General awareness on current topics is essential as not only you will be getting questions on GK in various MBA entrance exams but it will be useful for Essay writing test and WAT also.
Today, you will read General Awareness Topic: “Depreciation of rupee and it’s impact”
Price of a currency in respect to other country’s currency is called as exchange rate. The price of a currency moves upward or downward depending upon the demand and supply forces. If a demand for a currency rises, its price rises and it is called as appreciation, on the contrary, if the demand of other country’s currency increases, the home currency’s price falls and it is called as depreciation. Indian rupee has depreciated more than 26 per cent since 2011.
The persistent decline in rupee is a cause of concern. Depreciation leads to imports becoming costlier which is a worry for India as it meets most of its oil demand via imports. Apart from oil, prices of other imported commodities like metals, gold etc will also rise pushing overall inflation higher.
Even if prices of global oil and commodities decline, the Indian consumers might not benefit as depreciation will negate the impact. The depreciating rupee will add further pressure on the overall domestic inflation and since India is structurally an import intensive country, as reflected in the high and persistent current account deficits month after month, the domestic costs will rise on account of rupee depreciation.
Exchange rate risk also drives away foreign investors which in turn depreciates the local currency. Indian Rupee is currently caught in this vicious cycle; it will have to find a stable level to regain investors’ confidence. The depreciating rupee has serious effects on the external debt figures of the nation.
Owing to uncertainty prevailing in Europe and slump in international market, investors prefer to stay away from risky investments. This has significantly affected the portfolio investment in India. Consequently, flow of dollars start decreasing with respect to demand, and thus resulting in the fall of Rupee. Credit rating agencies also downgrade India’s rating.
Any outward flow of currency or decrease in investment will put a downward pressure on exchange rate. This Global uncertainty has adversely impacted the domestic factors (current and capital account etc.) and caused the depreciation of rupee.
While a country like China will be more than happy with a depreciating currency, the same doesn’t apply for India. China exports more than it imports, thus a depreciating currency makes its exports cheaper in the International market, in turn making China more competitive.
India on the other hand does not enjoy this luxury, mainly because of increasing demand of oil, which constitutes a major portion of its import basket. The fall of oil price to $90/barrel has helped India to fight the depreciating rupee up to some extent but at the same time Euro zone, one of the major trading partners of India is under severe economic crisis. This has significantly impacted Indian exports because of reduced demand. Thus India continues to see current account deficit.
Higher real interest rates also attract foreign investment but due to slowdown in growth there is increasing pressure on Reserve Bank of India (RBI) to decrease the policy rates. Under such conditions foreign investors tend to stay away from investing. This further affects the capital account flows of India and puts a depreciating pressure on the currency.
Key policy reforms like Direct Tax Code (DTC) and Goods and Service Tax (GST) have been in the pipe line for years. A retrospective tax law (GAAR) has already earned a lot of flak from the business community. Attempts are being made to control the subsidy bills but fiscal deficit continues to hover around 5% of GDP. This has further made investors sentiment negative over the Indian economy.
Primarily the consequences of weak rupee are to be felt through:
• Increase in the Import Bill: depreciation of the local currency results in higher import costs for the country. Failure of a similar rise being experienced in the prices of exportable commodities is going to result in a widening of current account deficit of the country.
• Higher Inflation: Increase in import prices of essential commodities such as crude oil, fertilizer, pulses, edible oils, coal and other industrial raw materials are bound to increase the prices of the final goods. Thereby making it costlier for the consumers and hence inflation might be pushed up further.
• Fiscal Slippage: The central government fiscal burden might increase as the hike in the prices of imported crude oil and fertilizer might warrant for a higher subsidy provision to be made for these commodities.
• Increase in Cost of Borrowings: Interest rate differentials in domestic and global markets encourage the industry to raise money through foreign markets however a fall in the rupee value would negate the benefits of doing so.
The advantages from depreciating Rupee to the export industry have been negated by its adverse effect on inflation, sluggish demand from western world, and increase in oil imports.
Therefore, stability in exchange rate is required to stabilize the economy and bring in additional investments. RBI can sell forex reserves and buy Indian Rupee leading to demand for rupee. But using forex reserves poses risk also, as using them up in large quantities to prevent depreciation may result in a deterioration of confidence in the economy's ability to meet even its short-term external obligations.
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Moreover, interest rates can be increased to prevent sudden capital outflows and will ultimately lead to higher capital inflows. But India’s interest rates are already higher than most countries. This is done to tame inflationary expectations. So, further increase in interest rates would lead to lower growth.
However, RBI can increase the FII limit on investment in government and corporate debt instruments. It can also invite long term FDI debt funds in infrastructure sector. The ceiling for External Commercial Borrowings can be enhanced to allow more ECB borrowings.
Government should take some measures to bring FDI and create a healthy environment for economic growth. Key policy reforms that should be initiated include rolling of Goods and Services Tax (GST), Direct Tax Code (DTC) etc.
The Indian Rupee has depreciated significantly against the US Dollar marking a new risk for Indian economy. Grim global economic outlook along with high inflation, widening current account deficit and FII outflows have contributed to this fall.
Steep fall in exchange rate will affect almost every sector either directly or indirectly, therefore, reforms measure should be undertaken to instill the confidence among the investors by assuring business friendly environment in order to make country move on the high growth path once again.