Free Fall of Rupee

Marking Economic Collapse

$img_titleRupee has been falling steadily in the last few months and ended at historic low at Rupees 54.1 per US dollar on May 16, 2012. Before this on December 15, 2011 also it had reached at rupees 54.30 per US dollar. It improved later to rupees 48.7 per US dollar on February 2012. It is generally believed that Europe's economic crisis, growing import bill, external debt amounting to nearly 20 billion US dollars maturing in 2012 are all putting pressure on already stressed rupee. It is generally believed that to prevent the tremendous upheaval in the exchange rate, central bank could play an important role. But Reserve Bank of India has been avoiding intervening in recent foreign exchange upheaval. Reserve Bank says that its intervention can cause more harm.

What Weak Rupee Means?
Country's currency weakness could be a boon to exporters, because they benefit from weak rupee. However, falling rupee is making life difficult for the commoners, as falling rupee is making imports dearer, especially the petro products, fuelling inflation. Weakening of rupee means more rupees to be paid per dollar of imports. Each year the country spends nearly rupees 2.5 lakhs on import of crude oil, which means with depreciation of rupee by 25 per cent, the country would be shedding more for its imports of crude oil, which is price inelastic. So our trade deficit will get further widened. The oil companies will raise prices of petroleum products, spoiling the budget of the middle class. Already fleeced due to inflation, the common man will get further hit with this. Depreciating rupee may cause our raw material and metal imports to become even more expensive; hiking the production cost for industries. According to recently released data about growth of industrial sector, industry has already facing the brunt of this increase in cost of fuel and raw materials including metals.   Annual growth rate of industrial production fell to 1.1 per cent in January and -4.1 per cent in April 2012, which was 14.5 per cent in April 2010. Economy's declining factory output continues to be a concern for policy makers. Due to falling industrial production growth, inflation may worsen.
Why Rupee is Weak?
It is paradoxical that on the one hand Europe's economic situation is worsening, and our rupee is sinking. Experts say that because FIIs are transferring large amount of their investment, in an attempt to save their funds. This is a phenomenon called 'flight to safety'. US government bonds seem to be more attractive for these investors, in comparison with Indian stocks. This only is not the cause. For some time, our import bill has been increasing very fast. In 2011-12 our imports are expected to reach US $ 488 billion, which was US $ 381 billion only in 2010-11. There are two main reasons for this rising import bill — one, the price of imported crude oil has been skyrocketing. Ever-increasing price of crude oil led international price of crude to reach US $ 105 per barrel in April 2012. In these circumstances our oil import bill increased from US $ 103 billion in 2010-11 to US $ 150 billion in 2011-12.
Two, for the last few years, silver and gold imports have been increasing and last year, i.e. 2011-12 it reached US $ 60 billion dollars, against nearly US $ 30 billion in 2010-11.
Advantage of Strong Rupee
Many times, it is said that depreciation of currency is advantageous as it would encourage exports and discourage imports. This is so because depreciation of rupee will make the imports costlier and exports cheaper. But in India devaluation has never improved balance of trade position. On the contrary, the experience so far reveals that devaluation actually has been worsening the inflation, as prices of petroleum products, essential machinery and equipments, metals and other raw materials increase the cost of production. The process of development is adversely affected due to devaluation. Therefore, strong rupee is in the interest of the nation because it helps in controlling inflation. Another advantage of strong rupee is that, if the popularity of rupee in international market improves, other nations would love to keep rupee instead of other currencies. In the long run strong rupee would help us in raising international loans in terms of rupee, which may reduce burden of repayment in terms of foreign exchange.
How to Stop Fall of Rupee
In the long run strong rupee is definitely is in the interest of the nation. However, at present the major challenge is to stop the fall of rupee. For this, it is imperative that the policy makers understand the reasons for weakening of rupee. It is true that FIIs are finding it safer to invest in US treasury and therefore they are disinvesting in Indian share market and putting their money in US treasury bonds. There has been no decline in software exports nor there is any fall in the remittances from Indians from abroad, still India is facing a major decline in rupee due to the fact that FIIs are not only bringing fresh investments, they are even taking their previously invested money abroad. In addition to this, in the recent past there has been a big jump in Indian imports and they have been rising at a much faster pace. Imports of power plants, telecom equipments and consumer goods have increase manifold in the recent past. As a result trade deficit has soared to US$ 185 billion in 2011-12.  Rising imports from China are worsening our trade deficit significantly. Today trade deficit with China comprised around 20 per cent of total trade deficit, which is alarming. Therefore, we can say that, FIIs though the major cause of weakening of rupee, are not the only reason.
Government and the Reserve Bank's statements that they have limited options in these circumstances are most unfortunate. Government must take some proactive measures to set its house in order. First of all imports should be discouraged at any cost. In the recent past concerns have been raised about security, health and economic risks arising due to imports from China. Based on recommendations of security consultants and health issues, government can impose restrictions on Chinese imports. In view of rising oil import bill measures could be adopted to promote the alternative sources of energy such as solar energy, wind energy, etc.
 Apart from this taking a cue from Brazil we can even impose tax on the profits of FIIs. There should be a minimum three years lock-in period for investments from FIIs. All this will help us in imparting discipline among the FIIs. Recent measures adopted by RBI and the government, namely, hike in tariff on gold imports and restrictions on exporters to partially convert their foreign exchange earnings into rupee are welcome steps. Government needs to more in order to stem fall of rupee lest the situation worsens.
(The writer is Associate Professor, PGDAV College, University of Delhi, email: ashwanimahajan@rediffmail.com)

Sunday, 03, June 2012
           
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