A Topsy-Turvy Indian Rupee: An Insight into the Intricacies of INR Depreciation
Written by Priyanka B
The depreciating value of the INR in relation to the US Dollar has more than a little impact on the the Indian economy. While multiple factors contribute to the depreciation, in our view, here are some of the major global factors:
- Turkey Lira Crisis: Turkey is going through economic uncertainty, leading to a weak currency. The Lira has fallen 40 percent against the US Dollar in the first half of 2018. Turkey’s crisis impact countries like India because these two countries get clubbed together as emerging countries in most investment models.
- Foreign Exchange: The main source of foreign exchange is foreign investment. Interest rates in the US are increasing, which is making investments in the US more attractive to American investors compared to destinations such as India.
- Rise in Current Account Deficit: Current Account Deficit (CAD) in India is rising continuously. The current account deficit, which is the difference between the inflow and outflow of foreign exchange, jumped to US$48.7 B, or 1.9% of GDP, in 2017-18. This was higher than US$14.4 B, or 0.6%, in 2016-17. Some imports, such as oil, cannot be cut down and these negatively affect India’s CAD.
The following figure shows the vagaries of the Indian Rupee over the last couple of years.
How has the Reserve Bank of India (RBI) intervened to stem rupee fall?
The RBI has intervened strongly in recent months to slow the slide, but it has still lost 3% since start of June. The fall in the rupee had instigated foreign investors to sell US$5.35 B in debt and equity in India. But flows turned mildly positive in July and August. Since April 2018, RBI started supplying dollars in the market to bring down the exchange rates and has sold US$21 B in spot and US$10 B in forwards, according to traders and analysts, estimating from the fall in overall foreign exchange reserves. RBI data says, it remained net seller of the US dollar 0.99 % in August, as it sold US$2.323 B of the greenback in the spot market. Also, in the same month, the central bank purchased US$3.680 B, while sold US$6.003 B in the spot market. RBI maintains that its intervention in the foreign exchange market is to restrict volatility in the rupee and not to target the range of domestic currency. In the forward dollar market, the outstanding net forward purchase at the end of August was US$5.730 B, compared with US$10.689 B in July, according to the RBI data.
Among many options, RBI can ensure the export earnings come back to India and encourage importers not to buy dollars in advance. RBI can also limit the use of the USD for specific purposes. The government should focus on improving exports practices that could benefit SMEs, which play a big role in India’s exports. Strong capital inflows will also go a long way to control the fall of the rupee.
Devaluation of the currency is another option. But, is it a necessary step?
Advantages of Devaluation
- Exports become cheaper and more competitive to foreign buyers. Therefore, this augments domestic demand and could lead to job creation.
- Higher exports and aggregate demand (AD) can lead to higher rates of economic growth.
- With a decision to devalue the currency, RBI can cut interest rates as it no longer needs to support the currency with high interest rates.
Disadvantages of Devaluation
Devaluation will lead to inflation because of the following reasons:
- Imports become more expensive.
- A large and rapid devaluation may scare off international investors. It makes investors less willing to hold the debt because of reducing value of their holdings.
- Aggregate demand increases causing demand pull inflation.
Monitor and mitigate Location Risk from a falling currency
A depreciating currency minimizes the inflow of foreign capital, increases external debt pressure, and also grows India’s oil and fertilizer subsidy bills. The biggest positive impact of depreciation of rupee is the inducement of exports, even while discouraging imports, thus improving the CAD. Though the country witnessed a significant growth in exports this year, Indian companies are reporting huge foreign exchange losses due to the depreciation of Indian rupee. As far as imports are concerned, for a country such as India, imports are necessary.
A depreciating currency could significantly impact third party risk, especially:
- if your suppliers are from capital intensive sectors
- you work with firms that have foreign borrowings, or
- if your suppliers import raw material in large volumes (aviation, Oil & Gas, metals to name a few).
Your operations could face a risk based on factors such as level of offshoring and hedging policy. Regardless of the effects of depreciation, it is important to note that any change in a supplier’s business operation is a trigger to assess the situation at hand.
For more insights/updates about INR depreciation related risks, subscribe to Supply Wisdom Alerts. Request a demo to see how we can help you stay up-to-date on latest trends and be more proactive about monitoring and managing risks across your global locations and suppliers.