Indian Rupee Depreciation against the US Dollar - Your Questions Answered

In the previous post "Is the Indian Currency Rupee Depreciation against the US Dollar Good or Bad?" we had taken a look at the reason why the Indian Rupee is getting beat up by the US Dollar in terms of value and why is the rupee going down so drastically. However, after the post, you might've had some questions about the whole phenomenon. Some readers posted their questions as comments.

Below are some questions that might arise in your minds about the Depreciation of the Indian Rupee against the US Dollar. Have tried to answer them as best I could. Do, drop a comment if you aren’t satisfied with the answer :-)

Thanks to Manish & Anonymous for the questions. I have included your questions too in the list below. Here we go!!!

1. Why is the Rupee Depreciating So Badly?

Because of many factors that are occurring in a simultaneous fashion. The crucial ones are:
1. Due to Risk Aversion on the part of Currency Investors, the Demand for the US Dollar has gone up world over
2. Uncertain Economic Situation around the globe
3. FII’s turning Net-Sellers and withdrawing funds from the Indian Market

2. In 2008, we saw a similar/drastic Rupee Devaluation against the USD. Is the current scenario similar?

Well, not really. Last time around, the devaluation was driven mainly by rise in Oil Prices. The price of oil reached USD 147 per barrel and was one of the key contributing factors. However, Risk Aversion was also a part which affected the value of the Indian Rupee.
Though the effect is the same, the combination of causes is different. Risk Aversion is the common culprit if you want to identify the common cause…

3. Has the Risk Aversion among the Investor Public changed when we compare the times in 2008 to now?

The concept of Risk Aversion is the same irrespective of what timeframe you are talking about. But, the current situation is much more riskier & pronounced than what was in 2007-08. Back then, the problem was localized to debt problems (loans & mortgages) in USA and had only a ripple effect across the globe. Right now, the problem is more profound and markets world-over are in a crisis and some countries are on the verge of Default. So, people are much more risk averse than what they were in 2008 and hence the situation is much worse than during the mortgage economic crisis.

4. How long do you think this economic crisis is going to last?

Well, frankly speaking I don’t know… speaking optimistically maybe a year or so. But, as more and more data comes out regarding the mess that the world economies have pushed themselves into, the timeline gets blurred. Practically speaking, nothing major can happen in short term (3 to 6 months). Any recovery can be felt or realized only after a year or so of sustained efforts from government’s world over.

5. Could the Reserve Bank done anything to protect the value of the Indian Rupee?

Yes, the RBI could have taken steps to protect the value of the Indian Rupee. But, unfortunately they did not. That is why Rupee is dangling at over Rs. 52 per US Dollar.

6. Why didn’t the RBI do anything?

The Central Bank of any country is entrusted with the responsibility of protecting the value of its home currency. They usually kick into action when they suspect any speculative attack on their currency by external forces (Intentional attempts to devalue a country’s currency)
In this case, the devaluation of the Indian Rupee was not due to some intentional attempt by anyone. It was due to the global economic scenario and any steps they take might backfire if the global economic situation worsens.
The RBI just let the economy take its course with the exchange rate between US Dollar and Indian Rupee because there was no foul play suspected.
A point to note here is that, the RBI is closely monitoring the situation and may intervene if they feel the depreciation is too much.

7. What can the RBI do to curb the depreciation of the Indian Rupee?

They can sell US Dollars. Last time around when there was such a problem, the RBI sold US dollars worth nearly 18 billion. This time around, they would have to cough up an even larger number to prevent the depreciation. Most importantly, this will be only temporary. The RBI selling dollars alone cannot fight the global dynamic risk and hence will not have any long term effect on the exchange rate. That is exactly why the RBI isn’t doing anything explicit to protect the rupee value.

8. What do you think the Indian Rupee will value against the US Dollar by next year (2012)?

Maybe around 46 or 47 Indian Rupees per US Dollar. To substantiate my claim, if the economic scenario recovers, there will be a lot of FII inflow of funds into India that will give a lot of strength to the Indian Rupee. And hence, it should come down below the 50 rupee mark and settle down between 46 to 48 Indian Rupees per US dollar.

9. Will all IT company’s post stellar profits due to the Rupee going down?

No. Not really. IT company’s in India have the concept of Hedging their foreign exchange income. They usually hedge against a particular value and project earnings/profit numbers for the subsequent quarters. So, the profit they make due to this rupee depreciation may not be as stellar as one might expect, but nonetheless, IT Majors will most probably post impressive numbers this quarter.

10. Will the Indian Rupee depreciate further against the US Dollar?

Maybe… This is not something that we can predict right away. But, by the look of things it looks like it may go up by another one or two rupees. Maybe 53 or 54 is realistic and possible.

11. If investors take out their investment from European countries to invest in US, would it have any effect on the exchange rate of rupee?

Not much. US Dollar investments made in India only will affect the exchange value between US Dollar and Indian Rupee. US Dollar investment in Europe will not affect the exchange rate in India

Is the Indian Currency Rupee Depreciation against the US Dollar Good or Bad?

All of us who read news would’ve seen the fact that the exchange rate between the Indian Rupee and the US Dollar has gone over the roof. In 2009 – 2010 the exchange rate was hovering around the 43 – 45 rupees per US Dollar level. Over the past one year, the rupee has consistently depreciated against the dollar with the last quarter of 2011 (calendar) being one of the worst in terms of Rupee Value Depreciation. The US Dollar is currently worth over Rs. 52.50 (as of this writing on 22-Nov-11 evening) and experts expect it go up.

The purpose of this post is to:
1. Understand why this happened in the first place
2. What this means for us – Is this Good News or Bad News?

So, lets get started!!!

Why would the Rupee Depreciate against the US Dollar?

Well, this is not something that can be answered in a single sentence. But to give an overall picture without getting into the deeper details, the reason would be:

“Exchange Rate is nothing but the price of a Currency in the International Market. If the demand for the dollar is higher than its supply, the Rupee should depreciate. If it is the other way round, it should appreciate”

The Key reason for this would be the global economic scenario. The economic situation, world over is very volatile. People are worried about the safety of their investments. Because of risk aversion on the part of people, US Dollar regained its place as a Safe Haven. People still believe that the US Dollar is much safer than any other currency in the world and hence are accumulating the US Dollar. This effectively means that, the demand for the Dollar is going up which essentially means the price of other currencies (Exchange Rate) may be affected.

Why did the Rupee Depreciate so much?

As suggested in the previous paragraph, the availability or rather the supply of the US Dollar in the Indian markets is pretty limited. Because of uncertainty in the global economic scenario, foreign investors (especially from USA) have turned net-sellers and USD Inflows into the country has fallen sharply. The US dollars into the Indian economy by the FII’s (Foreign Institutional Investors) not only guides the movement of the Indian Stock Markets, it also is a potent force that can determine the exchange rate movement of the Indian Rupee. The synopsis of this FII situation is as follows:

“If there is a net inflow of money (USD) from FII’s the rupee strengthens or appreciates against the US Dollar. When there are net outflows, it depreciates“

For Example: During 2010, there were record inflows of funds from FII’s into the Indian system and hence the Rupee was very strong. Remember the days when the Rupee was around 42-43 rupees per US Dollar??? Now in 2011, FII’s are withdrawing their funds and hence the value of the rupee is depreciating.

Is this Good News or Bad News?

Well, the answer is differnet depending on who you are.

Good News If:

1. You are an IT company like Infosys or TCS. Most of your revenue comes from USA and is in US Dollars. So, if the Rupee Depreciates, you earn more in terms of Indian Rupees even though, the US Dollar amount you get paid is the same.
2. You are someone working in United States of America. You send money to India for your family or investment. So, you are going to get more rupees for the same amount. For example, if you send USD 1000 every month to your parents, the would have got around Rs. 45000/- every month last year and now they will get Rs. 52000/-
3. You are a Manufacturer who exports stuff to USA or any other foreign country and get paid in US Dollars. (Reason, same as mentioned in the above two points)

Bad News If:

1. You are an Oil Company like Indian Oil or Bharat Petroleum. Since the price of oil is determined on a per barrel basis in USD, for the same barrel of oil, you end up paying more in terms of rupees
2. You are a manufacturer who imports stuff from other countries for your manufacturing. Not all stuff you want for your production is available in India. If your work has importing stuff from abroad, you might incur extra expenses in procuring the stuff you want

What’s the Verdict?

On the whole, this is more Bad News for the General Public. The price of oil and other materials which are imported from foreign countries are going to go up. This essentially means that Petrol, Diesel and other items are going to cost more. Already Petrol has crossed the Rs. 70/- mark per litre and the rupee depreciation may affect the situation further and drive the prices of petrol & diesel even further. This will mean that all items like vegetables, fruits, any and all items that are transported from one place to another before they are sold will get costlier. The cost of moving stuff from place to place is going to go up and the manufacturer/producer is going to pass on the extra cost to the end customer – “You and Me”. So, as a whole this is

REALLY BAD NEWS!!!!

Note: You might have a lot of questions about the Rupee Depreciation. So, if you have any, feel free to drop a comment and I will include the answer to your question in the next post, which is going to be about the various questions about the Rupee Depreciation…