Alok Ray

Behind the rupee's free fall

Alok Ray | Updated on March 12, 2018

The dollar earnings of Indian IT companies would translate into more rupee revenue.

Capital flight points to declining investor confidence.

Apart from being the worst-performing currency in the developing realm in recent times, the Rupee has reached a lifetime low by touching 53.40 to a dollar on December 13, 2011. Moreover, the downfall has been at high speed. The fall is nearly 21 per cent since August 1, 2011 (when it was 44.04).

What has caused this massive slide? Analysts are pointing to a confluence of external and internal factors. The worsening Eurozone crisis has caused the Euro to fall against the dollar (by approximately 9 per cent since August), which has correspondingly caused the Rupee to fall also against the dollar. But, as is clear, the fall of the Rupee has far exceeded the fall of the Euro against the dollar, indicating that the Rupee has fallen significantly even against the weak Euro. So, domestic factors have a large role to play.

Here, the proximate causes are the deteriorating current account deficit and capital flight from India. Export growth has come down in November to 3.7 per cent year-on-year (lowest monthly growth in two years). This is on top of the official admission that merchandise exports were over-reported by $9 billion in April-November, which means that the earlier reported high export growth was a fiction. The hardening of the global oil price has contributed to rising imports. Though total FDI inflows in 2011 have been higher than in the corresponding period in 2010, the pattern has been reversed since September 2011. Moreover, this has been more than offset by negative portfolio fund inflows. Between August and now, FIIs have sold some $2.3 billion, whereas, in that period last year, they bought $18 billion.


Why this capital flight? According to analysts, amidst the lingering global uncertainty, investors are moving funds to safe-haven US dollar and gold, hiking their prices. In addition, the slowdown of growth in India (may be below 7 per cent in 2011-12, against the earlier projections of 8-9 per cent), depressed company profits, rising fiscal deficit due to falling tax revenue, and ballooning subsidy bill, soaring current account deficit (may exceed 3 per cent of GDP as against the earlier projection of 2.7 per cent), policy paralysis in government holding up clearances of major investment projects and not allowing FDI in retail and insurance sectors, the recently-reported absolute fall in the Index of Industrial Production (IIP) and capital goods output — have all contributed to pessimism among foreign investors about India.

Thus, even among the emerging economies, India is becoming a relatively less attractive investment destination. As the market expects the Rupee to fall in the near future, exporters and people with dollar funds are postponing conversion of dollar earnings, while importers are rushing to buy dollars. The advantage of higher interest rate in India is getting neutralised by the expectation of an exchange loss (or the higher cost of buying risk cover), reducing the attractiveness of investing in Indian interest-bearing securities. Those who would like to invest in India prefer to wait till the Rupee stabilises. As a result, net capital inflows are slowing down. All these factors are making the Rupee fall further. Some would point to the real exchange rate movement as some sort of an explanation. Because of a higher rate of inflation, Indian goods have been losing their international price competitiveness. So, to maintain competitiveness, the nominal value of the Rupee has to fall to offset the inflation differential (the purchasing power parity doctrine). In fact, after the 21 per cent fall, the Rupee's real value (as measured by the 6-major-currency REER index) has roughly reached its value of 2004-05, justifying the depreciation. But this, at best, is a partial explanation, which focuses only on the trade account, to the exclusion of the capital account.

Finally, the role of RBI. Currently, India's foreign exchange reserves are $306 billion. But unlike China, these aren't ‘owned' reserves acquired by running a trade surplus. These are basically borrowed reserves, which need to be repaid in future. Net foreign liabilities (including NRI deposits, FII outstanding investments, foreign borrowing by Indian corporates) stand at $233 billion at the end of June 2011. So, RBI has little room to arrest the sliding Rupee by any significant sale of foreign exchange in the market. The market knows that. In addition, the RBI Governor has clearly stated that the RBI cannot, and will not, try to intervene to arrest the slide. At best, it may intervene to reduce sharp fluctuations.

Who are the gainers and losers? The gainers would be the exporters (like Indian IT companies) whose dollar earnings would mean more rupee revenue.


Indian NRIs sending money home (and their relatives in India) will benefit. Foreign travellers will get more by spending Dollars or Euros in India. On the other hand, Indian companies using imported inputs will have to pay more in rupees. If they sell their finished products in the foreign market, then their export gains will partly or wholly offset the extra cost of imports. But if they sell in the home market, (like Indian oil companies which refine imported crude to sell in India or power companies that use imported coal), they would be net losers.

Rising cost of imported goods — to the extent these are passed on to consumers in the form of higher prices — will add to inflation. If the oil companies aren't allowed to do pass prices (especially for diesel and kerosene), then, their losses will increase. Since a part of these losses are subsidised by the government, the oil subsidy bill and the government budget deficit will go up correspondingly.

Foreign travel and education abroad would be more costly. The debt servicing burden (in rupees) of companies that have borrowed foreign funds but haven't already hedged their exchange rate risk (by covering through the forward market) is shooting up, adversely affecting their bottom lines.


Is the Rupee going to rebound in the near future? If the US and the Eurozone show no signs of recovery, eventually money has to be invested somewhere in search of profits. The India growth story, though less credible than before, may still be more attractive than that of the West.

(The writer is a former Professor of Economics at IIM, Calcutta. The views are personal.)

Published on December 16, 2011

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