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Friday, November 25, 2011

Indian Rupee Depreciation against the US Dollar - Your Questions Answered


In the previous post "Is the Indian Currency Rupee Depreciation against the US Dollar Good or Bad?" we had taken a look at the reason why the Indian Rupee is getting beat up by the US Dollar in terms of value and why is the rupee going down so drastically. However, after the post, you might've had some questions about the whole phenomenon. Some readers posted their questions as comments.

Below are some questions that might arise in your minds about the Depreciation of the Indian Rupee against the US Dollar. Have tried to answer them as best I could. Do, drop a comment if you aren’t satisfied with the answer :-)

Thanks to Manish & Anonymous for the questions. I have included your questions too in the list below. Here we go!!!

1. Why is the Rupee Depreciating So Badly?
Because of many factors that are occurring in a simultaneous fashion. The crucial ones are:
1. Due to Risk Aversion on the part of Currency Investors, the Demand for the US Dollar has gone up world over
2. Uncertain Economic Situation around the globe
3. FII’s turning Net-Sellers and withdrawing funds from the Indian Market

2. In 2008, we saw a similar/drastic Rupee Devaluation against the USD. Is the current scenario similar?
Well, not really. Last time around, the devaluation was driven mainly by rise in Oil Prices. The price of oil reached USD 147 per barrel and was one of the key contributing factors. However, Risk Aversion was also a part which affected the value of the Indian Rupee.
Though the effect is the same, the combination of causes is different. Risk Aversion is the common culprit if you want to identify the common cause…

3. Has the Risk Aversion among the Investor Public changed when we compare the times in 2008 to now?
The concept of Risk Aversion is the same irrespective of what timeframe you are talking about. But, the current situation is much more riskier & pronounced than what was in 2007-08. Back then, the problem was localized to debt problems (loans & mortgages) in USA and had only a ripple effect across the globe. Right now, the problem is more profound and markets world-over are in a crisis and some countries are on the verge of Default. So, people are much more risk averse than what they were in 2008 and hence the situation is much worse than during the mortgage economic crisis.

4. How long do you think this economic crisis is going to last?
Well, frankly speaking I don’t know… speaking optimistically maybe a year or so. But, as more and more data comes out regarding the mess that the world economies have pushed themselves into, the timeline gets blurred. Practically speaking, nothing major can happen in short term (3 to 6 months). Any recovery can be felt or realized only after a year or so of sustained efforts from government’s world over.

5. Could the Reserve Bank done anything to protect the value of the Indian Rupee?
Yes, the RBI could have taken steps to protect the value of the Indian Rupee. But, unfortunately they did not. That is why Rupee is dangling at over Rs. 52 per US Dollar.

6. Why didn’t the RBI do anything?
The Central Bank of any country is entrusted with the responsibility of protecting the value of its home currency. They usually kick into action when they suspect any speculative attack on their currency by external forces (Intentional attempts to devalue a country’s currency)
In this case, the devaluation of the Indian Rupee was not due to some intentional attempt by anyone. It was due to the global economic scenario and any steps they take might backfire if the global economic situation worsens.
The RBI just let the economy take its course with the exchange rate between US Dollar and Indian Rupee because there was no foul play suspected.
A point to note here is that, the RBI is closely monitoring the situation and may intervene if they feel the depreciation is too much.

7. What can the RBI do to curb the depreciation of the Indian Rupee?
They can sell US Dollars. Last time around when there was such a problem, the RBI sold US dollars worth nearly 18 billion. This time around, they would have to cough up an even larger number to prevent the depreciation. Most importantly, this will be only temporary. The RBI selling dollars alone cannot fight the global dynamic risk and hence will not have any long term effect on the exchange rate. That is exactly why the RBI isn’t doing anything explicit to protect the rupee value.

8. What do you think the Indian Rupee will value against the US Dollar by next year (2012)?
Maybe around 46 or 47 Indian Rupees per US Dollar. To substantiate my claim, if the economic scenario recovers, there will be a lot of FII inflow of funds into India that will give a lot of strength to the Indian Rupee. And hence, it should come down below the 50 rupee mark and settle down between 46 to 48 Indian Rupees per US dollar.

9. Will all IT company’s post stellar profits due to the Rupee going down?
No. Not really. IT company’s in India have the concept of Hedging their foreign exchange income. They usually hedge against a particular value and project earnings/profit numbers for the subsequent quarters. So, the profit they make due to this rupee depreciation may not be as stellar as one might expect, but nonetheless, IT Majors will most probably post impressive numbers this quarter.

10. Will the Indian Rupee depreciate further against the US Dollar?
Maybe… This is not something that we can predict right away. But, by the look of things it looks like it may go up by another one or two rupees. Maybe 53 or 54 is realistic and possible.

11. If investors take out their investment from European countries to invest in US, would it have any effect on the exchange rate of rupee?
Not much. US Dollar investments made in India only will affect the exchange value between US Dollar and Indian Rupee. US Dollar investment in Europe will not affect the exchange rate in India

39 comments:

  1. Will the steps taken by central banks world over to avoid the european debt crisis ease the depreciation of the Indian Rupee against the USD?

    ReplyDelete
  2. @ Rajesh

    Not directly but indirectly yes. If the eurozone crisis eases and foreign investors start investing in India then yes, the rupee will strengthen

    ReplyDelete
  3. Hello Annandji!!
    I liked your blog very much.
    Simple and very clear!!!
    Good information also....
    Could you please give me your email ID?
    I need some help from you on investment matters.
    Thanks in advance...

    ReplyDelete
  4. @ Anonymous

    My email details are available in the facebook page of my blog. I dont think it is a wise idea to write down email address in the comments section :)

    ReplyDelete
  5. a very lucid and great way of explanation of the cause

    thank you.
    rishabh mallick

    ReplyDelete
  6. Hi Mr.Anand..wonder why you did not include Inflation as a causality. US core inflation vs India's.

    ReplyDelete
  7. @ SKP

    Inflation does not influence the exchange rate value directly. That is why I did not include it.

    Anand.

    ReplyDelete
  8. awesome explanation . liked it!

    ReplyDelete
  9. Hi Anand,
    Dont u agree that - Interest Rate Differential b/w India and Developed nations caused Rupee to slide from 46 to 49-50 - Interest Rate parity theorem.

    Tarun

    ReplyDelete
  10. hi Anand,

    Interest rate differential wrt Developed nations at the first place didnt cause the rupee to slide - As per the Interest Rate Parity theorem.
    Also, does not high Fiscal deficit reduce the value of rupee

    Tarun

    ReplyDelete
  11. @ Tarun

    No. Interest Rate Parity between two countries will not affect the value of either countries.

    The Country's GDP, Overall Debt Level, Gold Holdings, Foreign Exchange Reserves etc are all factors that affect the value of currency of two countries

    ReplyDelete
  12. Hi Anand
    Very nice and invaluable explanation...Nice way of writing a blog..I liked it very much...But why did you stopped writing after Nov 2011..I think this is the last post in the blog...Please do write..I just love your simple, clear and meaningful writing...

    ReplyDelete
  13. Dear Anand i am waiting for your new post...:-)

    ReplyDelete
  14. @ Ashutosh & Anonymous

    Thank you for the motivation. Two articles posted today guys!!!

    Thanks again for your patronage.

    ReplyDelete
  15. What will be the consequences, if RBI sells aprox. 80 billions? how it will help in this scenario?

    ReplyDelete
  16. @ Kunal

    It is not so easy to figure out the impact of selling an x amount of US dollars. However, RBI selling that many dollars may help the rupee cut some losses and appreciate against the dollar (Under the assumption that all other factors remain the same)

    Anand

    ReplyDelete
  17. Hi Anand,

    How are you doing? Well, it might sound a dumb question but how will rupee value go down in accordance with dollar meaning($1 goes less than 50 rupees and keeps decreasing)? Could you highlight some strategies by which this can happen? Is there any way to measure the fall of rupee value?
    For example-maybe giving more rupees to US banks and taking dollars or exchanging dollars with rupees at a low rupee value

    Thanx

    ReplyDelete
  18. Hi Anand,

    How are you doing? Well, it might sound a dumb question but how will rupee value go down in accordance with dollar meaning($1 goes less than 50 rupees and keeps decreasing)? Could you highlight some strategies by which this can happen? Is there any way to measure the fall of rupee value?
    For example-maybe giving more rupees to US banks and taking dollars or exchanging dollars with rupees at a low rupee value

    Thanx

    ReplyDelete
  19. Really great post...answers most of my questions.
    But I have a request if you could explain the effects of depreciating value of indian rupee in some more detail.
    I have already read your previous post- Is the Indian Currency Rupee Depreciation against the US Dollar Good or Bad?

    ReplyDelete
  20. I am a class XI commerce student, and I understood most of the article. However, some parts I did not understand:
    1. How could RBI selling US dollars help the INR?
    2. Can RBI be blamed for the low value of INR?
    3. How exactly is Risk Aversion related to the depreciating value of INR, and what determines the Risk Aversion?

    Meenal

    ReplyDelete
    Replies
    1. Hi,
      Answers to your Q's.
      1. The more the US Dollar supply in the market, lower its value. As of now everyone is trying to accumulate the USD so the demand is more and supply is less. As a result its value is high
      2. No. The global economic scenario is the main cause. However, the RBI is partially to blame because they are not taking any stern steps to control the decline of the rupee
      3. If I tell you - If you invest Rs. 1000 today, after 3 months I will give you Rs. 2000 or Rs. 0 depending on how the market behaves. What will you say? Sorry Anand, I would like to keep my Rs. 1000 intact and dont want to take a chance and lose it. This is risk aversion. Risk aversion is determined by the individual investors mindset.

      Anand

      Delete
  21. I understood most of the article but I do have one question
    If RBI does sell USD, won't the Foreign Exchange Reserves be affected?
    And couldn't it have an opposite effect to the one intended?

    Thank You,
    Tanvi

    ReplyDelete
    Replies
    1. Hi Tanvi,
      It is a simple matter of supply and demand. When something is available in abundance its price is always lower when compared to something that is much elusive. In this case this hike in value of the USD is partially due to the high demand and low supply. So, if people start selling the USD, the supply will ease the price going down.

      But, selling too much USD may have a negative influence on inflation. So, it has to be done in moderation.

      Anand

      Delete
  22. It's been many months since you posted this - but it does seem very applicable to today's scenario (May 2012).
    .
    You want to shed some light on the M2, M3 money supplies & the roles those items play in the currency-world. US Presidential Elections are around the corner (few more months) and the campaigning & the debates have heaped flak on the Federal Reserve. What amazes me is - even as the US Federal Reserve is increasing the supply of their fiat currencies, the value of the rupee vis-a-vis dollar keeps becoming worse.
    .
    How much of a blame could one place on RBI - for increasing the money supply in the past many years. There's just too much Indian rupees in the market that even an increasing amount of US Dollars does not seem to help rejuvenate the demand for Indian Rupees. And, I do agree that many investors (across the world) seem to fly over to the depreciating US Dollar.
    .
    Do you think Keynesian economics & central planning are part of the problem - you know the business-cycle booms & busts (from the perspective of Austrian School stalwarts like Mises, Hayek et al)?
    .
    MN

    ReplyDelete
    Replies
    1. Hi MN,
      Anything and Everything that affects the Supply or Demand of the US Dollar will affect the value of both currencies. US Elections or policies laid down by the Federal Reserve may bring uncertainty in the US Economy which might further increase demand for the USD and affect the value of the Rupee.

      A good 10% or so blame on this downfall could be placed on the RBI. Not because of increasing the money supply but for not taking any steps to arrest the fall of the dollar. We are sitting on approx 300 billion USD of Forex Reserves or more. By selling a portion of these we could have increased USD supply in our market to restore some value to the Rupee. Unfortunately the RBI did not take any steps. As a result the Rupee fell further and is continuing to fall.

      Sorry - I am not so familiar with these terms like keynesian economics or hayek etc. I need to spend some time to learn them. Once I do, will write about it :)

      Hope this answers atleast part of your questions.

      Anand

      Delete
    2. Hi Anand,
      .
      Thank you for the response. I do agree with most of your perspectives & I look forward to what you think about Keynesian Economics vis-a-vis Austrian School (& the likes of Ludwig von Mises, F. A. Hayek, etc) - whenever you get a chance to post your views on these topics.
      .
      I think Q-E 1 & Q-E 2 (Quantitative Easing) played an enormous role in the current financial mess the world is in. And I further opine that increasing the M2, M3 money supplies is a direct cause for inflation (in India) - because if the money supply was not increased, there'll be lesser INR in the market which automatically meant they'd be worth more.
      .
      I apologize for digressing in the following non-pragmatic rant.
      Have you ever wondered about the following?
      a. Back in the 1800's & early 1900's people did not have mass-manufacturing or mass-transportation facilities.
      b. Even so, in our great-grand-father's day & age they could get a full month worth of groceries for a paltry amount of money.
      c. Today, when we have advanced farming, mass-manufacturing & mass-transportation systems, we are spending more money towards monthly groceries?
      d. I do understand the concept of inflation - and why it caused the cost of goods to go up.
      e. What I wonder is: If we did not move away from solid-commodity-based-money to government-created fiat currencies will we have the same inflation?
      f. Inflation, in my opinion, is a direct result of a few "experts" (whether they're Federal Reserve or RBI or any other Central banker out there) getting to set the value of money. I don't think it is moral, ethical or sensible to trust a small group of elite bankers to set-up the value of money - because sooner or later this "lender of last resort" will *inevitably* make a wrong decision.
      .
      I'm confident you are aware of the sub-prime mortage, CDO, CDS & the 2008 crisis - I'd like to shed some light on one Mr. Raghuram Rajan - and the paper he presented *before* the crisis hit. Google: "https://www.google.com/search?aq=f&sourceid=chrome&ie=UTF-8&q=raghuram+rajan+paper" - and an online-wsj post "http://online.wsj.com/article/SB123086154114948151.html". It's a very interesting read - IF YOU'RE NOT ALREADY AWARE.
      .
      Once again, many thanks for your response & looking forward to learning more of your perspectives.
      .
      Thanks!
      MN

      Delete
  23. There is something completely missing here - Indian domestic policy.

    You state that "Due to Risk Aversion on the part of Currency Investors, the Demand for the US Dollar has gone up world over"

    So investors perceive that the US is a better investment. As an American, I can tell you there is quite a bit of fear in America because of our current government's completely irresponsible fiscal policies.

    If the Indian government had better fiscal policies, this would be a good time to brag about them around the world so that investors would wake up and find a safe haven in India.

    I suspect that the opposite is true. While India has a tremendous amount going for it, I suspect that like governments around the world, they are unable to control their spending. So why don't you spend some of your analytical power analyzing problems at home instead of blaming Europe and US?

    I am sincerely interested in knowing your opinion.

    ReplyDelete
    Replies
    1. Hi Greg,
      To begin with, I am not blaming Europe or the US for this situation. It is just an analysis of what is causing the value of the Indian currency to plummet downwards. The United States is not the reason for the decline in value of the rupee but economic uncertainty in USA is causing panic everywhere else. Do you agree?

      Foreign Investors (Esp from USA) form a huge chunk of population that invest in the Indian markets. Last year (2011) FIIs sold stocks worth over 2700 crore Indian Rupees (Approx 500 million USD) which was partially responsible for the Indian markets taking around 20% of its value. Though FIIs selling isnt directly responsible for the Rupee tanking in value, they are partly responsible for the Negative Investor sentiment which is responsible for this predicament

      The problem here is that, India is an Export Oriented Economy. Though there is a strong domestic demand on things manufactured in India, atleast 50% of the things that are made in India end up in USA or Europe. So, if either economies are in trouble, the impact can be felt in India. The saying, if America catches a cold, countries like India and China Sneeze is 100% true.

      As the value of the Dollar is going up against the rupee, the demand for the Dollar is going up. If I had bought 1000 USD last year around the same time, today my investment in terms of Rupees would have gone up by around 20%. That is a lot of growth isnt it? So, more and more investors in India are moving towards investment in USD which is causing this spike in demand for USD which in turn is driving the prices up. does this make sense?

      More over, the Indian Governments fiscal policies are heavily affected by the political scenario in the country. The policies they make are more towards satisfying their coalition partners to continue to stay in power instead of trying to do some good for the country

      The Reserve Bank of India, which is supposed to regulate the supply of the Indian Rupee and control its value too is sleeping in the hope that things will rectify themselves.

      All in all, multiple things happening in unison is causing the value of the Rupee to go down even further.

      At the time I wrote this article Rupee was trading at around Rs. 52 per 1 USD. Now it is at 56 USD. So, things are not improving. They are only getting worse...

      Looking forward to your comments :)

      Anand.

      Delete
  24. Hi Anand
    How does conversion of foreign currency earnings into ruppee help in controlling ruppee fall?

    ReplyDelete
    Replies
    1. If more and more US Dollars are available in the market for purchase, the demand for the dollar will come down correspondingly. This will definitely ease the fall of the Rupee. However, this alone cannot arrest the fall of the Rupee but it can definitely arrest the steep fall.

      Delete
  25. Hi Anand
    How does converting foreign currency earnings into ruppee help in appreciating it?

    ReplyDelete
  26. Hi Anand,
    Firstly.I would like to thank you as the information about depreciation of Rupee against USD was really useful ad enlightening..Can u please suggest what possible measures that indian govt should take to prevent further damage?As the depreciation of rupee value will directly impact prices of commodities etc on us.I think change in Govt can boost investor confidence.
    Awaiting reply.
    thanks,
    Santosh

    ReplyDelete
    Replies
    1. Unfortunately, a change in government means a new election and a few thousand crores of rupees spent. Definitely it will not help boost investor confidence. However, if the RBI takes steps to improve dollar supply and if the Finance Ministry takes steps to boost investor confidence, the fall in the value of the rupee will be arrested.

      However, with rising oil prices, I am not really sure what this Government is going to do to help the Indian rupee or its citizens

      God Save India :(

      Delete
  27. Will we ever see Indian Rupees valued more than dollar. Indian economy is doing well. US Economy is rattled. Then how come their currency is more expensive and our's is delvaluating ?

    ReplyDelete
    Replies
    1. To answer your questions

      No. I dont think the Indian Rupee will ever be valued more than the dollar. I wish it happen but in the next 15-20 years, No Way

      Indian economy is heavily dependent on the US Economy. So, the Indian economy too is partly rattled only.

      The value of a currency is not only dependent on the economy. There are numerous other factors like GDP, amount of forex reserves etc which determine the value of a currency. And as far as why our currency is going down - that is what this whole article was explaining about. Isnt it?

      Delete
  28. I ran a simple calculation on inr vs USD inflation differential from 1999 to 2010. Assuming inr=39 was fair value then the fair value now is inr=55

    ReplyDelete
  29. Very good points that you have mentioned. I wrote a similar article on this but a little bit late. Anyway I have covered some points regarding recent developments in this issue. Can you please suggest me your opinions on that http://greenxgene.blogspot.in/2012/06/reason-why-indian-rupee-value-tumbled.html

    By now the party that supported EU Bailout plan has won the election, which implies that Greece will not quit Euro. So some signs of recovery can be seen here.

    ReplyDelete

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