Rupee Depreciation

Currency depreciation is defined as a decrease in the value of one currency relative to another currency, i.e. because of change in exchange rates, unit of one currency buys less units of another currency.

 

The value of a currency can be maintained by the Central Bank of the Country in the following three manners:

 

• Free Floating: The value of one currency to another is determined by the supply and demand for that currency
• Partly Fixed: The rates are determined by the Supply and demand of the currency but the Central Bank of that country interferes through open market operations and thus controls the currency value. India’s Currency Management system is partly fixed.
• Fixed: The value of the Currency is kept fixed as compared to the other currencies. China’s currency is fixed.

 

Rupee Depreciating is Indian Rupee depreciating against dollar; it means that a unit of rupee will buy less units of dollar or that more units of rupee will be required to buy one unit of dollar.

 

Let us understand the dynamics of the currency movement. Just like any other commodity, the upward/downward movement of the value of a currency is based on the dynamics of demand and supply. As the demand for rupee increases, its value rises and vice versa. Thus if the rupee has depreciated against dollar, it means that the demand for dollar and supply of rupee is rising.

 

But there is a significant role of the RBI in this process. Since India’s currency is partly fixed so the Central Bank through its open market selling and purchasing of Rupee tries to fill the supply demand gap and thus control the value of the currency.

 

Now when we say that rupee is depreciating against dollar, it would mean that the demand for dollar is rising and there is a selling pressure on rupee. Now from where do the above arise?

 

Imports – If a person in India imports goods/services from a foreign country, he/she will have to make payment in the currency of that country. Now to acquire that currency, he/she will have to sell Indian Rupee to the banks. Thus in the process creating a demand for foreign currency against the Indian rupee

 

Investments abroad – If a person in India plans to invest abroad, he will have to acquire foreign currency by selling the home currency.

 

Repayment of loan – If a corporate had taken an overseas loan, the repayment is done in the lender’s currency. Thus at the time of repayment, corporate will have to acquire foreign currency.

 

Disinvestment by FIIs – When foreign investors liquidate their investments in Indian market, they sell rupee and buy foreign currency in order to repatriate the funds to their home currency. Earlier when Indian economy and Indian stock market was on a roll, strong capital inflows from FIIs had led to the rupee appreciation. Now, when the market is at its all time low, there is continuous withdrawal of capital by the FIIs from the market which has primarily led to this rupee depreciation.

 

Similarly, any activity that requires outflow of funds from the home country will create a demand for the foreign currency and hence would lead to rupee depreciation. Similarly, any activity that would require inflow of funds to the country, it will create a demand for the home currency and lead to rupee appreciation.

 

Having understood the reason for rupee depreciation we must understand its implications. Ask any patriotic enthusiast whether rupee depreciation is good for economy or bad for economy and probably his reply would be “Obviously bad for our economy….we are losing the battle to the green buck….”

 

Well let us understand its implication from a broader perspective.

 

Positive Implications of Rupee Depreciation:

 

1)      Higher revenue for exporters – Exporters earn their income in dollars which is spent in rupees back home for further investment or consumption. If the rupee depreciates, their earnings in rupee terms will rise.

To explain it better, say that exchange rate is USD 1 = 50 INR. If an exporter earns USD 1000, his earning in rupee terms is 50000 INR. If the rupee depreciates to USD 1 = 60 INR, then in rupee terms the earnings of exporter will be 60000 INR. A rise in earnings, despite the revenue in dollar remaining constant.

2)      IT Industry – IT industry has been a major contributor to exports. IT companies have more than 60% of their revenues from US. It is said that for 1% depreciation in INR, their earnings rise by 30 basis points. Other export oriented industries in India will benefit from the depreciating rupee.

3)      Repatriated profits – Remittances to India by NRIs - Rapid currency depreciation increases the value of repatriated profits.

4)      Tourism – India is now a cheaper place to visit.

5)      More foreign investments – increase in FDI/FIIs

 

Negative implications of Rupee Depreciation:

 

1) Importers – The importers of goods and technologies are the worst hit. The value payable in the Exporting country’s currency remains the same but the value payable in the Indian Rupee terms increases by a considerable amount.

2)OIL and OMC - Although crude price might have corrected by around 57 per cent in dollar terms, it has contracted by 52.5 per cent in real terms due to the nine per cent rupee depreciation in the last four months. "The crude's cut-off was around $67-68 per barrel when the rupee was trading at Rs 41-42 levels. But, on account of rupee depreciating to levels of Rs 49, recently, the cut-off has been revised to $59/barrel." Thus, the OMCs would make meaningful profits on their direct sales of petroleum products, if the crude prices sustain below break-even rates for a reasonable amount of time.

3) Corporate borrowings – The borrowing rates of Corporate (in case of borrowing from an International Lender) increases as they are supposed to repay more (both as principal and Interest) in Rupee terms in case of the rupee depreciation, since the amount payable is in the lending Country’s currency.

4) Mergers & Acquisition – In the event of an overseas acquisition by an Indian company, the Indian Company has to pay more and thus the returns of the Indian Company go down.

 

 

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