Q. Analyze the causes responsible for weakening of rupee and its implications for the India economy. (250 words)

Model Answer :

Approach:

• Why in news?
• Weakening of rupee - Causes
• Implications for India Economy
• Way Forward
• Conclusion

Why in news?

Rupee crashed to a lifetime low of 69 against US Dollar. Rupee was pushed to a life-time intraday low of 69.10 a dollar. The rupee is the worst-performing currency in Asia this year. It has lost almost 8% in value since January 2018.

Weakening of rupee – Causes

• Rise in crude prices – Brent crude prices have increased from $70.30 to over $80 per barrel since the beginning of the new financial year in April. This is mainly due to concerns over supply disruptions after the rise in US tensions with Iran, which contributes 11-12% of OPEC production. As oil prices rise, India’s trade deficit — excess of imports over exports — will worsen, which can in turn impact the current account deficit.
• A growing anticipation of interest rates rising in the US and consequent out flow of foreign funds – Expecting US interest rates to go up, FPIs have taken out Rs 27,000 crore from India in April and May so far, which is over $4 billion in less than two months. As the US Federal Reserve raises rates further — which is bound to happen — FPIs will prefer to invest in their home country as the arbitrage gain while investing in India and emerging markets will decline. A weakening rupee will also lower returns, which will in turn impact future inflows.
• China has been depreciatingits currency (yuan). This is to offset the effect of duties imposed by the US. The Indian unit also seems to be moving in tandem with the yuan so that exporters don’t lose out.

Implications for India Economy

• Effect over Imports

Importers will be hit as the cost of getting goods or equipment into India will increase. When the rupee weakens, importers, especially oil companies and other import-intensive companies, have to shell out more rupees to buy an equivalent amount of dollars. In this sense, a weak rupee can act as a kind of import tax. For the oil sector, it is a double whammy, as the rise in crude prices and the decline in rupee value add to retail fuel prices. Margins of oil companies will come under pressure.

• Effect over Exports

Exporters, especially software exporters, stand to benefit, as they get more rupees while converting dollar export earnings into Indian currency. This is expected to boost exports, which have been showing single-digit growth. In FY18, exports grew 9.78%, and given exports in April 2018 showed only 5.17% growth, it appears that the issues with GST implementation are yet to be overcome.

• Effects over people

A weak rupee is making overseas travel costlier this holiday season — a traveller will have to shell out more rupees to buy dollars. Students studying abroad too will see their costs rise.

But these are good times for those who receive remittances from abroad. According to the World Bank, the Indian diaspora remitted about $69 billion in 2017, the most in the world. The value of these remittances in bank accounts in India rises as the rupee depreciates against the dollar.

• Debt Affordability

Currency depreciation transmitting into materially weaker debt affordability is limited. This is because of India’s low dependence on foreign-currency borrowing to fund its debt burden. India’s significant build-up of foreign exchange reserves in recent years to all-time highs provides a support buffer. This will contribute to mitigating the external vulnerability risk.

• Overall effect

The fiscal and current account deficits are interlinked. When fiscal deficit is high, government borrowing rises, leading to higher interest rates. However, when foreign funds start flowing in, the rupee strengthens and exports become more expensive. Crude prices are expected to rise further this year, and imports are expected to grow by at least 14%, says a note from SBI Research. This is bound to enlarge the import bill and push up the trade deficit, which will in turn add to the CAD and push the FY19 figure to 2.5% of GDP. A widening CAD has macroeconomic implications. The best way to bridge the gap is by boosting inflows, but Indian markets have been witnessing FPI outflows, instead. Also, the rise in import costs as a result of a weak rupee can boost inflationary pressures.

Way Forward

With the tightening of monetary policy by the U.S. Federal further this year, there could possibly be more ramifications for the Indian economy. The recent increase in domestic interest rates by RBI is the response to the rising external economic risks.

The twin impact of FII outflows and worsening trade balance can hit the rupee further; to keep external metrics stable, therefore, exports of both services and merchandise need a further push.

The RBI facilitates the orderly movement of the currency through buying dollars from the market when the rupee strengthens, and selling the US currency when the rupee weakens. India’s foreign currency assets fell by around $6 billion to around $394 billion recently as the RBI apparently sold dollars from its foreign exchange kitty to stabilise the currency. It should keep doing such good work.

Conclusion

The currency’s fall and rise can be both negative and positive, depending on the macroeconomic situation, inflows, crude prices, strength against other currencies, real effective exchange value, etc. A strong rupee can hurt exports, but a weak rupee can push up the import bill.

Source:- Dheya IAS