A PROJECT REPORT ON

FALLING RUPEE (₹)

SUBMITTED

TO THE UNIVERSITY OF MUMBAI

AS A PARTIAL REQUIREMENT FOR COMPLETING THEDEGREE OF

M.COM (BANKING AND FINANCE) SEMESTER I

SUBJECT: ECONOMICS OF GLOBAL TRADE & FINANCE

SUBMITTED BY:

PILLAI ANUJA SURESH

ROLL NO.: 42

UNDER THE GUIDANCE OF1

MRS. RAJAM RAJAGOPALAN

SIES COLLEGE OF COMMERCE AND ECONOMICS,

PLOT NO. 71/72, SION MATUNGA ESTATE

T.V. CHIDAMBARAM MARG,

SION (EAST), MUMBAI – 400022.

CERTIFICATE

This is to certify that___________________________________

__________________________________________________________

of M.Com (Banking and Finance) Semester I (academic year

2013-201) has successfully completed the project on

______________________________________________________underthe

Guidance of Mrs. __________________________________________.

____________________________________

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(Project Guide)(Course Co-ordinator)

______________________________________

(External Examiner)(Principal)

Place: _____________

Date: ___________

DECLARATION

I,__________________________________________________

Student M.Com (Banking and Finance) Semester I (academicyear

2013-2014) hereby declare that, I have completed theproject on______________________________________________________________.

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The information presented in this project is trueand original

to the best of my knowledge.

Place: _____________

Date:_____________

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___________________

PILLAI ANUJA SURESH

Roll No.: 42

ACKNOWLEDGEMENT

I would like to thank the University of Mumbai, forintroducing M.Com( Banking and Finance) course, therebygiving its students a platform to be abreast withchanging business scenario, with the help of theory asa base and practical as a solution.

I am indebted to the reviewer of the projectMrs.Rajam Rajagopalan,my project guide for her supportand guidance. I would sincerely like to thank her forall her efforts.

Last but not the least; I would like to thank myparents for giving the best education and for theirsupport and contribution without which this projectwould not have been possible.

______________________

PILLAI ANUJASURESH

ROLL NO.42

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TABLE OF CONTENTS

Sr.No Contents Pg.No

1 Introduction 6-

(a) Overview 6

(b) Rationale 8

(c) Objective 8

(d) Chapterization 8

2 Life line of rupee 9

3 How Rupee has moved against dollar 12

4 Causes of Rupee fall 14

5 Impact of Rupee fall 19

6 Belated steps taken by authorities 21

7 Policy options for India 22

8 RBI and ailing rupee 24

9 New prescriptions for ailing rupee 28

10 Conclusion 30

11 References 32

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OVERVIEW

“We invented money and we use it, yet we cannot understand its laws or control its actions. It has a life of its own.”- lionell trilling, american literary critic

The most concerning chapter for India during last two years andspecifically last two months is the weakening of rupee againstdollar. It is not only that rupee has lost its value in theglobal context but also dollar has improved its performance inthe global trading markets. The outstanding performance of USequities and the improvement in the labor market has madeAmericans more optimistic about the US economy, therebystimulating greater hopes of QE(Quantitative Easing) tapering.

The government of India is still unable to generate heavy capitalinflows.If US Federal Reserve withdraws its bond buyingprogramme; there will be unexpected outward flow of money leavingIndia clambering for dollars. The slowdown in the Indian economyhas made the situation more fickle.

The government has a strong role in controlling currency in theform of policy regulation and reforms. The current UPA leadershiphas failed to strike with some heavy reform to generate more cashinflows. As a result the government has gradually lost itscontrol over rupee depreciation. Investors’ sentiment plays apivotal role over here

Oil and gold imports account for 35 per cent and 11 per cent ofIndia’s trade bill respectively.There has been an uninterrupteddemand for the dollar from the oil importers pushing the rupee

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lower. Likewise the falling gold prices have made the centralbank to reduce imports, which increases CAD and hits the currencydirectly. Indian economy requires a strong structural reform tomaintain a positive balance of payment.

Also, government spends excessively as election approaches justto woo electorate votes. This causes the rupee to depreciate.Then the government beats around the bush to control the currencybehaviour. Most of the times these measures worsen the economiccrisis to a great extent.

The foreign institutional investors have been selling indexfutures and Indian equity market is weakening. As a result thereis a heavy demand for dollar and Indian currency as well aseconomic situation is looking too gloomy.

These worries, combined with a record high current accountdeficit and now uncertainty over the central bank’s monetarypolicy stance, have prompted foreign investors to sell more than$12 billion of Indian debt and equities since late May.

Reserve Bank of India has taken certain steps and some more to befollowed to have a control over rupee.

But the Question comes here, What are the implication? Is it that badoverall?

The best business prototype anyone can have is to spend in rupeesand earn in dollars, which is what the giants of India Inc,including the top IT companies, excel in. Basically the sectorwhich is targeting exports for its industrial operations are theone wins the game.Dollar appreciation would be positive for sectors such as IT,pharmaceuticals, hotel, textiles and automobiles which have thetotal foreign exchange earnings of these firms are far greaterthan their forex spends. As much as the rupee weakens, the

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foreign exchange earners gain provided the other factors remainsconstant.

A sharply declining rupee triggers inflation, broaden the currentaccount deficit, hits investor sentiment and creates burdens fororganization with high exposure to foreign debt. The governmentand the Reserve Bank of India have taken several reforminitiatives to resist the downturn, but their success stories arelooking gloomy.

Buying imported materials will become very costly. A weak rupeewill create extra stress on Oil Marketing Companies (OMC) andthis will surely be passed on to the consumers as the companiesare allowed to do so after the deregulation of petrol and partialderegulation of diesel. If the OMCs increase fuel prices, therewill be a substantial increase in overall cost of transportationwhich will trigger inflation.

If the depreciation is steep and without control, it will strikeup inflation. As a result the Central bank would have very lessroom to impose further rate cut and that’s the burden theborrower would have to bear.

Indians who have gone to abroad for tours or studies are highlyaffected in these times. The only smiling people in this contextare the NRI’s who gain more on sending money to their homeland.

As a whole we can say that though weakening rupee is the reasonfor someone’s smile it is a real threat for the country’s overallfiscal health and increase the current account deficit heavily.But in my opinion this huge downgrade is a temporary phenomenonand the rupee is really oversold. Now the Central bank andGovernment should work hand in hand and find out the policymeasures to stabilize the frightening scenario. I personally hopea further cut in SLR to ease the liquidity to save rupee and alsoimport duty hike in gold and other related materials. RBI can buybonds to ease liquidity in the market. Finally we can say that

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the situation is tight and challenging for us, but we can notonly hope for the best but also should contribute the most to getback Indian economy in the driving seat.

RATIONALE

The purpose of undertaking this project is tounderstand as to why the rupee has been the worstperformer in Asia since late May 2013, when the USFederal Reserve first signaled that it may begintapering its monetary stimulus this year, sparking anexodus of cheap money from emerging markets worldwide.

OBJECTIVE

The Main objective of this Project is to analyse andincur as to how and which factors are contributing inailing the Rupee value. Thereby it also aims atdiscussing and bringing out various solutions forAiling Rupee. It also intends to bring to the Noteabout the current and new RBI governor Raghu ramrajan’s entry at this stage of crisis and what actionshe plans to adopt will also be shortly discussed.

CHAPTERIZATION

The first part of the project takes back to theperformance of rupee against dollar in the past.Then itconcentrates on the current scenario thereby explaining

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its causes and impacts. It also lays out variousstartegies adopted by authorities to curb the fallwhich unfortunately couldn’t do well.

The second part then deals With RBI, New governor andNew prescriptions for ailing rupee thereby listing theimpacts of the measures to be taken

This project then ends with a conclusion.

LIFELINE OF RUPEE

Yesteryear humanist Mehamood was morethan symbolic when hecrooned “Na biwi na bachcha na baap buda na maiyya/ the wholething is that ki sabse bada Ruppaiya” in the 1976 movie “sabsebada rupaiya”

The movie released a few years after a politically controversialmove to devalue the rupee in the mid-60’s, mirrored the inescableimportance of the currency note in India’s socio economic milieu

India’s currency history is a spectacular continuum since theancient ages to the current rough and tumble of a globalizedeconomy, with each era’s coinage, and worth, broadly imitatingthe prevailing political, social and economic environment

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EARLY DAYS“Punch marked” coins of the 6th-7th century are believed to be thefirst documented use of currency in India- called thus because ofthe peculiar technique to make them by thumping bear symbols intosilver planes.

The “Ruppaiya” whish has evolved into the modern day rupee, wasfirst introduced as a silver coin for transaction by emperor Shershah Suri, Who built the grand trunk road in the 16th century.

It also perhaps , hold out lessons on the role of currency andhousehold savings in raising public resources to build massiveprojects.

Thrifty households could well turn out to the primary financiersof highways and ports if India’s savings sustains at high levels,primarily due to its armies of young people entering workforce.

POST INDEPENDENCEIn 1947, One could change a Rupee-Worth a US dollar then-into 16annas, but in value, this was no loose change. Those days for ananna you could buy a kilo of Ghee, now priced anywhere betweenRs.300 and Rs.400-a nearly 2000 fold jump.

India’s exchange rate has developed from a fixed regime where thegovernment and RBI determined the rupee’s value-similar to whatChina does for its yaun against the dollar-to a market ruledsystem determined by the laws of demand and supply, pretty muchlike other commodities.

Between 1947-1971, India followed a “par value system” where therupee’s value was fixed at 4.15 grains of fine gold. Thecurrency’s devaluation in june 1966 reduced the par value ofrupee to 1.83 grains of fine gold.

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DEVALUATIONIn 1966, the Government announced its first major intervention inthe foreign exchange market announcing rupee’s devaluation by37.5% ( from rs.4.75 the dollar became expensive to rs.7.50 inone single stroke).

A devalued or depreciated currency boosts exporters earnings inrupee terms. For every dollar, devalued currency gives them morein rupees terms. This encourages them to slash prices for theirgoods in the world market making them more competitive thanglobal peers.

Two wars- with china in 1962 and with Pakistan in 1965- hadcrippled the Indian economy. The broad objective of devaluing therupee was to raise export earnings, liberalise imports and boostIndia’s chances of securing more foreign aid, underlying theimportance of currency administration as a policy tool.

According to John P Lewis who was the head of the USAID (unitedstates agency for international development) mission to India inthe mid 60’s:” Devaluation was not aid in itself. Devaluation wasan instrument ;it was essential if freeing the market was towork. Whether formally or de facto, it had to come sooner orlater, and in purely economic terms; it made sense to get on withit.

25yrs later, buffeted by a precarious BOP crisis, Manmohan singh,who was the Finance minister between 1991 and 1996, againdevalued the rupee in 1992 to encourage exports and earn preciousdollars. The rupee’s value fell sharply from just over rs.25 to adollar to near rs.32 to a dollar.

That was the last time India has used devaluation as an economicpolicy instrument. India has since moved on to a fully marketdetermined exchange rate regime. Trans continental capitalmovements decided by the click of a jumpy computer mouse play akey role in deciding the worth of the rupee, which only three

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year ago joined the elite club of symbol endowed nationalcurrencies that include the dollar, the pound, the euro and theyen.

PAIN AHEAD The rupee has had a sharp fall since May 2013 and is menacinglythreatening to canter past Rs.70 to a dollar. If the country’stop economy managers have gone into a huddle after the currency’srecent slide, it is only symptomatic of the anxiety inflictingIndia’s broader economy.

Ever since the world recovered from the doctom bust and found anew mantra-emerging markets –foreign investments, both directdirect and financial, has been chasing on India’s story thatdeliver returns in igh double digits a year. The tide has sinceturned, bringing the rupee and other emerging markets, currenciesdown.

Analyst warned of more pain ahead as the world settles down to anew normal state of economy.

“Taming Inflation or the currency(as in the case currently) mayrequire policies that result in increasing the economic miseryfor people in the near term. Unfortunately, we see no short cuts”claims Sonal varma, economist at Nomura.

Eventually, funds will return to India and it’s peers, for thesewill remain the island of global growth. As Herbert stein, aformer economic adviser to US president Richard Nixon and Geraldford had presciently observed “If something cannot go on forever,it will stop”. India’s policy makers, and its people, will onlybe hoping the stein’s rule prove true for halting the rupee’sfree fall.

15BOX 1

Exchange rate? What’s that?

Like any commodity, the exchange rate or price of a commodity is determined by the laws of Demand and Supply

HOW RUPEE HAS MOVED AGAINST DOLLAR

₹1=$1(1947)-India gains independence.

₹6.35 (1966) -Government devalues rupee to encourage exports.

₹7.67 (1973)-Oil crisis breaks out; Government enacts FERA toclamp down on illegal forex transactions

₹8.41 (1975)- Government inposes political emergency.

₹12.36 (1985)- Rajiv Gandhi government launches first stirringsof liberalization through long term fiscal policy

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BOX 1

Exchange rate? What’s that?

Like any commodity, the exchange rate or price of a commodity is determined by the laws of Demand and Supply

BOX 2

Currency Devaluation/Depreciation??

If a currency is depreciating, his implies that its value has fallen in relation to another currency. In the current context, the value of the rupee has fallen or depreciated from about rs.55 against the dollar to about rs.65,over few months.

₹22.63 (1991)- India mortages gold to wriggle out of a BOPcrisis. Also, Finance minister Manmohan singh dismantles theIndustrial licensing regime in a budget that marks te beginningof India’s economic reforms.

₹25.92 (1992)- Government sets up SEBI to regulate stock marketin the wake of Harshad Mehta securities scam.

₹31.44 (1993)-India moves to a full market determined exchangerate system after merging the dual rates of the transitionalliberalized exchange rate management system (LERMS) introduced byRBI earlier.

₹35.43 (1996)- Import licensing is abolished and tariffs broughtdown substantially

₹36.32 *(1997)- Finance minister P Chidambaram presents “Dreambudget” bringing down tax rates

₹41.27 (1998)-The Asian currency crisis hits;the rupee sinks to anew low.

₹48.60 (2002)- The prevention of money laundering act(PMLA),2002, is enacted, forming the core of the legal frameworkto combat illicit monetary transactions across the country.

₹ 45.32 (2004)- UPA government with Manmohan singh as PM comes topower.

₹43.31 (2006)- India’s growth rate hits a record of 9.8% on theback of high domestic and global demand.

₹43.50 (2008)- Wall street icon Lehman Brothers collapses,pushing the world economy into its worst crisis in eight decades.

₹48.40 (2009)- UPA government returns to power

₹53.32 (2012)- Government announces retrospective taxation ofcorporate deals, spooking investors.

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Rupee canters past 55, touching 57.

P.Chidambaram returns as Finance minister; shepherds in a string of reformist moves, including plans to push india to the path of fiscal consolidation.

₹ NOW:

US Federal reserve chief Ben Bernanke hints at withdrawing cheap money policy amid signs of recovery in the US.

The rupee plunges to a new low, breaching 65 to a dollar despite a slew of measures including forex controls on individuals and companies

The government appoints Raghuram Rajan as governor of the RBI.

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BOX 3

Why is the rupee falling-US Federal connection??

The US federal reserve has hinted at winding down the programme to pump in billion of dollars, amid signs of recovery in the US.

Part of this money came in to Indian equities.

Portfolio investors are now withdrawing money from emerging markets, causing the demand for dollars to rise, pulling down local currencies.

CAUSES OF RUPEE FALL

The Indian Rupee has depreciated to an all time low with respectto the US Dollar. On 28th August 2013, the Indian rupee had gonedown to 68.825 against the Dollar but the situation was somewhatrevived by the Reserve Bank of India that decided to open aspecial window for helping state owned oil companies – Indian OilCorp Ltd., Bharat Petroleum Corp and Hindustan Petroleum Corp.

The beneficiaries will be able to buy dollars through this windowtill further notice is provided. These companies, together,require about 8.5 billion dollars every month to import oil andit is expected that this will help them meet the requirements.This has had an immediate effect as is evident from the fact thatthe INR has started at 67 against the USD at the earlyproceedings in the Interbank Foreign Exchange Market.

The question, however, is why this is happening. There areseveral reasons that can be enumerated in such a scenario.

WHAT BASIC LAW OF ECONOMICS SAY??

As per the rudimentary laws of economics if the demand for USD inIndia exceeds its supply then its worth will go up and that ofthe INR will come down in that respect. It may be that importersare the major entities who are in need of the dollar for makingtheir payments. Another possibility here could be that theForeign Institutional Investors are withdrawing their investmentsin the country and taking them elsewhere.

This can create a shortfall in supply of the dollar in India. Infact, of late, the FIIs have been heading to greener pastureslike Singapore owing to the greater operational efficiency and

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lesser bureaucratic problems that have unsettled the Indianbusiness fraternity and hampered its overall economic growth.

This situation can only be addressed by exporters who can bringin dollars in the system. If somehow the FIIs can be wooed back,then this imbalance can also be addressed to a certain extent.

GOING FOR GOLD

Gold is a physical asset and has been a traditional favourite forparking surplus income. Gold is considered to be a safe harvestasset. In times of high inflation and volatile stock markets,gold prices usually tend to go up. It becomes costlier in rupeeterms as the US dollar turns expensive. High gold consumptionahead of the festival and wedding season could see a rise inpurchases despite recent import curbs, further pushing down therupee.

EUROPEAN RECOVERY

There are signs of recovery in Europe after years of recession.Higher consumer spending in major European economies such asGermany will nudge companies to expand capacities. Additionalproduction lines in factories to meet greater demand or purchaseswill push up energy consumption in Europe. This will lead tohigher crude oil demand. This, coupled with the Syrian crisiscould push up oil prices further. For India, the import billcould get even wider and could push down the rupee further.

US MONETARY EASING

The US federal reserve is printing extra dollar to pump in $85billion every month to boost spending and investment and help theeconomy turnaround. Part of this money came into emerging markets

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0.2% estimated growth in euro zone during april-june, making an end to recession.

including India. In may, Fed resereve chief Ben Bernanke signaledwinding down the stimulus amid recovery signs. This has promptedforeign portfolio investors to withdrawing money from India andother emerging markets. The resultant rise in dollar demand haspulled the rupee down to record lows

Since the beginning of QE program, much of the money has leakedinto emerging markets offering higher yields and better growthprospects. The emerging markets have been the biggestbeneficiaries of Fed’s loose monetary policy, which has pumpedextra liquidity since the global financial crisis of 2008.According to the IMF, emerging markets received nearly $4trillion in capital flows from 2009 to early this year.

The investors borrowed cheap short-term money in the US andinvested in higher yielding assets in India, Indonesia, SouthAfrica and other emerging markets. This resulted in more moneyflowing into debt, equity and commodity markets in thesecountries. In India, many companies resorted to heavy borrowingsoverseas. The massive capital inflows also enabled India tocomfortably finance its trade and current account deficits ratherthan addressing the structural aspects of CAD.

However, this money will quickly leave India and other emergingmarkets when the tapering of QE program begins. Already, emergingmarkets are witnessing a huge outflow of dollars as investorshave started pulling money out of bond and equity markets. Theforeign investors pulled out a record Rs.620 bn ($10 bn) from theIndian debt and equity markets during June-July 2013. If theFederal Reserve decides to taper the QE program, the liquiditywithdrawal would continue to put pressure on the rupee over thenext 12 to 18 months.

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$85 billion, US federal reserve has been injecting monthly into the system.

SYRIAN CRISIS

A possible millitary intervention by the US in Syria has sparkedoff fear that a war would break out in the oil rich asset area.This has pushed up oil prices fuelling a rebound in US dollar asinvestors flocked towards the dollars safety. India importsnearly 2/3rd of its crude oil requirements and global oil pricesis bad news as it will push up the oil import bill and consequenthigher dollar demand would further impact the rupee

BILLING THE CAD

The rupee’s fall is symptomatic of a wider Current accountdeficit(CAD) or the difference between dollar inflows andoutflow. In 2012-13 India’s CAD had touched an all time high of$88 billion or a record 4.8% of GDP. Foreign porfolios investorsare waiting for cues on the calendar for rolling back themonetary stimulus. A spurt of dollar outflow could make india torein in the CAD. A wider CAD carries the risk of weakening therupee further.

VOLATILE STOCK MARKET

When the economy is performing well and the stock market isperforming better than other countries, overseas investors willbecome heavy investors here. It is a known fact that Indian stockmarket is dominated by overseas investors. To invest here, theyneed rupee. This will increase the demand for rupee and willresult in higher value for rupee. On the other hand, when theseinvestors are pulling money out of Indian stock market, rupeewill be depreciated. Indian market is in a bad shape for the last2 years. The sentiments after the US downgrade and the Europeancrisis etc. resulted in overseas investors selling rupee,buyingdollars and rupee depreciation. In a bad performing market, when

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$117 per barrel, the price of crude as on 25/08/2013, highest in 6 months

there is depreciation in rupee, it will bring down the overseasinvestors real returns. So they will start selling, which willagain worsen the situation. The dollar is still the safest papercurrency in the world! So, there is more demand for dollar involatile condition like this. This will add to the rupeedepreciation.

THE ROLE OF OFF SHORE NDF MARKET

Amidst all these developments, the critical role played by theoffshore non-delivery forward (NDF) market in determining thevalue of rupee should not be overlooked. The rupee NDF market hasmushroomed in key global financial centers with theliberalization of trade and capital flows since the 1990s. 

NDFs are over-the-counter (OTC) derivatives instruments fortrading in non-convertible currencies such as the Indian rupeeand the Korean won. The contracts are called “non-deliverable”since no delivery of the underlying currency takes place onmaturity. The counterparties settle the contracts on maturity bypaying the difference between the spot rate (decided by the RBI)and NDF rate, usually in US dollars.

Since NDFs are the OTC derivatives, the actual size of the marketis not known but various surveys suggest that the trading volumesin the NDF markets are larger than the onshore markets. Accordingto a study by the Bank for International Settlements (BIS), thedaily turnover in offshore rupee NDF market was $10.8 bn in 2010,nearly 52 percent of the total turnover ($20.8 bn) in foreignexchange forwards and forex swaps.

The NDF market for the rupee is mainly concentrated in Singapore,Hong Kong, Dubai, London and New York. In recent years, Londonhas become a key centre for trading in the rupee NDFs. Accordingto FXJSC Semi-Annual FX Turnover Surveys, the average dailytrading in rupee NDFs in London increased from $1.5 bn in 2008 to$5.2 bn in 2012, a jump of 250 percent.

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Being an offshore market, the Indian authorities have no powersto enforce regulations on it. The domestic banks and companiesare not allowed to transact in the NDF markets. The mainparticipants in the rupee NDF market consist of commercial andinvestment banks, hedge funds, currency speculators,international subsidiaries of Indian companies and big diamondmerchants.

Although the NDF market is primarily meant to provide a platformto companies to hedge their foreign exchange risk and relatedexposures, the dominant players in this market are thespeculators (who bet on the movement of the rupee) andarbitrageurs (who exploit the price differentials betweenoffshore and onshore markets).

GROWING INFLUENCE OF NDF MARKET

Being a 24×7 market, the offshore NDF market exerts considerablepressure on onshore currency markets, particularly when themarket sentiment is fragile for the rupee. Before Indian marketsopen for trading, the NDF markets in Hong Kong and Singapore setthe price movement of the rupee. A bearish or bullish trend inthe NDF market set the tone for trading in the domestic rupeemarket.

An empirical study by a RBI staff member found that there arevolatility spillovers from NDF market to spot and forward marketsin India. The study also found that the magnitude of volatilityspillover from NDF to spot and forward markets has become higherafter currency futures were introduced in India in 2008. This isprobably due to large arbitrage taking place between futures andNDF market, says the study.

In its latest Annual Report (2012-13), the RBI has acknowledgedthat there is a long-term relationship between the spot and NDFmarkets for the rupee. “During the period of depreciation, shocksoriginating in the NDF market may carry more information, whichgets reflected in on-shore segments of the market through meanand volatility spillovers”, states the Report.

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FOREIGN BANKS PLAYING THE ARBITAGE GAME

Since foreign banks and institutional investors are present inboth onshore and offshore markets, they profit from hugearbitrage opportunities using the prevailing negative sentimentsin the market. Such entities buy dollar-rupee forwards in onshoremarket and sell forwards in offshore NDF market. According toIndia Forex Advisors (a foreign exchange consulting and treasurymanagement firm), a large demand for forward dollar pushes upforward rate and thereby influences the spot exchange rate inIndia. As witnessed during July-August 2013, the increasedspeculative trading in the NDF market exacerbated volatility inboth the spot and the forward market in India.

Primarily six foreign banks (namely Citibank, HSBC, DeutscheBank, UBS, J P Morgan, and Standard Chartered Bank) are the keyplayers arbitraging between the rupee NDF market and domesticmarkets. Besides, a few international subsidiaries of big Indiancorporations and some diamond merchants are also engaged inarbitrage practice.

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INDIA NOT WORST HIT

It’s not in India alone where stocks and currencies have contracted a global flu after investors began flocking to safer locations such as the US ever since Federal reserve chief hinted about rolling back th quantative easing policy toaid recovery in the worlds largest economy.

Country Real GDP Current A/c Balance

Exchangeratefallsince

may(against $)

Forex reserves

India 4.8% -4.8% -16% 6.8China 7.5% 2.6% 0.33% 22.4Malaysia 4.3% 4.5% 7.60% 8.1Indonesia

5.8% -3.1% -7.00% 6.2

IMPACT

FUELLING INFLATION

Our transport bill could go up further. A weak rupee has widenedoil firms crude import bill sharply over the last few months.This will eventually force them to raise retail fuel prices tocover for potential revenue losses. Thus costlier transport fuelwill knock up prices and stoke inflation.

SOVEREIGN DOWNGRADE

India has been the target of unsparing criticism by credit ratingagencies for its precarious public finances. Ratings agency“standard & poor” cautioned that India faces a rocky road ahead ahigh CAD, Low rupee and a high fiscal deficit can raise thechance of a downgrade of India’s sovereign ratings spookinginvestors and currency and equity markets.

INTEREST RATES

The RBI had been forced to raise banks borrowing costs to curbliquidity in the system. The central bank wants to discouragebanks lendable resources being used for taking speculativepositions on the rupee. But costly funds for banks could forcelenders to raise rates for final consumers. Already, many bankshave raised rates. This could keep your EMI’s high.

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5% is India’s GDP growth in 2012-13, the slowest in a decade.

FOREX RESERVES

India’s forex reserves can fund just about 7 months of imports.The possibility of import payment default may be still far away,but lower reserves will limit the RBI’s ability to prop up therupee by selling dollar outflow , in wake of the rolling back ofthe US stimulus Package, can also deplete the reserve.

INFLATION GRAPH AND FISCAL DEFICIT TO SCALE UP

Currently, India is suffering from a near two digit inflationarypressure. A depreciating rupee would only add fuel to this. Itwould lead to high inflation, as India imports around 70 per centof its crude oil requirement and the government would have to paymore for it in rupee terms. Due to the control on oil prices, thegovernment may not easily pass the increased prices to theconsumers. Further, this higher import bill will lead to rise infiscal deficit for the government and will push the inflation.

On November 21 alone, overseas funds sold more than US$500million worth of Indian-listed shares over the five tradingsessions, reducing net inflows for 2011 to under US$300 million.The rupee has lost more than 10 percent of its value this year,making it one of the worst performing currencies in Asia. In thelight of uncertainty and fall in global stock market, FII’s aresupposed to be pulling out their money from various EME’s(Emerging Market Economies) and taking them back to their homecountries in order to sustain themselves.

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A BLOW TO INDIAN IMPORTERS

The Indian import industry would also have to pay more in rupeeterms for procuring their raw materials. This would happendespite a drop in global commodity prices, only because of adepreciating rupee against dollar. Corporate India is a net bor-rower of dollars and to that extent a depreciating rupee wouldimpact its balance sheet adversely. Companies with foreign debton their books would also be impacted. With the rupeedepreciating against the dollar, these companies would need morerupees to repay their loans in dollars. This will increase theirdebt burden and lower their profits. Obviously, investors woulddo better to stay away from companies with high foreign debt.

The depreciating rupee has pushed up the prices of electronicgadgets and home appliances. Car makers who import 10 to 40percent of the components are contemplating increasing prices.This is an attempt to offset the increased import costs owing tothe depreciating rupee. An increase in prices could span from Rs10,000 for small cars to Rs 50,000 for luxury vehicles. Therising interest rates and fuel hikes have played spoilsport forthe car industry that is brimming with a wide array of choice forconsumers.

NEGATIVE IMPACT ON INDIAN STUDENT AND TRAVELLERS ABROAD

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Individually, travelling abroad becomes more expensive as travelcost could go up by around 10 per cent compared to last July

figures. Students studying abroad too will be hit as more rupeeswill go out to pay for the courses, stay and other expenses.

RUPEE FALL IS A BLESSING???

As reported, Policy makers are spending sleepless nights over thefalling rupee, but it spells a winfall for NRI, who are racing topark their maney back home.

Expatriates working in west asia are borrowing from friends andcolleagues and even taking personal loans to cash in on the otherside.

And bankers in kerala (the state has got around 2.8 millionpeople working abroad, most of them in gulf countries) report a30% surge in remittances in the last 3 months.

Smart people have approached their companies and sponsors toadvance their salaries to make maximum use of the rupee slide

BELATED STEPS TAKEN BY AUTHORITIES

During July-August 2013, following measures were announced by theIndian authorities to stem the depreciation of rupee and containthe current account deficit:

• The duties on the import of gold, silver and platinum wereincreased to 10 percent.

• The limits on foreign ownership of sensitive sectors (such astelecoms and insurance) were further liberalized.

• New restrictions were imposed on Indian residents seeking tosend money abroad to buy property.

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• In mid-August, the existing limits on overseas directinvestments by Indian companies were substantially reduced.However, this policy was withdrawn by the new governor of RBI onSeptember 3.

• The interest rates limits for deposits meant for non-residentIndians were liberalized. 

• New restrictions on open interest on USD-INR trades wereimposed.

• Banks have been banned from trading in domestic currencyfutures and the exchange-traded options market on their own.Banks can only trade on behalf of their clients.

• The margin requirement on the domestic dollar-rupee forwardtrade was increased to 100 percent of the traded amount, whichmeans investors will have to give the entire amount of thetransaction upfront.

• The state-owned oil marketing companies (OMCs) – which buydollars to finance their imports – were asked to trade only witha single state-owned bank. 

It is surprising to note is that the above-mentioned policymeasures failed to arrest the sliding value of the rupee in thecurrency markets.

POLICY OPTIONS FOR INDIA

Several episodes of financial crises in the 1990s (from Mexico toSoutheast Asia) highlight the eminent role played by currentaccount deficits in triggering a currency crisis. An economic

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boom fueled by short-term capital inflows and debt-drivenconsumption is a recipe for currency crash. 

India’s external sector vulnerability is a symptom of a muchdeeper malaise in overall development strategy and domesticpolicymaking. Despite the deterioration in major indicators ofexternal sector vulnerability, the policymakers remain complacentin defending India’s growth story.  There are no quick fixes tocountry’s imbalanced external sector and the Indian economyremains vulnerable to external shocks and global liquidityconditions.

Some analysts believe that India can rely on its foreign exchange(forex) reserves of $275 bn to arrest the currency fall. ButIndia’s short-term external debt (with a maturity of one year orless) has already reached an alarming level. According to theofficial statistics, India’s short-term external debt stood at$116 bn in March 2013 and the ratio of volatile capital flows(consisting of short-term debt and portfolio investments) tocountry’s forex reserves was as high as 96 percent. At currentlevels, the forex reserves can barely meet the country’s importbill for seven months.

Firstly, New Delhi should take urgent policy measures to curbinessential imports. Since increasing exports may takeconsiderable time, it is desirable to impose more curbs on gold,silver and non-essential items. In addition to higher customduties, strict quantitative restrictions on the import of gold,silver and non-essential items should be imposed. The governmentshould also consider imposing higher custom duties on thoseconsumer electronics goods which are not part of InformationTechnology Agreement of the WTO. Indeed, such a policy regime mayencourage smuggling but there are ways and means to check it. 

Since oil is the biggest item in its import bill, India shouldimmediately accept Iran’s offer to sell crude oil entirely in

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rupees and at concessional terms. By accepting this offer, Indiacould potentially save $8.5 bn in foreign exchange spending. Oilimports from Iran have declined substantially in the last fiveyears due to unilateral sanctions imposed by the US and theEuropean Union.

Secondly, India should immediately work out modalities fortrading of goods in local currencies. India could begin tradingin local currencies with BRICS partners and Asian countries.Russia, Malaysia and some other countries have expressed interestin trading in local currencies with India.

Thirdly, issuing dollar-denominated sovereign bonds in the midstof a crisis-like situation is a risky proposition. Besides, Indiawill have to offer a higher rate of interest to attract investorswhich in turn would further increase country’s externalindebtedness.

Instead of approaching the IMF for a standby loan which comeswith stiff conditions, India could enter into currency swapagreements with key trading partners. Recently, India and Japanexpanded their bilateral currency swap facility to $50 bn. On thesidelines of the G20 Summit at St Petersburg in September 2013,BRICS countries worked out operational details of launching a$100 bn Contingent Reserve Arrangement (CRA) to ease balance ofpayment difficulties.

Fourthly, to rein in rampant speculation and manipulativeactivities in the offshore NDF market, the RBI should work outarrangements with other regulatory authorities in the form ofinformation sharing and the setting of general standards.Currently, a new regulatory framework for OTC derivatives marketis under preparation following the Dodd-Frank Act in the US, theEuropean Market Infrastructure Regulation (EMIR) in Europe andthe Basel III standards. As a member of G20, India should engagein the ongoing international initiatives aimed at increasing

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transparency and reducing systemic risk posed by the $560trillion global OTC derivatives market.

Lastly, the Indian authorities should not hesitate to imposecapital controls as a macroeconomic policy tool to protect thedomestic economy from a sudden capital flight. In this regard,capital controls imposed by Malaysia and Iceland on the capitaloutflows are worth examining.

RBI AND THE AILING RUPEE

Outgoing Reserve bank of India governor D Subbarao expressed hopethat his successor Raghuram Rajan would be like Arjuna and find hisway out of the Chakravyuha that the economy is in.

So the question is “CAN ARJUNA GET COUNTRY OUT OFCHAKRAVYUHA??

Raghuram Rajan had made his intentions clear a few days before hetook over as the 23rd governor of the Reserve Bank of India onSeptember 4. On his penultimate day as chief economic adviser,the 50 yr old economist told an informal media gathering at theNorth block that the governor’s allegiance , as per the RBI act,lay with protecting the value of the rupee and curbing inflation.So, his decision to hike Repo and Reverse repo rates, Despiteincreasing government pressure to slash them, should have been

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expected. It, however, surprised analysts, stock markets, Indiainc and more importantly, the government.

The government, led by union finance minister P.chidambaram, hadbeen pressing for a reduction in the Interest rates to boosteconomic growth. Many expected Rajan to toe the government linein a stark departure from his hawkish predecessor DuvvuriSubbarao. Rajan however, showed that he has his own plans.

IN HIS MAIDEN POLICY REVIEW, Rajan hiked Repo rates and ReverseRepo rates by 25 basis points to 7.5 per cent and 6.5 percent,respectively. In a bid to tighten liquidity, RBI lowered themarginal facility rate by 75 basis points to 9.5 per cent, andbrought down the minimum daily maintenance of the cash reserveratio(CRR) from 99 percent to 95 percent of the requiorement. TheCRR rate remained untouched at 4%.

The US federal Reserves decision to postpone the tapering off ofthe Quantitative easing(QE) also failed to change Rajan’s mind.He says, “Let us remember that the postponement of tapering isonly that, a postponement, “a cautious Rajan said.

According to me , Rajan’s assessment that the tapering off of QEis inevitable. A country like India which is funding its currentaccount deficit(CAD) primarily with the help of portfolio inflowcannot afford to overlook structural factors that are driving CAD

What to expect in future??

Analysis forecast that Rajan might further increase interestrates to rein in inflation . However, SREI infrastructure financesaid in a statement: “India needs huge investment ininfrastructure and half of that is expected to come from theprivate sector. It is difficult to foresee how private sectorwill be able to mobilise resources from domestic sources inthisscenario.

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The society for Indian Automobile manufacturers said that: “Theindustry had been hoping for a recovery through the ensuingfestive season, anticipating an improvement in markets. But thismove comes as a surprise dampener...”

Interestingly, Despite the pain, everyone privately, at least-agrees that rajan made the right choice, and that he is a strongand worthy successor to subbarao.

In short we can quote Raghuram’s move as “PAINFUL WISDOM”

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Know your Guv Raghuram rajan

SCHOLARLY CREDENTIALS

Massachusetts institute of technology, Ph.D.,may 1991; Thesis title:Essays on banking, IIM Ahmedabad MBA 1987, IIT delhi,btech (electrical), 1985

BOOKS

Fault lines:How hidden fractures still threaten the world economy and many more

EMPLOYMENT

Eric j.gleacher distinguished service professor of finance, graduate school of business, univ of Chicago

Chief economic advisor, finance ministry,GOI

Economic advisor to PM of india

Chairman of high level committee on

MULTIPLE RESPONSIBILITIES OF RBI

RBI, unlike its peers, has many critical duties:

MONETARY AUTHORITY- It formulates and implements the monetary

policy, mainltains price stability and credit to productive

sectors

BANKING REGULATOR- It is the main financial sector watchdog

tasked with the duty to protect depositors interest

CURRENCY ADMINISTRATOR-It prints money with the primary

objective to give the public adequate quantity of supplies of

notes and coins

FOREX MANAGEMENT- It has the responsibility to facilitate

external trade and payment and also prevent volatility in the

forex market

GOVERNMENTS BANKER- It performs merchant banking functions for

the central and the state governments; also acts as their

banker

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RAJAN’S TRILEMMA

STABILISING RUPEE-20% fall in rupee’s value since may 2013.

More liquidity tighteningmeasures can choke growth by

companies borrowing costs

TAMING INFLATION-9.6% India’s retail inflation in july 2013. A

depreciating rupee has made imported goods costlier, but

raising interest rates to cool prices will hurt investment.

BOOSTING GROWTH-4.4% India’s real GDP growth during April-june

2013. High lending costs have forced companies to defer

investment. But a rate cutcan weaken the rupeeas also push up

inflation.

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RATE RULES

Cash reserve ratio(CRR):

Proportion of deposits banks have to park with

RBI

REPO RATE:

Rate at which RBI lends to bank

REVERSE REPO RATE:

Who’s Exposed to the risk of a sudden stop of easy money from US??

MOST EXPOSED: Brazil, Mexico, South Africa, Turkey, Ukraine

BODERLINE: Argentina, Hungary, Indonesia and Poland

MODERATELY EXPOSED: Chile, Columbia, Czech republic, India, Korea, Malaysia, Thailand

LEAST EXPOSED: China, Israel, Peru and Russia

NEW PRESCRIPTION FOR THE AILING RUPEE

RUPEE SUPPORT

MEASURES IMPACT38

RATE RULES

Cash reserve ratio(CRR):

Proportion of deposits banks have to park with

RBI

REPO RATE:

Rate at which RBI lends to bank

REVERSE REPO RATE:

RBI will swap dollars raised bybanks under longterm deposits at fixed rate of 3.5%

Will encourage banks to raise dollars overseas without currencyrisk

Banks overseas borrowings limitdoubled to 100% of Tier 1 capital; RBI to swap dollars at100 bps discount

Banks will bring in more dollars as cost of hedging comes down

Bank provisions for cash reserve ratio and statutory liquidity ratio to be cut

RBI may ease liquidity in forthcoming monetary policy

BANKING LICENSE

Ex guv Bimal jalan to head panel to screen applications for bank licenses, new licensesbefore end january

Removes uncertainity of delay due to elections

Liberalized branch licensing for banks which meet rural obligations

Increase availability of banksin rural areas

Roadmap for freeing the entry of new private banks and allowing different types of banks

More competition in banking

More leeway for foreign banks coupled with more regulation and supervisory control

Strengthening of financial system

MARKET CONFIDENCE

Cap on a company’s overseas buyat 100% of its net worth relaxed

Companies can freely acquire businesses upto 400% of their net worth if funding through ECB

Limit for Rebooking cancelled forward exchange contract doubled to 50% for exporters

Almed at inspiring confidence,greater risk management flexibility for exporters

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Importers to be allowed to rebook cancelled forward contracts upto 25%

Will enable better risk management

BANKING REFORMS

Panel headed by deputy guv Urjit patel to review monetarypolicy frame work

RBI may drop mid quarter review for consistency

RBI director Nachiket Mor to look into direct lending requirement under priority sector norms

Improved efficiency in ending

Liberalization of markets and allowing speculation

Seen to be hinting at removal of restriction on banks fakingposition in currency futures

Aadhar to be used for collating an individual’s credit history

Improved credit for individuals

FINANCIAL INFRASTRUCTURE

Electronic bill factoring exchange for MSME’s where bills against corporates can be auctioned

More credit options for MSME’s

Deputy guv Anand sinha and Guvto look at speeding up of working of debt recovery tribunals and asset reconstruction companies

Speedy resolution of Bad loans

Deputy guv KC chakrabarty to review NPA’s central registry to record loans by large corporates across banks

Reduce risks from large accounts going bad

White label Pos(card swipe) machines and mini ATM’s to be

Increased penetration of electronic payments

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allowed

At a time when every surprise from RBI has been unpleasant one, new governor Rajan sought to assuage markets with his action list for the next 6 months. “The time frame for these measures is not years but months and weeks in some cases” Rajan said

CONCLUSIONThe rupee's recent decline might appear sudden but it hasn'treally come as a surprise to keen observers. This crisis has beenbuilding up for a long time. For years, successive governmentshave relied on capital inflows to balance the CAD and support therupee. In the past, fortunately, the capital has come in. During2003-08, capital inflows averaging $45 billion per year easilywiped out the up to $15 billion CAD and exerted upward pressure

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on the rupee. But they have dried up since then, and thegovernment is now appearing powerless to rein in the CAD to itstarget of $70 billion for FY14. The global economic crisis hasn'thelped. In fact, the Indian economy has managed to hit theperfect storm: the government has been twiddling its thumbs, sothe courts have shown an unprecedented inclination towardsjudicial activism.

While dithering on matters of economic policy, government haschosen to focus on unaffordable doles and subsidies. The latestin that trend is the rather ambitious food security Bill. Itscost is expected to be in excess of Rs 100,000 crore. God aloneknows if the intended benefits will actually reach those for whomthey are intended, as the malfunctioning of the PDS scheme iswell known. Meanwhile, the prolonged regulatory process ofenvironmental clearances and the difficulties in land acquisitionhave made industry rethink new projects. The economy has beendrifting directionless, with many delays in much needed economicreforms and without incentives for FDI.

Largely compelled by government lethargy, the Supreme Court hasbeen intervening in policymaking. This has resulted in furtherregulatory uncertainties for investors. Sectors ranging fromtelecom and mining to pharma and real estate have been leftshaken.

In the coal sector, India has some of the largest reserves in theworld, of around 300 billion tonnes. Yet, it's expected to import82 million tonnes of coal in FY14. With an average price of$100/t, the bill will total to around $8 billion. It was with thevery aim of tackling such shortages that successive governmentshad chosen the policy of captive coal block allocations, insteadof taking the auction route. With Coalgate simmering inside SC,and outside, it's now unlikely that coal production will rise inthe near future as both government and investors will dither intaking initiatives. Why would an investor choose to develop a

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captive coal block if the court or the government is likely tode-allocate the same? And why would someone develop any powerintensive project associated with a coal block?

In the case of natural gas, not only is the KG-D6 basin producingonly a fraction of the projections, the matter of pricing thisgas has also landed in SC now.

Even the star of India's rise in the last decade, the telecomindustry, is now in doldrums on account of the double whammy ofever-changing regulations and consequent SC actions. Telecomreceived cumulative FDI of Rs 58,782 crore in the last 13 years,which accounted for 7% of the total FDI inflows into the country.FDI in the entire telecom sector, which includes radio paging,cellular mobile and basic telephone services, plunged 81.64% in2012-13 to Rs 1,654 crore. Since SC's '2G scam' decision, only avery brave foreign investor would venture to put his foot intowhat could be a legal landmine.

Lastly, FORGET POLITICS UNITE TO SAVE ECONOMY

We can ignore the economic crisis only at our peril. There iswidespread panic as the rupee depreciates sharply with everypassing day and there's no telling where it will stop. There aremultiple factors behind the free fall. Global issues are a bigcontributing factor, the biggest at the moment being the fear ofan impending US intervention in Syria and the resultant hardeningof oil prices. Otherwise, the currencies of other emergingmarkets wouldn't also be crumbling

While we cannot fully control what happens beyond our shores, wecan at least change the growing perception of domestic drift.There's a sense that no one's quite in control in Delhi, thatthere's a deficit in decision-making, and that there's a lack ofclarity of thought. No wonder currency speculators are having afield day and making a bad situation worse.

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What we need is a bipartisan response to the crisis. While theburden lies primarily with the government, the opposition tooneeds to throw its weight behind a national effort to pull theeconomy back from the brink. When the Prime Minister addressesParliament on Friday, he should take the initiative and call fora concerted effort by the entire political class, setting asidefor the moment any political oneupmanship. The Pension Bill andthe Insurance Bill need to cleared; pending projects must befast-tracked; the Supreme Court should be approached for a reviewof the ban on iron ore imports. The two sides should also resolvethe obstacles to rolling out the goods and services tax GST

At the same time, there should be an agreement to try and leavecontentious policy decisions aside for the time being. The lastthing we need is a further deterioration of sentiment. Also, itdoesn't really help when BJP leaders say that only the nextgovernment can save the economy. The next election is eightmonths away. What do we do in the meantime? Play politics andallow the situation to worsen?

Will all this immediately strengthen the rupee and put theeconomy back on track? Perhaps not. But it will certainly sendout a signal that all hands are on deck. And that our politicianscan set their differences aside in the interest of the nation.

Are we being naive in calling for a bipartisan effort? We wouldlike to believe we aren't. We hope this appeal won't fall on deafears and that our political leaders will rise to the occasion. Ifthey do so, they can yet prevent the economy from keeling overthe edge. They can also, in the process, redeem themselves in theeyes of the electorate they are so keen to woo.

REFERENCES

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The Week Magazine Times Of India articles Hindustan times articles Economic times articles www.rbi.org.in

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