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Weakening Rupee: It's causes and effects

Weakening Rupee: It's causes and effects

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: Weakening Rupee: It’s causes and effects
It is generally believed that Europe's economic crisis, growing import bill, external debt amounting to nearly 20 billion US dollars maturing in 2012 are all putting pressure on already stressed rupee.
It is generally believed that to prevent the tremendous upheaval in the exchange rate, central bank could play an important role. But Reserve Bank of India has been avoiding intervening in recent foreign exchange upheaval. Reserve Bank says that its intervention can cause more harm.
Country's currency weakness could be a boon to exporters, because they benefit from weak rupee. However, falling rupee is making life difficult for the commoners, as falling rupee is making imports dearer, especially the petro products, fuelling inflation. Weakening of rupee means more rupees to be paid per dollar of imports. 
Each year the country spends nearly 140 billion dollars on import of crude oil, which means with depreciation of rupee by 25 per cent, the country would be shedding more for its imports of crude oil, which is price inelastic. So our trade deficit will get further widened. The oil companies will raise prices of petroleum products, spoiling the budget of the middle class. Already fleeced due to inflation, the common man will get further hit with this. Depreciating rupee may cause our raw material and metal imports to become even more expensive; hiking the production cost for industries.
The movement of rupee depends on several factors. The important ones being the interest rate regime, fiscal deficit, export and foreign investment in India. The foreign exchange market is very big to be controlled by any central bank. The Reserve Bank of India (RBI) tries to arrest the rupee movement by asking state-owned banks to buy rupee in the forex market. But, this provides only temporary relief.
Fiscal deficit of a country is an important factor that drives the currency of that nation. Higher deficit means the government will have to pay more and also print more rupee notes. This would result in excess supply of rupee in the market, leading to inflation and reduction in its value.  Similarly, current account deficit (CAD), which represents the net of import and export, results in more obligations for the country to make its payments in foreign currency.
General Anti-Avoidance Rule (GAAR) proposed by the government has been termed as negative for FIIs investing in India, through companies in Mauritius. The rule, if implemented, is likely to burden FIIs with more tax, thereby reducing the net profit. Foreign companies may reduce their investments in India. Obviously, this would lower the demand for the Indian rupee and weaken it further. The current crisis in the Euro zone may make investors more risk-averse. As a result, they may reduce their asset exposure from emerging economies like India, thereby selling more rupees. 
As far as impact of weak rupee is concerned, first, a weak rupee would push up the fiscal deficit further. India imports around 70% of its requirement of crude oil and the government will have to pay more for it in rupee terms. Due to the control on oil prices, the government may not be able to pass on the high prices to the consumers. This strains its finances and leads to an increase in fiscal deficit. Also, higher oil prices would also push up inflation, which is perilously close to the double-digit mark. Companies will also have to pay more in rupee terms for their raw materials, despite the fall in global commodity prices, due to a depreciating rupee. More importantly, a weak rupee could negatively impact FII flows into the Indian markets.
Companies which export goods and services to the US are the main beneficiaries of depreciation of the Indian rupee. They receive their revenue in US dollars whereas their major expense is in the Indian rupee. With rupee depreciation, their rupee-denominated revenue will continue to grow even though there is no change in expense. Information Technology (IT) is one such sector, which receives more than half of its revenue from the US.
The sectors that use heavy machineries usually import them from outside India. These items are very expensive and require a huge amount of initial cash outflow. Typically, companies borrow in foreign currency, also known as ECB (external commercial borrowing) to finance their investments. The interest and principal repayment is spread over several years. When the rupee depreciates, these companies have to shell out more rupees to meet their payment obligations. Those which are planning to set-up a new machinery at this point of time would be the worst hit. Companies in telecom, power and infrastructure are the likely target of this category.
Thus weak Rupee is affecting almost all the sectors of the economy. Gradually with more global linkages, effect of exchange rate movements will be more acute on different sectors. Therefore stability in exchange rate is essential for stability in economy and this stability will not be assured by buying and selling of dollars by RBI but by stable growth of both export and import based industries of the country,