It is all across the place – Rupee has touched all time low. At the time of writing this article, Rupee is quoting at Rs. 56. Depending upon which side of the fence you are sitting, you may either be laughing with extraordinary gains which you may be making due to currency depreciation or weeping the hell out due to excessive losses owing to it. There may be other category of people who would not be on either side of the fence but sitting on the fence and are not aware of the impact of currency depreciation on their day-to-day life and hence are not concerned with the currency movements. The objective of this article is to unravel the impact of currency, specifically currency depreciation on the people from all walks of life.
What does Currency Depreciation Mean ?
Before I even start harping upon the impact of Rupee depreciation, let me explain what does the word depreciation mean in the context of currency. Technically speaking it means that Indian currency is worth lesser now in comparison with some other currency. For India, this other currency is primarily ‘US Dollars’. Lets have a look at the chart of how Indian Rupee has behaved in comparison to US Dollars for past 10 years.
source – Yahoo Finance
One thing you may notice that in last 10 years Dollar was quoting as low as Rs. 39 in 2008 and is now quoting Rs. 56 . What does it mean ? In order to buy 1 Dollar, we had to pay 39 rupees in 2008. Now in order to buy the same number of dollars, we have to shell out 56 Rs. per dollar (an additional Rs. 17 per dollar). This reduction in the purchasing power of Rupee in terms of dollars is called Depreciation of Rupee.
What Causes Rupee to Depreciate ?
This topic can be much better described in a complete book as the causes of depreciation of a currency are multiple which in combination push and pull the respective currency’s quotation in conjunction with other currency. A couple of the main reasons which are currently troubling Rupee are as follows :
1. Demand Supply Rule – Rupee quotation follows the simple economic rule of Demand & Supply. If there is more demand for dollars in India than the supply for it, Rupee would depreciate and vice-versa. Demand of dollars may be created by Importers requiring more dollars to pay for their imports, FIIs withdrawing their investments and taking the dollars outside India, etc. On the other hand, supply is created by exporters bringing in more dollars from their revenues, NRIs remitting more funds, FIIs bringing more dollar in India to spur their investments.
2. Fiscal Deficit – How would others feel of your financial position if you earn Rs. 100,000 a year, but end up spending Rs. 110,000 ? The excess of your expenditures over your total income is called Fiscal Deficit. In order to bridge a Fiscal Deficit, you may end up taking a loan of Rs. 10,000. The more loan you take, the more riskier you would become in the eyes of lenders. This is exactly the case in India. India is currently spending more than it earns via taxes resulting in a mounting fiscal deficit. The major brunt of this spending is going into subsidies. With mounting fiscal deficit, foreign investors start feeling uncomfortable and pull their money out of India resulting in rupee depreciation.
2. Oil Prices – are another significant factor in putting pressure on the Rupee. Oil import contributes as the biggest percentage of India’s import. By quantity, the oil demand is increasing year on year. By prices, Oil is quoted in International Markets in US Dollars. Oil prices are current over $100 a barrel and have significantly jumped up from sub $40 levels in 2002. With the increasing price of Oil in international markets, India has to pay an increased amount of dollars to import the same quantity of oil. Further more, with an increase in the quantity of oil imported into India, a further pressure is imposed on the demand of dollars to pay to our suppliers from whom we import Oil. This increase in demand for dollars depreciates the Rupee further.
3. Weaker Capital Markets – If the capital markets (share markets) are on a boom, there is a continuous flow of dollars into India which adds to the overall supply of dollars in the country. Unfortunately, the current situation is opposite. Capital markets are at status-quo for a couple of years and hence not influencing the supply side of dollars in the country. All in all – weaker supply and excessive demand is resulting in sharp depreciation of Rupee
4. Speculators – Once a trend is set, speculators tend to punt against the rupee adding further to the bearish tone of Rupee.
Effects of Rupee Depreciation
In the globalised world where we are living today, we are no longer shielded from the global economics and product prices. Economies have started taking advantage of countries which are producing specialised products at a cheaper rate and instead of producing them locally, they have started importing them. Economies which have competitive advantage in producing a product at a cheaper price have become exporters, hence opening up the global trade – exports & imports. With opening economies, currency exchange rates have started playing an important role in the cost of imports or competitive advantage in exports.
Lets start on a positive note detailing upon some of the good effects of rupee depreciation in India.
Benefits of Rupee Depreciation
1. For Exporters
Exporters are perhaps the biggest beneficiaries of the Rupee depreciation as every dollar of their sale fetches them more Rupees. Hence if they don’t reduce their prices, with the same quantity of sales, they earn more in terms of Indian Rupees.
If they intend to capture market share, depreciating rupee gives them an opportunity to reduce the price of their products in dollar terms and still making the same amount of profits in Rupee terms. This makes their products more competitive in international markets and helps in selling more volume of products due to cheaper prices in dollar terms. For example, the cost of producing a product is Rs. 5000. When the Dollar was quoting 45 Rs., the dollar cost of producing this item was $111. The exporter wanted to make 50% margin and hence he priced his products at $166 or Rs. 7666 (at 45 level). At this level he is making a margin of Rs. 2666. When Dollar is now quoting at 56 Rs, the exporter is now getting Rs. 9296 for the same product which is priced at $166. If the exporter wants, he can now reduce his product prices in international markets to $136 without loosing his margin of Rs. 2666. With the reduced product prices, he would become more competitive in international markets and gain more customers / buyers.
2. NRIs become richer
Believe it or not, where ever NRIs are, most of them count their net worth in Rupee terms and find depreciating Rupee to their advantage. For example, a NRI earning 100,000 dollars, when converts his earning in Indian Rupees would be earning equivalent of Rs. 56,00,000 (when USD is Rs. 56) compared to Rs. 45,00,000 (when USD was Rs. 46). This adds additional Rs. 11,00,000 to their kitty due to currency movements. Depreciating Rupee hence gives NRIs a big incentive to remit more funds into India for investment purposes, adding to India’s forex reserves.
3. Tourism industry
With a depreciating rupee, holidays in India become cheaper. Take for example, a holiday package in Kerela backwaters costs around Rs. 200,000 for 10 days stay. When Dollar was quoting Rs. 45, this holiday would cost around $4400. With Dollar quoting at Rs. 56, the same holiday package would cost $3500, a whopping $900 cheaper ! This promotes foreigners to visit India as India becomes an attractive Tourism spot owing to its financial competitiveness.
Negative Effects of Depreciating Rupee
The cons of a depreciating Rupee are perhaps more than its advantages and hence the government and RBI tends to focus their policies and energies to control the excessive fluctuations in the currency. To understand the aftermath of the current currency depreciation, lets visit through the following points :
1. Expensive Imports
Quite opposite to exports, a depreciating Rupee would mean that every dollar which we have to pay for our imports, costs more. For example, if we have to pay $100K for an import, it would cost Rs. 45 lacs when dollar is at Rs. 45 and would cost Rs. 56 lacs when the dollar is Rs. 56. Though it means that the imported commodity / product would become costly in India and any product with elastic demand would result in lowering the demand for such imported products. However, in case of India most of our imports are of products which are inelastic, e.g. Oil, luxury products, etc. and hence despite of rising import prices, our imports don’t come down.
2. Oil Contagion
Oil prices in India are a subject of two factors – international crude oil prices and the currency factor. A barrel of oil costing in International market at $100, would cost Rs. 4500 in India when dollar is quoting at Rs. 45 and Rs. 5600 when dollar is quoting at Rs. 56. Hence even though oil prices may decline 10% in International markets, currency depreciation may offset this decline resulting in high oil prices in India.
As a result, high oil prices creeps into the prices of almost every commodity and product in the economy. Oil plays a fundamental role in India’s economy as it supports the fundamental structure of all Industries by fueling up the energy requirements. A higher oil price would result in higher cost of production and higher logistics / transportation costs.
3. Higher inflation
This paragraph gels in perfectly with the above points which stresses upon imports becoming expensive with a depreciating Rupee. And a direct consequence of it, the inflation in the economy shoots up ! Higher inflation results in commodities becoming more expensive. Countries which import their essential commodities suffer more than countries who are major exporters. Unfortunately, as mentioned in above paragraphs, India is a major importer of Oil which tends to hit the cost structure of the economy and fueling the inflation scenario in the economy.
4. Poor returns for FIIs
When it comes to FIIs, they need to report returns on their Indian portfolio in their local currency. For example, FIIs from USA would need to convert their Indian portfolio in US Dollar terms. Lets assume that a particular FII has a portfolio of Rs. 70 million in India. When they value their portfolio in dollar terms (when dollar is at 45 Rs.), the value would be $1.55 million. However, the same portfolio would be valued at $1.25 when dollar is at Rs. 56, shaving off a neat $300K from their valuation owing to currency movements ! This at times triggers FIIs to sell out of their holdings to prevent any further losses and exit from India resulting in large scale withdrawal of funds from the country.
5. Repayment of Loans
A couple of years ago, the option of borrowing cheap money from overseas was the hottest and the most fashionable financial option which every capable company was exploring. No one even dreamed that a time may come that owing to Rupee depreciation, they may be messed up badly, making their cost of borrowing much more expensive than what they could have borrowed within India. Not that the interest rates on external borrowings went up, but the impact of currency depreciation meant that the borrowing companies had to pay more Rupees to repay their dollar denominated loan. This completely screwed up their financial computations, whereby some companies even ended up defaulting on their loan payments.
6. Foreign Education
Believe it or not, there are more and more Indian students taking admission in foreign university. However, foreign education doesn’t come cheap and on an average can cost over 40,000 dollars. When dollar was at 45 levels, the same foreign education used to cost around Rs. 18 lacs. Now it costs over Rs. 22.5 lacs. This is not a small difference for a student who has to take an education loan to sponsor his / her education and then repay it with interest.
7. Foreign Holidays
This is last thing on my mind today. A holiday package to Swiss costing $3000 would increase from around Rs. 1.4 lacs to Rs. 1.7 lacs per person. For a family of two, it adds over Rs. 60K to the cost ! However, foreign holiday is a luxury which not many can afford and the ones who can afford it, additional 60K perhaps may not be a big dent on their savings.
I hope this article would have highlighted the widespread impact of Rupee depreciation and how it hits every one, either directly (such as NRIs) or indirectly (such as a person who is fueling up his car’s fuel tank). At times controlling the Rupee depreciation is not within the hands of the Reserve Bank of India and the government does need to intervene and take conscientious steps to come up with policy reforms to control the currency movements. Hopefully the Rupee would back trace its steps and come down to more comfortable range of 40s rather than the current dangerous levels of 50s.
It would be interesting to note from the readers if they have any other items in their mind which gets affected by currency fluctuation in India. Please feel free to note them down in the comments section of this article.