The Drowning Currency - Rupee Depreciation to Hurt India

Posted in Finance Articles, Total Reads: 2107 , Published on 01 December 2013

Indian economy has been going through a rough phase for the past few years. Declining exports, increasing inflation, falling GDP, poor manufacturing sector outlook, increasing NPA’s of banks are some of the major problems that India is facing. This coupled with the depreciating currency has made the matter worse. Since March 2012, rupee has depreciated by more than 20% vis-à-vis US dollar (Figure 1), 16% vis-à-vis pound sterling, 19% vis-à-vis euro. On July 8, 2013, rupee breached the 61/USD mark and touched a record low of 61.20 a dollar.

Image Courtesy: David-Castillo-Dominici,

Persistent rupee depreciation has adversely impacted the profitability of various industries, widened the current account deficit and has also fuelled inflation that has adversely impacted the common man. It is also undermining the government and RBI’s effort to bring economy back to growth trajectory. Depreciation of currency has become a major concern for both Ministry of Finance and Reserve Bank of India. If certain important steps are not taken than fall in the value of rupee will have some serious impact on the long term growth prospects of the country.

Figure 1

Here is a detailed analysis of the factors that have caused depreciation of Indian rupee, possible effects of it on different sectors and industries, policy measures taken by RBI to arrest the fall of rupee and effects of these measures on the economic outlook of the country.

There are basically four factors that have led to the depreciation of rupee

1. Strong Dollar

In the past two years, demand of dollar has increased significantly. This increase in demand can be attributed to increased confidence of investors in US economy. A marked improvement has been observed in US labor market and US equities have also performed well. Also, with euro zone still in crisis, investors are preferring Dollar over Euro. Investors are opting for capital preservation rather than capital appreciation. This increase in demand of dollar has resulted in its appreciation vis-à-vis other countries.

2. Crude price

Price of crude is one of the major factors that have contributed to depreciation of rupees. India is one of the major importers of crude oil. Increase in demand of oil all over the world combined with its shortage resulting from the political uncertainties in Arab countries, has lead to increase in price of oil. Rising crude price (Figure 2), on the other hand, has resulted in a higher demand of dollar since crude oil is quoted in dollars. This rising demand of dollar in turn has weakened the Indian rupee. It might be the case that Indian economy is at the initial stage of J-curve effect with respect to the demand of oil but till the effect reaches its maturity, rupee is expected to depreciate further.

Figure 2

3. Decline in Investor Confidence

India has witnessed a massive decline in investor confidence. Overseas investors have pulled out a massive Rs 44,162 crores from the Indian capital market in the month of June, 2013 itself. The efforts by the Ministry of Finance to infuse confidence in foreign investors have so far failed miserably. Declining FII and weakening currency actually results in a vicious cycle. FII outflow results in currency depreciation and currency depreciation, on the other hand makes it less attractive for the investors to invest in the currency.

4. Import-Export Mismatch

India for long has been facing an import-export mismatch; imports far exceed exports resulting into a persistent current account deficit. This in turn leads to another vicious circle. Persistent CAD leads to currency depreciation; depreciated currency further increases the price of imports which in turn further adds to the current account deficit. Figure 3 depicts the widening current account deficit to GDP ratio since 2004-2005. As we can see that this ratio has continually been increasing and it is expected to increase further this financial year. As of June, 2013 India’s current account deficit already stands at staggering $ -18.1 B.

Figure 3

Adverse impact of weakening of rupee can be witnessed on various sectors and across various segments of Indian Economy.

1. Original Sin

India external debt as on June, 2013 stands at about $390 billion . And most of the debt is dominated in foreign currency i.e. most of the money has been borrowed in foreign currency since developing countries like India find it extremely difficult to borrow in domestic currency. As a result, depreciation of rupee has put tremendous stress on government balances. If the depreciation continues, government may actually find it difficult to meet its debt obligations.

2. Input Costs

Automobiles, electronic good, airlines, fertilizers, oil marketing companies are few sectors that will be adversely impacted by the increase in input costs resulting from the weakening of rupee. Fuel is one of the major inputs in most of these industries. For example, in case of airlines fuel alone account for 35 percent of their operating costs and their ability to pass on the costs is also very limited. Figure 4 depicts that prices of crude petroleum has not only been increasing but increasing at a greater rate and much of this increase can be attributed to weakening rupee. This is severely going to impact the profitability of these industries. A weak rupee will also increase under recoveries of oil marketing companies. Under recoveries could be up to Rs 1050 billion in 2013-14.

Figure 4

3. Companies with foreign debt

A falling rupee is likely to have an adverse impact on the balance sheet of companies that have high foreign debt. According to a CRISIL Research report “For companies in the CNX Nifty (excluding banking and financial services), around 40% of debt is denominated in foreign currency. In total, corporate India had forex debt outstanding of over $200 billion as of March 2013, of which close to 45% is short-term debt”. All these companies are likely to face a tough time in meeting their debt obligation.

4. Inflation

A major impact of depreciating currency will be on inflation. Imported goods will become costlier. Companies may pass on the increase in their input costs on the consumers. Price of petrol, diesel and fertilizers may increase if government tries to cut down its subsidy bill, which has been constantly rising because of weakening rupee. Apart from this, cost of foreign travel and foreign education will increase manifold. Inflation as measured by the consumer price index has already witnessed an increase of 0.56% from May to June, 2013 (Figure 5).

Figure 5

In month of July, Reserve Bank of India (RBI) has taken a no. of steps to arrest the fall of rupee. It recently tightened liquidity to contain speculation and volatility in the foreign exchange market. It reduced the Liquid Adjustment Facility to 0.5 percent of the total deposits from the previous level of 1 percent. RBI has also made it mandatory to export 20 percent of the all gold imported into the country. Besides these steps, RBI has been actively intervening in forex market as well.

All these steps by RBI may prove to be fruitful in containing the free fall of the rupee but they do have certain adverse effects. Frequent interventions in the foreign exchange market have had a toll on the forex reserves of the country. In the first three months of fiscal 2013-2014, Forex reserves have fallen by 4.6%. They stand at $280.2 billion (Figure 6) as of July 12, 2013. Also, borrowing costs of banks and corporate have gone up due to the monetary tightening and this has in turn impacted the economic growth.

Figure 6

On 31 July, 2013 rupee again breached 61 level. Investors were upset with no action in RBI policy review on 30th. Government is planning to come up with sovereign bond issue to overseas investors in order to attract dollar inflows. This may temporarily improve India’s current account and may prop up Indian rupee but it can best act as a quick fix. In the long term, issue of these bonds may compromise with the financial stability of the country. Also, steps like increasing duty on gold imports are less likely to be fruitful because India has somewhat inelastic demand of gold which is unlikely to be affected by the increase in prices.

The depreciation of rupee is more of a structural issue rather than monetary. In the short run, efforts made by RBI and the government may prove to be fruitful but in the long run it will have certain adverse impacts on the growth of the economy. There is an urgent need to address structural problems in order to restore the confidence of foreign investors. Also, there is need to spend more time and effort in building the export oriented industries (other than IT) in the country in order to keep a check on the current account deficit. Effective efforts on part of the Government and RBI are required in order to boost confidence in the Indian economy and save the drowning currency.

This article has been authored by Vikram Chhabra from Faculty of Management Studies,Delhi


1. 10 reasons to worry about the rupee depreciation- Economic Times

2. Rupee depreciation to hurt India Inc- Crisil Research

3. Five reasons why rupee is depreciating despite strong FII flows- Economic Times

4. Rupee depreciation: How it will affect you- Zee News

5. Rupee faces stiff resistance at 58.50 –58/$; RBI policy eyed- Economic Times

6. Avoid firms with high foreign debt- Hindustan Times

7. India’s forex reserves see 4.6% erosion in three months- Business Line


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