By now even school going kids know that the Rupee is falling. Since it started its southward trip in 2009, there has been no end to its fascination with the trip. Sometime it looks like a skydiver on a rapid decline but with the hope that the parachute would open successfully and the fall would be halted and eased till reaching a stable surface. Only that in this instance the parachute is nowhere to be seen or has malfunctioned thus continuing the rapid fall.
While it is being discussed fervently by one and all in the financial sector, many might not know how it influences all of our lives. Also it would be interesting to note if anything could be done to mitigate the situation. Here I present my analysis of the situation and possible steps to rectify the situation
Reasons for the fall:
Firstly, we have to understand that, the Rupee is performing badly against the $ but not essentially against all currencies. So why bother at all? Unfortunately there is plenty to bother about because entire International Trade is done in and measured against the Dollar. Many transactions happen in nothing but the dollar. So, not only the Rupee but every currency in the world has to keep a track of how it measures against the dollar. On an earlier occasion I had presented an analysis to show how this benefitsAmerica.
Secondly, this situation can be viewed as a simple case of demand and supply. There is demand for $ but shortage of supply. We know from our common sense that this would undoubtedly lead to increase of the cost of that commodity. That’s exactly what happened. We have to spend more Rupees to buy the same amount of $, in other words $ has indeed become expensive!
Thirdly, why is $ in short supply and why is there a demand for it? Unfortunately to buy Petrol and Gold any some of the other imports we have to spend $. Which means people have to use their Rupees to buy $ and then use the $ to buy the imports. So the $ quantity in country reduces. So we can see why there is a demand. There is an uptake in demand for the yellow metal and hence more $ than usual is used up to buy Gold hence creating a shortage.
Fourthly, we are also unable to increase the supply of $. Why? Because we don’t control the printing of $ and there is a decrease in interest to invest in India. So FII and FDI have pulled funds out of the country. Also announcement by Fed that it is looking at ending the quantitative easing (more $) as its economy seems to be well on the path of recovery has meant that there is a sudden rush in the market to buy $ now. These $ would be part of forex reserves and when the $ actually reduces in the market the $ reserves would rise in value and help in buying goods for cheap. So both these points put together there is a shortage of $.
Fifthly, India’s current deficit is increasing. Which means we import more than we export or we receive less of $ compared to the $ we send out. Even though with the falling Rupee Indian Exports become cheaper –but the macroeconomic situation in Europe and America is contributing to lesser consumption of exportable goods.
Impact of a Falling rupee
Beneficial for Some:
For all the organization who are dependent on export, this is a great time to earn revenue as every $ they earn gives them more Rupees.
The family of those people who work abroad and remit their earnings periodically.
Detrimental for Some:
Any organization that is dependent on importing material for its own productivity would find these imports more expensive and hence an impact to their overall health.
Government of India which relies heavily on imports of essential fossil fuels or other items would find a heavy drag on its exchequer, as all the imports become expensive.
Increased expenditure of the Government will mean lower revenues which could be made up only by increasing cost of products or tax on products
Inflation would increase and impact the common man
With already more Rupee chasing less $, RBI cannot cut any key rates thus leading to stifling of economic activity.
What could possibly be done to stem the fall of the rupee? Here Government policies and RBI intervention are critical to recovering the situation.
- Increase $ in the market
- RBI needs to sell its reserves to increase the $ availability in the market (already done)
- Making Remittance more attractive – more $ inflow into the country
- Discourage import of Gold (attempted by RBI by imposing fresher tax)
- Decrease dependency on imports
- Increase FDI and hence increase inflow of $ (no wonder Chidambaram is in the USA)
- Join China in the demand for a neutral currency like IMF SDR for international trade