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INR has depreciated rapidly in the recent past, registering all-time lows against the USD and thereby marking a new risk for Indian economy. In the year 2011, the INR depreciated by around 18%. It nosedived again in 2012, after a brief spell of appreciation in January and February triggered by the sudden inflow of foreign capital. It appreciated by around 8% in the first two month of the year but again fell by 13% since end of February.
Factors which lead to downside (depreciating) of the INR:
The recent fall in the rupee can be attributed to the following domestic and global factors:
Widening Current Account Deficit: Current Account Deficit (CAD) means when import is more than export leading to depreciation in the currency.India’s CAD worsened to new lows in Q4 FY12, at 4.5% of GDP. The FY12 CAD at 4.2% of GDP is much worse than the 3% seen in FY91, the BoP crisis year. The widening in the CAD in FY12 was driven by the worsening trade deficit, which breached the 10% of GDP threshold for the first time. High oil prices, high gold imports and weak software exports as well as slowing growth in the G7 economies has led to widening of the CAD.
Growth Inflation Matrix: Economic growth in India continues to slow down with Q1 FY13 GDP coming to 5.5%, the lowest it has been this decade. On the other hand inflation, except for the last couple of months, has remained around 9-10% for almost two years. Higher inflation led the central bank to increase policy rate, thereby impacting growth prospects. With domestic growth outlook turning negative, the depreciation of the rupee was a natural outcome.
Lack of Reform: There was been complete policy paralysis and very few meaningful reforms have been instituted over the last few years. This has put global investors in a jittery mood and made them shy away from making any investment inIndia, leading to capital outflow from the country.
Risk of Trade Globally: The global economy continues to remain in a highly uncertain zone. This has sent global investors to opt for risk-off trades such as US treasury, which has cause the US dollar to appreciate against most currencies.
All these reasons together have led to sharp depreciation of the rupee. Apart from lower capital inflows, uncertainty over domestic economy has also made investors nervous over investing in the Indian economy, and this has further fuelled depreciation pressure.
Factors which could lead to upside (appreciating) of the INR:
Measures like the government taking steps to address its fuel subsidy bill would provide some respite to the INR as it will have a favourable impact on the twin deficits, i.e., the fiscal deficit and the CAD. This will also give some headroom for the RBI to follow an aggressive reversal stance in interest rate which would provide the impetus needed for the economy to grow at a higher rate.
Another round of quantitative easing operation from the US would also imply an appreciation for the INR. In addition, as clarity emerges over the political situation in the Eurozone, risk-on trades would return and would lead to a reversal in the current trend.
Impact:
Depreciation of INR has both positive and negative impact. On one hand, it helps exporters and makes their products competitive in global markets, but at the same time it makes imported items costlier. As the global economy is very weak currently, the overall demand for export is not increasing whereas the prices of imported commodities are rising and impacting Indian inflation. Overall, in the near term it is expected that the INR would remain under stress, but over the medium to long term the currency should stabilize and appreciate from the current level, as it is expected that money always flows to growing economies and India is still among the fastest growing economies in the world.
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