The Indian Rupee has been on a free fall and has devalued by more than 13% since the beginning of the year 2018. With every fall, price level for essential items are sky rocketing. Economist and financial experts have expressed concern about the continuous downfall of the rupee. The Finance Minister and Reserve Bank of India had to come out and assure the nation that the fall is not the matter of worry. Of course, the common man is not dealing with foreign exchange, but he is being affected most severely.
Historically, rupee had always been devalued. In 1990 the value of rupee against one US dollar was around 17 rupees, and now it’s almost 74. It means it is devalued by around 335%. However, the devaluation has happened gradually with few exceptions, so the impact was not so sudden and pinching.
The value of a country’s currency is linked with its economic conditions and policies so let’s decode in common, understandable language.
First, let’s understand the purchasing power of a currency. It is the value of the currency which can be exchanged for goods or services. When currency is devalued, its purchasing power is reduced. If we evaluate in current rupee fall, an item which could have been bought for Rs. 100 at the beginning of the year it has now become expensive and could be bought for Rs. 113. It means you have to spend Rs.13 more for the same thing reflecting the decline of purchasing power of rupee, termed as devaluation.
The value of a currency depends on factors that affect economy such as the balance of payment comprising import and export, interest rates, growth rate, geopolitical issues, and many more.
The balance of payment (BOP) is summary of all transactions the country does through its all entities to anyone outside the country. These transactions consist of imports and exports of goods, services, and capital, as well as transfer payments such as foreign aid and remittances.
Trade deficit: In simple language trade deficit occurs when a country’s imports exceed its exports. It represents an outflow of domestic currency to foreign markets. The deficit mounts pressure on the rupee, as a result of which the value of rupee depreciates.
In an Indian context, we have to understand that India is always a net import country, meaning imports are more than exports, so there is always trade deficit. Oil import is one of the major components of the Indian import bill. Energy-hungry India imports around 80% of its oil requirement. When oil prices in international market increases, trade deficit widens, and it brings significant setback to the Indian economy. Usually, this trade deficit used to be supported by capital inflow like foreign direct investments which are also declining and exports, which are not growing enough to support deficit. Hence there is a free fall of rupee value.
Current Financial year deficit (From April-18 to Aug-18) is US Dollars 47.71 billion, of which in the month of Aug-18 is US Dollars 17.39 Billion. Trade deficit of India is increased from 8.9 Billion Dollars in Sept-17 to 17.390 Billion Dollars in Aug-18, which is almost double. Imports have increased by around 20% in the current year, at the same time; Indian exports are showing sluggish growth and haven’t picked up enough, thereby increasing trade deficits. Surprisingly, not only oil is contributing to the trade deficit, but electronic imports (US Dollars 35 Billion-2017) are also a significant contributor to the import bill.
This is something more worrying cause as our industry can’t meet rising aspiration of Indian middle class, and electronic good are imported at the cost of valuable foreign exchange and aggravating fall in rupee. Dwindling foreign investment flows (US Dollars 8.579 Billion in Sept-17 to US Dollars 1.981 Billion in Aug-18) and strengthening of US Dollar due to development of the US economy is fueling the deficit. As India always has a current account deficit, it continually needs dollars which is not met by increasing exports thereby widening the trade deficit and furthering the depreciation of rupee.
Ideally, the falling value of rupee also has some positive impact on the economy and one of the significant impacts is boosting Indian exports. As rupee falls, Indian products become cheaper to foreign buyers. Increasing exports bring more foreign currency. For years, Indian exports are showing slowing growth, so this would be an opportunity to boost exports.
As Indian economy is consumption driven and things which can’t be manufactured locally are imported. It imports non-essential things in significant volume whereby demand to meet foreign payment increases. Falling rupee leads to an increase in the price of imported goods which in turn reduces its demand and helps in curtailing imports. In another way, it helps domestic manufacturer as their products can now compete with imported products. Also when prices of oil products go up; it’s an opportunity for Govt. to garner more tax on increased prices.
How can rupee devaluation be controlled?
One of the short-term measures controlling falling rupee is selling US Dollars by Reserve Bank of India (RBI), which increases the supply of foreign currency and increases rupee demand. However, this time it seems that RBI either not interested or ineffective in controlling free fall of rupee. After a long falling trend, Govt. has taken some measures by increasing customs duty on non-essential imports. It seems that Govt. also wants rupee to be cheaper to have positive impact on the economy. Both of the measures mentioned are short-term. Long-term measures include increasing exports and make the country as preferred investment destination attracting foreign capital.
As India hasn’t improved significantly in ease of doing business, foreign investors are losing interest. Unfortunately, on the export front, India couldn’t take advantage as it lacks competitiveness. Same stands true when it comes to curtailing imports of non-essential consumer electronics and gold as it doesn’t have enough capacity or quality to support domestic consumption.
Due to current Geo political risk, oil prices are soaring which will bring more pain. In such times, Govt. usually encourages Indian diaspora to improve foreign exchange reserve by offering attractive schemes. Rupee fall is an opportunity for Indian diaspora. They can remit more money to their home country, and since diaspora is huge, the amount remitted is beneficial for the Indian economy.