Depreciation of Indian Rupee 2012

The Indian Rupee has depreciated significantly against the US Dollar marking a new risk for Indian economy.Till the beginning of the financial year very few had expected Rupee to depreciate with most hinting towards either appreciation or status quo in the rupee levels.Those few who had even anticipated may not have imagined the scale of depreciation with rupee touching a new low of around Rs 56 to the US Dollar.

Union Finance Minister Pranab Mukherjee has attributed the depreciation of the rupee to a “cumulative effect” of several factors impinging on the economy, both at the global and national levels.There are multiple reasons that are responsible for the fluctuation in the value of the currency.The volatility in oil prices and uncertainty in Europe has resulted in a situation where many agents were putting their surplus in the United States-considered a “safe haven” at present.

• Factors at the national level-both the fiscal deficit and the current account deficit of the country were increasing,causing the rupee to depreciate further.If we were to simply analyse the import export figures of 2011-12, then against exports of $300 bn the imports were $ 450 bn (in round figures). Thus there is a trade deficit of $150 bn. Holding on to these figures and on an estimated 235 trading days annually, it means there is a shoratge of app $ 0.64 bn ( Rs 3447 crore) per day only on import export activities. Taking other requirements into consideration, JP Morgan the financial firm has estimated that, India needs $ 340 million on each trading day in 2012, to bridge its current account deficit. Another report by the broking firm Enami Securities points out that India needs $ 800 million (nearly Rs 4300 crore) every day to bridge its trade deficit, which it rates as the highest in the world today.A decade ago, it says this figure was just $50 million.widening of the current account deficit would result in outflow of dollars from the Indian economy accentuating the depreciation in rupee.

• Because of reduction in export and increase in import, on one side the fiscal deficit has increased and on the other,current account deficit is rising. Europe was an important export destination for the country and reduction in the demand there (due to Eurozone crisis) adversely hit Indian exports.

• High Fiscal deficit means more borrowings which means demand for more dollars.More demand for dollars increases its value against rupee.

• Strengthening of Dollar - The Euro has depreciated 6.55% against the dollar in the last three months which has in turn made the dollar stronger vis-à-vis other currencies, including the rupee.With the growing demand for oil,dollar is only expected to move further upwards. Domestic oil importers have also contributed to this strengthening to meet higher oil import bills.So, FIIs have withdrawn funds from emerging markets like India and invested back in the dollar which has been strengthening.

• Withdrawal of funds by foreign institutional investors (FIIs) from domestic economy is another main reason behind rupee depreciation.After pouring hefty funds into the Indian equity market in the first three months of the year, overseas investors turned bearish in April and pulled out Rs 777 crore amid S&P lowering India’s credit outlook to negative from stable.Market experts attributed the outflow to a host of factors including government’s anti-tax avoidance rule (GAAR) proposal announced in the Budget. This has been the real dampener for several FIIs whose clients had used participatory notes to invest in the Indian stock market. The sentiment was further soured by ratings agency S&P’s move to lower India’s outlook to negative from stable, citing slow progress on its fiscal situation and deteriorating economic situation, experts added.In fact after S&P’s move, FIIs have withdrawn nearly Rs 1,300 crore from the stock market in the last three trading sessions.

• Lack of reforms is one more reason for rupee depreciation. There have been very few meaningful reforms in the last few years in Indian economy. Moreover, the policies seem to be getting increasingly populist. The government wanted to reverse this perception and announced FDI in retail but had to hold back amidst huge furor from both opposition and allies. This has further made investors negative over the Indian economy.According to Moody’s, “Since the Indian government’s political capacity to implement fiscal and structural reform is weak, depreciation is a market response".Without new reforms and innovation in the fiscal policy India is not an attractive destination for the FIIs and FDIs . 

      All these reasons together have led to sharp depreciation of the rupee.