By Anjan Roy
The Indian currency has depreciated beyond the psychological level of Rs 90 to a dollar in course of trading during Wednesday. It closed at 90.22 at the close of trading.
It now looks as though the Indian rupee is inevitably set for continuous depreciation. Some traders and financial markets operators are airing such views to the financial press. But in the worst of times, in 1992, when the rupee was first put to float, it showed surprising strength. It did depreciate sharply, but then it stayed calm for a long while.
In March 1993, when the rupee became fully market based it stood at 31.52 to a dollar. A decade later, it had depreciated to Rs 48.39 but then it rebounded robustly to Rs 40.28 in 2007-8, just before the global financial melt-down. After the global financial meltdown, rupee depreciated again to 47.44 in 2009 again to recover somewhat in a year.
The next phase of rupee depreciation had come after the taper tantrums since when the rupee has been going down.
In contrast, the Chinese renminbi had remained rock solid against the US dollar for what now seems ages. Why is that so. The answer can be found in the sharp differences in the fundamentals of the two economies. China has developed a massive manufacturing industry and it grown immensely in the intervening years, which sets it apart from all others.
Exchange rate fluctuation reflects several aspects of the functioning of an economy. The current fluctuations in the rupee exchange rate are the end result of uncertainties in the global markets and economy; more fundamentally, these could also reflect the divergences between the domestic economy and the global economy.
The current slide in the exchange rate of the Indian rupee against the US dollar points at these twin factors — while the global turmoil and uncertainty put pressure on the rupee, the inflation differential between India and its major trading partner also played a role. The adverse impact of these factors have further been compounded by the continuing low factor productivity.
The shortcomings of the real economy are now being morphed into a financial markets fall through the exchange market. Rupee’s depreciation against the dollar is a reflection of the troubled global economic situation and its transmission into the Indian economy.
The primary trigger this time came from the sharp hike in withdrawal of funds by the foreign institutional investors —FIIs. The FIIs have taken out close to $1 billion in November alone.
When the global economic situation becomes uncertain, such as at present, large investors re-work their investment positions. Generally, they show a marked preference for dollar denominated assets because the dollar remains the single most important currency and it is least prone to depreciate against other currencies.
Foreign institutional investors are withdrawing their funds from the Indian stock and debt markets and at the same time taking their money out of India. As they convert their sales proceeds into the US dollar, the rupee comes under stress and depreciates.
This is the nexus seen every time there are disturbances on the global markets and prospects. The Indian rupee had depreciated considerably during the global financial melt-down in 2008-09. In course of that instability the rupee had lost from around Rs 40 to a dollar to much lower levels around Rs 50.
Thereafter, the rupee had come under pressure in the years known as “taper tantrums” as the US Federal Reserve was working to reverse its monetary policy stance of large accommodation to prop up the US dollar and subsequently cutting down the large fund infusion.
During the years of taper tantrums, the rupee had fallen from around Rs 50 to over Rs 60 to a dollar.
Now, once again, the Indian economy is facing uncertainty as the US slaps high tariffs on Indian goods exports to USA. These tariffs drive Indian exports out of the US markets by making these costlier vis-a-vis the exports from other countries.
In fact, Indian exports to USA, one of the largest markets, have dropped. This means India earns less dollars and therefore there would be lower flow of dollars into the country compared with dollar outflow on account of withdrawal of funds from India by the foreign institutional investors or FIIs.
In addition to these market level plays, there are some fundamental factors at work too. Some of the perceptive market players have pointed at these factors. Indian inflation rates at 5%-plus compared with the inflation rates of less than 2% in other major economies, make for a reflection of these factors on the currency.
Others have also pointed at the productivity levels in India and overseas economies. That is, for every unit of inputs Indian labour produces less of the end product. That means we are less efficient than producers abroad and it reflects on the overall competitiveness.
All these factors are combining to drive the rupee value down, but as of now, the basic factor which is giving rise to the sudden loss of value of the rupee is the spurt in sales by FIIs in the Indian stocks markets and subsequent remittances from India to their more lucrative markets in USA. (IPA Service)
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