This presentation explains the recent depreciation of rupee against dollar, in the backdrop of European Debt Crisis and India's domestic woes. It also reflects on the possible solutions to this dramatic fall and its impact on us.
2. The Situation
Rupee has continued its downfall over the course of
the previous year.
As on May 22nd, 2012, it plunged to a a low of Rs.
55.70 against the $.
3. Blame it on a global trend
Recently, Dollar has gained in value against a lot of
major currencies, namely, the Euro (A year back one
dollar was worth €0.71, now it’s worth €0.78.), the
Swiss Franc (A year back one dollar was worth 0.88
Swiss francs, now it is worth 0.93), the Brazilian Real
(It was worth around 1.63 real a year back. It is now
worth over 2 real.) and the INR (It touched a low of Rs.
55.91 and is expected to touch Rs. 60)
However, the Dollar has also lost against the
Japanese Yen (A dollar was worth around 82
Japanese yen around a year back. Now it’s worth
around 79.5 yen.)
4. Blame it on a global trend (contd.)
In the face of European economic crisis, large
institutional investors have moved out of the Euro and
into the Dollar.
In spite of the fact that the debt of the US government
($14.6 trillion) is almost equal to its GDP ($15 trillion),
the world at large is considering the dollar to be a safe
haven and moving money into it by buying US treasury
bonds.
The conclusion is that not all countries have lost value
against the Dollar, and those that have lost value
have lost it in varying degrees.
There are other individual issues at play as well when
it comes to currencies losing value against the dollar.
6. High current account deficit:
When a country’s imports of goods are more than its
exports, it means that is paying more than it is making
in terms of the currency in which it is trading. (paying
more dollars than we are making)
This difference has to be purchased from the market
where the basic principles of demand and supply
determine the price of the currency. It means that the
foreign exchange market has an excess supply of
rupees and a shortfall of dollars. This leads to the
rupee losing value against the dollar.
This is what we are witnessing currently. The situation
has been similar over the last few years. In fact, in
2011-12, India ran a trade deficit of $185 billion
7. Why are our imports more than our
exports?
Our nation has an unquenchable thirst for gold and oil.
Since we dont have much of either, we have to import
these. Oil is sold in dollars. Hence, when India needs
to buy oil it needs to pay dollars.
But with the rupee constantly losing value against the
dollar, it means that Indian companies have to pay
more per barrel of oil in rupees. It is actually a cycle,
where falling rupee leads to higher oil bill that in turn
leads to increased subsidy burden on the government,
leading to higher fiscal deficit that leads to a higher
trade deficit leading to a depreciating rupee.
8. Why are our imports more than our
exports? (contd.)
The government of India does not pass on a major
part of the increase in the price of oil to the end
consumer and hence subsidises the prices of diesel,
LPG, kerosene, etc.
This means that the oil companies have to sell these
products at a loss to the consumer. The government in
turn compensates these companies for the loss.
This leads to the expenditure of the government going
up and hence it incurs a higher fiscal deficit.
10. High Fiscal Account Deficit
Where does the government get money to pay for the
imports? By running a high fiscal deficit. The huge
increase has happened due to the subsidy on food,
fertilizer and petroleum.
Every year, in the budget, the finance minister
estimates the amount of subsidy the government will
have to bear. But instead of providing for the
expenses, the expenses are underestimated in favor
of a populist budget.
In 2011-12, the fiscal deficit had been estimated at
4.6% of the GDP as against the actual of 5.9%.
11. High Cost of Subsidies
Generally, all the three subsidies of food, fertiliser and
petroleum are underestimated, but the estimates on
the oil subsidies are way off the mark.
For the year 2011-2012, oil subsidies were assumed
to be at Rs 23,640crore. They came in at Rs 68,481
crore.
In 2010-2011, he had estimated the oil subsidies to be
at Rs 3,108 crore. They finally came in 20 times higher
at Rs 62,301 crore.
In 2009-2010, the estimate was Rs 3,109 crore. The
real bill came in nearly eight times higher at Rs 25,257
crore (direct subsidies plus oil bonds issued to the oil
companies).
13. Solution (Short Term)
Stop subsidies on oil products and pass the burden to
the consumer. If these products are priced correctly,
their consumption is likely to come down as well in the
near future, given that their prices will go up.
Lower consumption is likely to lead to lower imports
and thus a lower trade deficit. A lower trade deficit
would also mean that the fall of the rupee against the
dollar may stop.
This, in turn, would mean a lower price for the oil we
import in rupee terms and that in turn helps overall
economic growth.
But of course, it’s easier said than done.
14. Solution (Long term)
An obvious solution to the high deficit is increasing the
earnings (tax collections).
But with a populist government, corruption and several
corporate lobbies, that is a different story altogether.
15. Is this trend benefiting anyone?
Theoretically, a falling rupee should benefit anyone
who is earning in Dollars.
For example, $100 billion Indian IT/BPO industry
earns revenue in Dollars/foreign currency, so their
margins should improve.
However, with most companies hedging their earnings
well in advance, the current fluctuation may not make
huge difference.
In fact it hampers the planning process for managing
volatility.