Everyone has been expressing
worries over the rupee losing substantially against the dollar. Indeed, there
is something about this that should induce the feeling of worry. However, there
are certain things that need to be kept in mind before we comment upon this.
Presented below are some of the key facts and theories that should be
associated with the context before taking a decision.
What happened?
Over the past week, there have
been some strange movements in the financial markets across the globe which has
drawn eyes from all over. In context of India, some important observations are
–
·
Rupee fell to an all-time low of ₹58.90 against
the US dollar.
·
The stock markets crashed with Nifty falling
below 5800 and Sensex also losing 300 points
·
The prices of oil are expected to be increased
by the end of this week
·
Something worth noticing is the net cash outflow
of FII investments
On a close analysis, there are a
lot of interlinked relationships that undermine how the economy would behave
over the next week and what it means for you. In this post, I have tried to
explain the underlying concepts and link them with the facts in hand in order
to grasp a bigger and closer look at the situations in hand.
The reason for the downfall
Understanding economics is
generally very easy. There is a big possibility that we establish the link
between the cause and the effect. Nevertheless, the dispute arises when we are
unable to determine whether an event serves as the cause or the effect! This
fallacy is an inevitable part of economic analysis. In the given case,
something similar happened.
According to experts, the basic
reason for the downfall of the rupee is the heavy sale of debts by FIIs in
India. Think of it this way, a lot of institutions from abroad had invested
money in India in the form of debentures or bonds. Now, they suddenly began
withdrawing their investments. How do they do this? Simply by selling the bonds
in India and realising rupee; and then by SELLING the rupee to convert it into
dollars and taking the dollar away! When the price of rupee begins to fall,
other FIIs who have not sold the investments yet start to worry. This is
because the value of their investment is likely to fall. Consider it this way –
had I sold my investment to withdraw money earlier, I could have got $ 1 for
every ₹ 55. However, now I shall have to sacrifice ₹ 58 to get one dollar
(which means lesser number of dollars). This fear induces a further sale of
investments and lead to a further fall in the price of the rupee!
The impact on the stakeholders
The news regarding the rupee
crashing against the dollar has been in hype for quite a while now. It is
apparent in such situations for everyone to be curious about how this
significant change would impact their lives. Therefore, I have shortlisted some
of the key observations that people may find interesting and important with
regard to this economic observation –
The importers
Due to the depreciation in rupee,
the purchasing power of the rupee has gone down. Therefore, the importers will
find it costlier to pay the import bills. Since India is largely dependent on
import, this is a reason to worry. Many companies that import raw materials
will find that it clearly affects the cost. Most likely, the cost of
depreciation will be transferred to the ultimate user who will then face
increased cost.
The exporters
On the contrary, exporters have a
merry time. Indian industries, such as the IT industry considers it a good news
that the rupee is depreciating since it would mean a higher rupee earning for
their export bills which are mostly denominated in the US Dollar. It is
expected that the IT Industry, pharmacy and the BPO industry will be the
largest gainers in this case.
Indian investors – stock market
As the fact speaks, stock prices
are expected to tumble as a result of the rupee depreciation. However, it is
interesting to observe that the exodus of the FIIs from the debt market has not
been observed in the equity market. This means that the present downfall in the
equity market is more due to the sentiments of Indian investors and not due to
FIIs. In my view therefore, the stock markets will not continue this behaviour
in the future and should recover soon.
Foreign Institutional Investors
In the debt market, most of the
FIIs have already started exiting the Indian markets. A big reason for this is
that the dollar is on the rise. That is to say, it is not the weakness of rupee
but the strength of the dollar that is affecting it this way. The world economy
has realised that the dollar would rise in the future, owing mainly to the
Eurozone crises. In this case, it is generally advisable to invest in the
dollar rather than the rupee. For this reason, the FIIs are expected to
continue exiting from the Indian market. This will lead to a further rise. In
my view, some corrective action by the market regulators like the RBI is
required to prevent this from happening.
It has been observed that the RBI
had actually intervened in the market by using its forex reserves to purchase
Indian Rupee and thereby increasing the demand (and stabilising the price fall
in the process). However, no significant action has yet been observed.
Borrowers
There are many organisations that
have purchased debt from abroad. In other words, they have borrowed money from
the US banks. For them, this is a bad news. They have to account for interest
which is denominated in the dollar. It is interesting to note that a similar situation
arose back in 2009 and heavy losses were depicted in the accounts of many
companies. We should recall how AS-11 was amended to allow the companies to
debit those losses over a period of time.
Generally speaking, the fall in
the value of rupee will have a direct impact on the financial results of most
of the Indian corporates; except maybe those that are net exporters (such as IT,
Pharmaceuticals etc.). However, most of these exporters hedge their positions,
which is why they may not gain extraordinarily.
The consumer – you and me
The consumers will generally have
to bear the high cost of imports. The most significant impact will be observed
in the petroleum industry. The Economic Times has already reported that the
prices of oil are likely to increase by the end of this weekend. Apart from
oil, imported products in general would get costlier. It should be noted that
currency depreciation has a direct impact on inflation.
Lenders (Investors)
There are many people who invest
their money in bank accounts in anticipation of interest. It is interesting to
analyse how the interest rates in India will move as a consequence of this.
Generally speaking, when the investments move out of the country, the demand
for Indian rupee falls. As a result of this, the interest rates also fall.
However, in case the RBI decides to intervene, a very major tool (apart from
using the forex reserves) is to increase the interest rates in India.
When the interest rates in India
increase, it will lure investors from abroad and will therefore allow the rupee
to gain again as the demand for rupee rises. However, it should be noted that
any such step will have a direct impact on the inflation. Therefore, a lot
depends on how the central bank seeks to solve this situation.
The irony worth noting
The basic reason why the rupee
began to fall is not an inherent weakness in the rupee, but a visible strength
in the dollar. Think of it this way, the dollar is anticipated to rise in the
future and so everyone expects to invest in the dollar. All other investments,
whether in rupee or in any other currency are consequently withdrawn. This is
evident from the fact that the Indian Rupee is not the only currency that has
seen a steep fall in the recent time.
Therefore, there is not much to
worry. As the rallying towards the dollar stops, FIIs will be attracted towards
all the markets as such. The chief economic advisor to the government was
yesterday reported as saying that the government is ready for short term intervention
(such as selling the dollar by using up the forex reserves) but no fundamental
intervention is required. What he probably meant was that there is no reason
why the interest rates should be tampered with in this situation.
Rupee cheaper and money dearer
In the whole process, the net
impact will be saddening due to the fact that the purchasing power of the rupee
has gone down. Now, as a whole, you will be able to buy lesser material for the
same amount of money than you used to buy earlier. This means inflation, in all
the aspects of the term.
However, as I pointed out
earlier, this is not an inherent weakness in the rupee which is causing this
demise. It should be noted that rupee is amongst a barge of currencies that are
being offloaded to invest into the dollar. How long the arbitrage continues
depends on the inherent strength of the dollar, which is not so easy to
determine. The good news is that many of the Indian companies had hedged their
positions against the falling rupee. Due to this, the losses are likely to be
restricted.
The future seems dismal, but
there will be a sunlight soon. How soon? Well, we will have to wait and watch!
CA. Palkesh Asawa
Mumbai, India
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