices.
• India’s trade deficit: India’s import bill is rising when its export contribution to the country’s GDP has a hit a 14 year low. The trade deficit has increased to $156.8 billion during the financial year 2018 when compared to $105.72 billion during last year. This means that we have to spend more dollars to buy from other countries than selling goods and services to other countries, leading to weaker Rupee.
• Withdrawal by FIIs (Foreign Institutional Investor): The FED (Federal Reserve System – central banking system of USA) has been gradually increasing its interest rates. In 2018 the FED increased its interest rates from 1.5% to 1.75% (in March) to 2% (in May). This has induced Americans, who were previously investing in foreign countries like India, to withdraw their investments and invest in FED. This has led to a decline in foreign investments in India from ₹24,608 crore in October-December 2017 to 19,823 in January-February 2018. The net withdrawal increased to ₹46,600 crore by the end of June.
The effect of falling rupee value
• The import of oil has become costlier and will continue to do so till the increase in the output by OPEC to meet the shortfall in the export of oil due to sanctions against Iran or lifting of sanctions on Iran.
• With the fall in the value of the Rupee all the imports in general will become more expensive and the export will become cheaper. This means we will pay more for the same amount of goods we have been importing before and USA will pay fewer amounts for the same amount of goods they were exporting before. Theoretically, our exports should increase as more and more will be exported since it has become cheaper. This will go on until the exports become costlier bit by bit and have reached a level equal to that of imports. And imports should decrease as it has become more expensive. It will decrease until it is equal to the exports.
• As the imports are expensive, the raw materials we get will be expensive. The products we make using these expensive raw materials will cost more. If these products are exported then the exports will be costly. Expensive imports have indirectly increased the price of exports. But this does not happen in real life. As mentioned, India mostly exports materials which are used as raw materials, which are also used to make domestic products too. This will increase the prices of domestic products.
• Increase in the price of goods and the increasing petrol prices will lead to inflation (a situation where the prices of good and services increase, decreasing the purchasing power of the currency – how much you can buy with one Rupee). Meaning, there will be a further decline in the value of Rupee. Inflation plus less FII will result in the decrease in the GDP (Gross Domestic Product – the monetary measure of the amount of good and services produced in a country yearly/quarterly).
• Due to the decline in FII, there will be less investment. India has already lost a huge amount of foreign investment, which is crucial for development of any business and growth of the economy.
To arrest the falling value of Rupee, the government on 14th September, 2018 has announced certain measures. The government has stated that it will take necessary steps to cut down the non-essential imports and increase the exports. To attract forest investors, the government has decided to review the present cap of 20% of Foreign Portfolio Investors (FPI- investors who hold a short term view on the company) investment in a single corporate entity and other conditions. To encourage Indian corporates to issue Masala bonds (Masala bonds are rupee dominated instruments issued abroad by Indian borrowers which are not affected by the depreciation in the Rupee), the government has exempted them from withholding tax. The government has decided to review the mandatory hedging condition for infrastructure loans borrowed under the external commercial borrowing (ECB) route. The manufacturing companies borrowing upto $50 million through ECBs will be able to do so for one year as against the three year term allowed earlier.
The trade war between USA and China, the lifting of sanctions on Iran and fall in the crude prices are not going to happen in the next two to three years. Hence, the government should come up long term solutions to strengthen the weakening rupee.