While depreciation means a reduction in value, it can be advantageous as it makes exports in the depreciated currency less expensive. For example, suppose one unit of Currency A is worth one unit of Currency B. If Currency A depreciates such that it becomes worth half of one unite of Currency B, then exports denominated in Currency A are only half as expensive when trading in a Currency B market. SIGNIFICANCE:- * When a country's exports are high, the buyers of these exports need its currency to pay for those exports. When the country's central bank increases interest rates, people will want that currency to deposit in the banks to earn that higher interest rate. * When employment and per capita income in a country increase, the demand for its goods and services increases, along with demand for that country's currency in the local market. * Demand for any country’s currency on the foreign exchange market is determined by demand for that country’s exports of goods and services and by changes in foreign investment in that country.
This is because when foreigners buy another country’s exports of goods or services they must pay for these in the currency of the exporting country. * In the same way, Supply of any country’s currency on the foreign exchange market is determined by that country’s imports of goods and services and by its investment in other countries. * Thus when the demand for a currency rises its price goes up and it becomes costlier. * An increase in exports of a country will lead to an increase in demand for the currency and thus the value rises. * Rapid domestic growth increases the demand for mports, while slow or no growth with foreign economies can cause a decline in demand for the country's exports. * If prices in both countries remain the same, depreciation will make foreign goods relatively more expensive to you, leading to a fall in imports. It also means that, even if prices remain the same, your goods will be cheaper to foreigners. They will buy more of your goods and exports will rise. As a result, your country's net exports will increase. * The devaluation of the dollar will have a positive impact on the importers, while it will have adverse effect on the exporters.
Importers of goods and services will be getting the goods and services by paying less THEORETICAL FRAMEWORK:- Currency depreciation is not at all good for economy of a country. Government always keeps an eye on currency fluctuation. More depreciation can cause major loss to a country. All this is related to export and import of a country. If a currency depreciates, it is the exporters who make good profit, where as importers are on the losing side. Depreciation discourages purchases of imported goods stimulating demand for domestically manufactured goods.
The governments worldwide monitor appreciation and depreciation by using powerful tools like the base interest rates, which are usually set by the country’s central bank. Many a times this tool is often used to intentionally depreciate the currency rates to encourage exports. However, this can cause major damage to imports. Always a balance has to be maintained between export and import. Within a p of 5 year, the value of INR has significantly increased from around 40 to 54. 24 with respect to dollar. Indian economy is among the fastest growing economies of the world.
The appreciation of the rupees against the dollar would be another giant sign towards its economic prosperity and augmentation. However, the economic epidemics like poverty, unemployment etc. , could not be dealt in the short-run. In the past one year, the dollar has dropped by around 15 per cent against Indian rupees. This reveals that positive or negative impact on volume of export or import would be around 15 per cent, which cannot be over looked as the exporters are suffering losses, whereas importer are on gain. However, the impact will remain until there is depreciation of dollar against rupees.
If it continues, then a great change can be expected on a long run in international trade arena. Another impact would be the fantasy of dollar has been losing ground day by day. From analyses made it clear that earlier people were, fascinate about dollar due to its value against Indian rupees. However, the scenario has completely changed. Those, who were planning to move to US for job, now might plan to settle in Britain, as British economy is one of the strongest economies in the world REASONS BEHIND INR DEPRECIATION (SINCE AUGUST 2011)
Since the transition from fixed exchange rate regime to market determined exchange rate regime in March, 1993, the INR value with respect to the United States Dollar [USD] had decreased manifold (Dua & Ranjan, 2010). The primary reasons that catalyzed the INR fall could be the increased trade between other countries. Post liberalization, the country witnessed an ever-increasing flux in the foreign inflows particularly due to the enticing growth potential of the country. However, this effect could not overpower the gap between import and exports [called the Trade Deficit].
The offsetting effect of foreign inflows strengthened till mid-2008 (the rupee was once comfortably trading at 39. 15 INR/USD) when the banking crisis unfolded in the US leading to recession. Though commentators say that emerging economies like India and China were the least hit by the recession (in terms of output) (Ghosh & Chandrasekhar, 2009), the crisis took its toll on the INR. With the flight of foreign funds to safer haven currencies and better investment opportunities, the INR had no other choice but to fall. However, the recent round of depreciation of the INR is peculiar in some aspects.
Though there was another crisis that hit the world markets, i. e. the Euro zone crisis, there was considerable lag in the effect, with the Euro zone crisis started looming as early as late-2010, the INR’s depreciation is felt only in August 2011. Major reasons behind this depreciation can be listed [in decreasing order of importance] as follows: * Outflow of funds (and/or) Impeded inflow. * Increasing Current Account Deficit [CAD] * Recovery of USD and Japanese Yen [JPY] – the long-term safe haven currencies. * Lack of intervention from RBI FALLING RUPEE AGAINST DOLLAR 011 was the year of great stress for Indian Rupee. It has lost greater than 10 % of its value in the year 2011, making it one of the worst performing currencies in Asia. Logic says rupee appreciation shows the Indian economy is strengthening against US economy and depreciation makes the economy weaker. Overseas funds sold more than US$500 million worth of Indian-listed shares over the last 5 years, reducing net income for 2011 to less than US$300 million – a tiny sum compared with record investments of greater than US$29 billion earned last year, on November 21, 2011 alone.
According to Federal Bank report, the premium banks pay to borrow dollars overnight from central banks will fall by half a percentage point to 50 basis points. The move was coordinated with the monetary authorities in Canada, the U. K, Japan and Switzerland and the Central Bank of Europe. ROLE OF GOVERNMENT OF INDIA AND RESERVE BANK OF INDIA The exchange rate is a significant tool used to examine the efficiency of economy. The exchange rate of the Indian rupee is dependent upon the market conditions, where the demand and supply play a major role.
In order to adopt the effective exchange rates the RBI makes buy and sell transactions to keep the low variability and volatility in exchange rates. RBI also removes the excess liquidity from the economy by increasing the CRR and SLR. The Government of India also managed floating exchange rate mechanism. This means that the Indian government interferes only when the circumstances demand and/or if the exchange rate gets out of control by increasing or reducing the money supply. Hedging: Using forwards and futures contracts help in mitigating the risks arise due to exchange rate fluctuations.
This process is known as Hedging, but none-the-less the impact is substantial. Reduce Trade Deficit: The main factors for the depreciation of rupee are slowdown in capital flows, high trade and current account deficit and high crude oil prices. To stop fluctuations in rupee it is necessary to reduce these deficits. RBI Control Policy: When rupee depreciates, it results in a price hike in the petroleum products and fertilizers. This increases the inflation. This becomes a challenging period for RBI. If they increase the key rates, it will affect our growth rate and there will be stock market crash.
If it is not, inflation will kill the normal public. As per analysts, say the rupee depreciation is considered as a short-term scenario. The Indian market will be a good destination for FIIs in years to come. Huge investment is expected in the coming years. Gradually the rupee will gain its value. Investors need not worry about the rupee depreciation. Since March 2010, Reserve Bank of India [RBI] hiked the interest rates 13 times and thus compromising on growth. RBI’s interest rates hikes seemed futile since the inflation was due to supply falling short rather than the demand rising.
Both inflation and RBI’s action reduced the color of the vibrant economy once India displayed in 2007-2008. According to intelligence reports by the Associated Chambers of Commerce and Industry of India, sectors of India Exports are as follows- Sector of Import| Share in Total Imports| Petroleum| 77| Heavy Engineering Goods| 22| Pharmaceuticals| 19| The sectors of Import gain if the rupee appreciates. They would have to pay less for the imported raw materials, which would increase their profit margins. Likewise, depreciation in rupee value makes exports cheaper and imports expensive.
Exports from India are of handicrafts, gems, jewelry, textiles, ready-made garments, industrial machinery, leather products, chemicals and related products. Since the 1990s, India is the world’s largest processor of diamonds. The mentioned export items contribute substantially to foreign receipts. During the periods when the dollar was moving high against the rupee, exporters stood to gain, when $1 = Rs. 48, was getting them Rs. 4800 for every $100. Since the beginning of the year 2007, rupee appreciated by about 10%.
With its value of rupee Rs. 39. 35 = $1 as on 16 Nov 2007, for every $100, exporters would get only Rs. 3935. This difference is towing away the profit margins of exporters and BPO service providers alike. Imports to India are of petroleum products, capital goods, chemicals, dyes, plastics, pharmaceuticals, iron and steel, uncut precious stones, fertilizers, pulp paper etc. With the same scenario as given for export, if we analyze - an importer is paying Rs. 3935 now instead of Rs. 4800 paid during yester years for every $100.
This gain on FX is likely to create savings in cost, which could be passed on to consumers, thereby contributing to control inflation Exhibit showing the quarterly values of Foreign Investment Flows in India Source: Public Debt Management Quarterly Report (July-September 2011), Ministry of Finance, November 2011 CONCLUSION:- Conclusively, appreciation and depreciation of rupee cannot certainly be taken as beneficial to the Indian economy in general. On one hand, the rupee appreciation will affect exporters, BPOs, etc. , on the other, rupee depreciation will affect importers.
So now, it depends on what the future has to reveal for, how effectively the central bank can balance the FX rates with little impact to the relative areas of FX usage. Though RBI is trying its level best in controlling inflation, due to the inherent supply-driven nature of the inflation, monetary controls remain as futile attempts. Systemic inefficiencies, like improper supply chains, must be immediately addressed by the Government to stall inflation. RBI has already done the damage by ruthlessly increasing the base rates and thus compromising the growth and discouraging investments.
In order to control currency depreciation, any central bank is expected to hike the interest rates. Since the prevailing interest rates have already reached a high, RBI is helpless in managing the exchange rates through interest rate hike. Another option left with RBI is to use its foreign exchange reserves to sell dollars in the currency market to improve the value of INR. Though RBI’s argument of non-intervention is justified (Gokarn, 2011), it must strike the right balance between intervention and controlled-intervention.
Generally, foreign exchange reserves deplete because of daily operations of central banks in the wake of domestic currency depreciation. Considering all the above factors, is the way ahead gloomy for the Indian rupee? Well, nothing can be told so surely in this uncertain environment. The market sentiments truly drove the INR to the edge. The INR may correct itself and settle in a lower value than that is prevailing currently as the market sentiments fade out. On the other hand, tight monetary control by the RBI, which led to high interest rates, widened the interest rate differential thus inviting inflows.
Overselling of rupee than that is necessary might have caused the slide in the value of INR. If the rupee starts rebounding, it would definitely start yielding high results due to the low base effect. Therefore, if the rupee is actually oversold, investors who are confident about the resilient Indian economy might put their money on the rupee since no other asset would give such high returns in this current scenario. However, there are conditions attached to the argument - rupee must bounce back and foreign inflows must find their way back into the Indian economy.