Impact of Rupee

Appreciation

Nipun Mahajan

06-II-601 (F1)

PGDM (2006-08)
 Table of Contents

S.No. Topic Page No.

1 Introduction 3

2 Causes/ Drivers for the rupee volatility 4

3 Phases of Rupee Journey 5

4 Impact

 On Exporters 10

 On Importers 10

 Other Side Of The Coin 11

 Other Impacts 12

5 Role of govt. 14

6 Flaws in govt.’s action 15

7 New Actions 17

8 Conclusion 17

9 Recommendations 18

10 Bibliography 19

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 Introduction
From 2003-07 Indian market is booming at leap & bound manner, today after
China India is 2nd fastest growing economy of the world with the growth rate of
9.4% in the first quarter. It’s a “trillion dollar country surpassed Russia &
become world’s 10th largest economy, today (till 30th march, 2007) Indian
forex reserve is around $200 bn.

From july 2006- to sep 2007 the value of rupee is highly appreciated by
13.9% from Rs.46 to Rs 39.58. There is a big dilemma in everyone that does
it will adversely effect our economic growth or it’s an indicator of Indian
growing economy.

There are so many research are going on this issue and there are two school of
thoughts are there one: some believes that it’s a symbol of booming economy &
its beneficial for our economic growth rate while another school of thought: it’s
a impact of recession in US economy and will adversely effect our country’s
economy.

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 Causes/ Drivers for the Rupee Volatility

BASIC DRIVERS

 Huge Foreign Investment:

 Slow Down of U.S Economy
 FII Inflows
 ECB Attractive
 Decline in U.S Fed Reserve Rate
 Flexible Exchange Regimes

 The Journey of Rupee appreciation can be split in to three

phases:

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  Phase I: Ist Aug 2006- 31st March 2007:
 Slow Down Of U.S Economy: The dollar has lost about 5% against the
pound and the euro this year. From India’s perspective, a decline in the
dollar against the major currencies invariably means appreciation for the
rupee. (Source: ‘Dollar Under Siege’; Business Standard , Date 23rd July
2007, page 13)
 ECB Attractive: The External Commercial Borrowings (ECB) are foreign
currency borrowings by Indian companies outside India. ECB provides
medium to long term funds, bridging the gap between domestic savings
and capital expenditure. ECB are permitted as an additional source of
finance to Indian companies for financing import of capital goods, new
projects, and modernization etc especially of SMEs.
Since ECB carries the benefits of low cost of capital (LIBOR rates
1.3% to 6.3% as compared to 10-14% of Indian Public Sector
banks), international pricing flexible instruments; has flooded
foreign cash inflows in the country especially in the last months
the ECB is 16.1% of the FOREX.
Note: More attractive ECB even at unchanged interest rate differential.
Even if the rupee can fall over overvalued, then the balance would tie up
the other way.
(Refer: “External Commercial Borrowings”, Treasury Management: May2007).

Currency Composition of External till Dec2006

(Source: “Currency & Finance”; www.rbi.org.in)

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  LIBOR Gears Up:

In the post-liberalisation phase, the forward premia of the US dollar vis-à-vis

Indian rupee has generally remained high indicating that rupee was at a
discount to the US dollar. In recent times, however, reflecting the build-up of
foreign exchange reserves, the strong capital flows and the confidence in the
Indian economy, the forward premia has come down sharply.
(Source: “Currency & Finance”; www.rbi.org.in)

 Phase II (1st April -30 Sep 2007):

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  ECB Attractive: The ECB continues to be attractive and it increased to
37% in the past 6 months (31-3-07) from 26.7% contribution in the
foreign exchange reserve.

 FII Inflows: The rupee's gains have been mostly on account of continued
capital inflows into the country, while the central bank’s sterilisation
programme has helped fuel inflation. The country’s foreign exchange
reserve is surged by $11.871 billion to touch $247.762 billion for the week
ended September 28, 2007. The rise in reserves is easily an all-time record.
(Refer: “Foreign Reserves Swelled By $11.9b”; Business Line, Oct 5).
(over $3.9bn net inflows in the first 10 months of this Fiscal). In India there
is a Current Account surplus for the first time in years due to Increased
Merchandise exports and Invisible, resulted in supplies of Foreign Currency
going up sharply and thereby creating demand for Rupee in FOREX
Market.

(Source: www.rbi.org.in, annual report 2006-07)

 Huge Foreign Investments: Nokia, Elcoteq, LG, Motorola, Samsung are

going to set up mobile handset plants. Dell Computers, Flextronics are
setting up plants for PCs & laptops to match growing demand in the
country & nearby countries. Samsung, Taiwan based Foxconn are setting
up their plants in India and many more investments are in pipeline.
(Refer: business world 6th aug 2007).

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  Increase In Money Market Interest Rates: The rupee has been
exhibiting the lowest exchange rate volatility among the nations who
claim to have a floating exchange rate (only after Malaysia) and the
volatility of interest rates and reserves is 4 times that in the US.

Deviations between money market rates and the policy interest rate, in
particular, have at least two adverse effects. First, they weaken the monetary
policy transmission mechanism and introduce an element of uncertainty.
Greater the influence the central bank has over interest rate levels, the easier it
is for it to manage demand in the economy and attain its objective of low
inflation and sustained growth. Second, a large spread entailing a mismatch
between inter-bank rates and the central bank’s policy rate could lead to
inefficiencies in the financial intermediation process.
(Source: “Currency & Finance”; www.rbi.org.in).

 Decline in U.S Fed Reserve Rates: US Fed Reserve rate was cut by 50
basis points there by making the interest rate more attractive in the
emerging markets especially Indian markets, which lured inflows there by
appreciating the rupee.
(Source: Business Standard, ‘Rupee jumps on Fed Reserve rate cut, liquidity
improves’ , date: 20th sep 2007).

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  Phase III (1st Oct-15 Nov 2007):

 Flexible Exchange regime: All currencies would ultimately have to move

towards a flexible exchange rate regime, and by moving upwards first
rather than downwards, economies would be in a better position to deal
with crises. ( Source:www. Sifybusiness.com ‘ is rupee appreciation
healthy’)

 Inflation Check: The rupee has been allowed to rise and is currently at a
nine-year high against the dollar. One important trigger for the reversal of
policy has been the concern about the rising inflation rate. (Refer:Rising
Rupee : Causes and Consequences , Business Line 14th Oct 2007)
 RBI has increased the interest rates: Recently govt. has hiked the CRR to
7% , repo rate to 7.75% to curb the inflation rate(5.5%) , which increased
the floating interest rate and its adversely affects many of the businesses
like real estate and exporters too. Over the same period, India's foreign
exchange reserves have surged by 25% to more than $200 billion.

(Source: “Currency & Finance”; www.rbi.org.in)

 Valuation Gains: Since valuation gains are ‘not going anywhere’, why
would FIIs be in a hurry to encash them? The answer is that they won’t;
until a decisive minority decides that Indian stocks are now at or near
their peak, or that the market is transiting from a phase of exponential
acceleration to a state of steady growth.

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 IMPACT OF RUPEE APPRECIATION:
On Exporters:
 Around 30% of share of exports in economy which will surely be affected
at one hand. According to commerce ministry report (Oct, 2006) around
86% of export & 89% import deals invoiced in USD. So, in this case
exports houses have suffered badly.
 Today IT industry is growing by 31%, but major operations around 80-
85% are outsourced from US based companies, so this event hampers its
growth by few points but if it will continue for long time then companies
like INFOSYS will be in trap because its 90& operations are for US based
companies.

 Hotel companies (Taj Gvk, ITC hotels etc) are set to loose as their 50% of
revenues are in dollar terms. (Source: ‘Rupee Blisters slow export growth
to 14% Business Standard: date 2nd Aug 2007, page 13).
 Silk industry had to bear the maximum burnt as it was 71% sensitive to
the hardening of the currency, cotton and jute were less sensitive to the
rising rupee at 23% and 18% respectively and IT sector companies were
up to 90% sensitive to rupee appreciation. China is the main competitor
of Indian textiles in the global market. (source: Business Standard:’
Strong rupee hits textiles sectors’, Date: 31st july 2007).
 Manufacturing industry: It is also facing the same problem because
major chunk of the customers are US Companies and due to that this
industry is also suffering but on other side it have profit also because
70% or above raw material is imported in USD which gives relief to the
company but in this around 11,000 workers lost their job due to this
event.
On Importers:
 Oil companies are highly benefitted, more than 80% crude oil import gulf
and other counties. Acc to IOC manager: “for every Rs1 appreciation
crude oil price dip by 2%”.
 Irony: Due to increase in consumption and middle east political
tensions it soared as high to $99.98/ barrel on 2nd nov 2007. The
dark cloud continues to be crude oil. (Refer: Oil Crisis: Global
Economy Risk, Business Line 17 oct)
 Recent acquisitions made by Indian companies:
 UB Group- whyte & Mackay.
 TATA steel – Corus are Benefitted.
 International borrowing (from US Banks) by Indian Companies.
 Beneficial for country external debts because 10% increase in Rs reduce
the debt amount by 10%.
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  Consumer electronic goods, imported apparels etc will be available at
cheaper price.
 The sectors like gems and jewellery were not much affected as India’s
competitor Thailand was also hurt by rising currency. (source: Business
Standard:’ Strong rupee hits textiles sectors’, Date: 31st july 2007)

According to an industry analyst - “Every 10 paisa appreciation in

rupee negates one dollar upward movement in international
prices”

 Other Side Of The Coin- Impact of Dollar Depreciation:

 When a country’s exchange rate depreciates, aggregate demand for its products
can increase. This comes about because both domestic and foreign demand for its
products may increase as they become Cheaper. Such cases apply to economies
whose currencies are pegged to the dollar as they depreciate in line with the dollar.
As currency depreciation increases competitiveness, demand for their exports may
increase, while these countries’ import demand may decrease, leading to increased
aggregate demand.
 The monetary side of this is that the country’s receipts from foreigners may exceed
its outgoing payments, resulting in an improved balance of payments. The flipside
of an increased supply of foreign currency is that domestic currency will be in
short supply. This will place upward pressure on the domestic currency.
 A key feature of the pegged exchange rate arrangement is that monetary
authorities will not allow this to happen. They will expand the money supply in
order to neutralize the pressure and maintain the fixed exchange rate. Increases in
the money supply raise price levels.

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Other Impacts:
 Rupee appreciation has helped control inflation. The appreciation of the
rupee has dampening effect on inflation. ( C.Rangarajan, Chairman EAC).
 Impact on Gold: The gold prices have touched the roof across the globe,
but stronger rupee is helping the Indian customers with the Indian currency
gaining strength. The price of gold is normally fixed in dollar-term. But as
the US currency weakened against euro, yen and rupee, rise in prices in
these currencies are relatively smaller than dollar. This drove the demand of
the yellow metal in international markets. Americans are also buying gold to
hedge against dollar depreciation.

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 Role Of Government:
 Tax incentives, interest reductions, reduction in service taxes. The
interest on exportis reduced to below five per cent and allowing
conversion of shipping bills.
(Refer: FICCI publications. “ FICCI reaction on Rupee Appreciation” sep 3rd
2007).

 Export duty reduction & waive custom duty

 Forward contracts with customers to protect exporter’s interest.
 Purchase of dollars from the markets by RBI to stem the rise of rupee
appreciation by curbing the liquidity; however is a short term remedy.
(Source: Business standard: 26th sep 2007 “ RBI intervention checks Re”)

Other Measures:
 Establishment of various councils such as Engineering Export Promotion
Council (EEPC) in which DEPB (Duty Entitlement Passbook) Scheme has
been launched in which duty drawback rates had been increased by
1.5% for engineering items.
 Exchange stabilization scheme has been launched which can
compensate a portion of the loss suffered by exporters on account of
rupee appreciation.
(Refer: “Exporters seek relief as rupee appreciates”, June 23rd Business
Line)

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 Flaws in the Govt./ RBI measures to control rupee acceleration

I. Weaker Currency is not a cure at all

 One School of Thoughts: Policy makers wants a weaker rupee so that

India’s competitiveness will rise. They do not think that it is normal for
the rupee to appreciate as a result of greater foreign exchange inflows
into the economy. This absurdity will continue until policy-makers
turn their attention to raising productivity of governance and the
competitiveness of the aggregate supply chain. It is a pity that
many of India’s exporters have chosen to rely on a weak rupee to
sustain their competitiveness.
 But the rupee will inevitably strengthen if inflows of foreign exchange
exceed outflows. They will then argue that the strong rupee is a threat
to India’s competitiveness. There will be more sops.

 Other School of thoughts (Modern Approach) or Productivity &

Competitiveness: The reason for the above schools of thoughts is
simple ad straight forward, that the sops turns unprofitable exports
profitable. But latest approach states that Competitiveness stems from
productivity. National competitiveness and economic welfare are
determined primarily by productivity in both the traded and non-
traded sectors.

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  Productivity is the amount of output produced relative to the amount
of resources (human effort, and physical and technological assets) that
go into the production. It is quantitative. It does not depend on the
monetary value of the output relative to the inputs. Productivity and
competitiveness improve when the quantity of output increases
relative to the quantity of input.

By contrast, profitability is the value of output relative to the cost of inputs

used. Profitability improves when the cost of inputs used is reduced relative to
the value of output. Sops are aimed at reducing the cost of inputs without
reducing the quantity of inputs. It is no surprise that superficial commentators
love sops.

Profitability also improves when the value of output is raised. The weak rupee
is aimed at raising the rupee value of output without raising the quantity. It is
no surprise once again that the merits of the weak rupee are presented
most assertively by those who have no clue about making the Indian
economy more productive and more competitive

(Refer: “ Weaker Rupee is not the cure at all”, Business line, July 19)

II. Change In Monetary Policy (CRR, Repo, Reverse Repo rate): Recently
govt. has hiked the CRR to 7% , repo rate to 7.75% to curb the
inflation rate(5.5%) , which increased the floating interest rate and its
adversely affects many of the businesses like real estate and exporters
too. According to manufacturing Industry analyst, SMEs share in exports
is 30-35% , a huge part and these SMEs work on credit basis they took
loan from banks sometime at fixed rate & floating rate too so this RBI
announcement is also going to affect them. It’s a cyclic process each
change affects the whole economy of country.

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 Country Growth RBI Monetary
Rate Affected Policy (CRR, Repo
rate) Increased

Growth rate High Interest Rate

affected Affects Loan

Business Affected
Like Real Estate

(Refer: “ Weaker Rupee is not the cure at all”, Business line, July 19)

 Further Steps taken by govt. to remove their earlier flaws:

 Market Stabilization Scheme: MSS is basically a method by which government

of India and RBI regulate exchange rate and monetary market operations in order to
manage the foreign exchange market as well as reduce the burden of RBI.The main
purpose of this scheme is to differentiate the liquidity absorption from day to day
normal liquidity management operation. After this MSS, the function of liquidity
absorption will be divided into 3 parts viz: LAF (liquidity adjustment facility), MSS,
and normal monetary market operations. (Indian Express: “MSS not enough to curb
liquidity surge”, 8th oct 2007).
 Now, the government has increased the limit of MSS to 2, 00,000crore. In this
current financial year the government has increased the limit by1, 50,000crore.
 MSS AND CRR:- There is an important relation between MSS and CRR.
CRR is used for controlling liquidity in market. But Prior CRR increases
have hurt banks since interest income through advances has been
sluggish due to low credit off take. Bank credit has grown only 21 per
cent so far this year, against 31 per cent in 2006. thus the increase in

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 MSS will reduce the pressure on CRR. (Indian Express: “MSS not enough
to curb liquidity surge”, 8th oct 2007).
 Participatory Notes Norms Revised: Without FII’s one could not have
thought about the Sensex reaching 19000. With more FII’s certainly the
indices are poised to reach higher levels.

However, the regulators’ concern about the genuiness of such inflows is

certainly a valid one. SEBI has all the interest and authority to add, amend or
modify regulations to the investing and trading procedures at Indian stock
markets (Refer :www.TheIndianStreet.com, “Participatory Notes; Good or
bad”, 17thoct,2007).

Conclusion

Currencies Year July Oct4 2007 Nov 16 % change wef

May 2007 2007 may 2006
2006
Rs in terms 46.2 41.05 39.58 39.35 14.82%
of USD
Rs in terms 59.05 55.35 56.14 57.56 2.9%
of Euro
Rs in terms 41.1 33.2 34.06 35.71 13.12%
of Yen
Rs in terms 86.6 82.2 80.72 80.52 7.02%
of GBP
(Source: Business Standard: Date: 27th July, Oct 4 th 2007,Nov16; section
II Money & Market)

According to the exchange rates given above we can conclude that rupee is
appreciating with all currencies given above which reflects that Indian economy
is doing very well, though it carries with it certain demerits (mentioned above).
But these demerits can be worked upon and transformed into a blessing for the
economy.

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 Recommendations:
The things that have to be taken into consideration too:

 By boosting productivity and improving business conditions, the export

growth can remain buoyant despite stronger rupee. Rapid productivity
growth plays an important role in explaining why a country’s export
performance can remain robust even when it’s currency strengthens.
 All currencies would ultimately have to move towards a flexible exchange
rate regime, and by moving upwards first rather than downwards,
economies would be in a better position to deal with crises. (
Source:www. Sifybusiness.com ‘ is rupee appreciation healthy’)
 Normally foreign currency exposures are covered for a maximum of a
year, but now exporters are contracting forward contracts for 3-5 years
to curb the impact of an appreciating rupee on their profits. Hedging of
commodity exposures also risen sharply with volatility in global markets.
(Source: Business standard: 26th sep 2007 “ Exporters go long to cover Re
Effect”)
 In any case, weaker rupee would provide no guarantee that the exports
would grow faster.
(Source: ‘ Stronger rupee: End of India’s export boom’; Business
Standard: date 6th Aug 2007, page 13).

 Various factors influence the outcome of exchange rate changes, and

exchange rate movements also affect numerous other aspects of an
economy. These factors are interlinked and dynamic. Moreover,
adjustments can take a long time, and short-term and long-term effects
often differ. The mixed empirical results demonstrate that countries need
to be particularly careful when considering using exchange rate policies
to achieve desired output growth, as the expenditure switching effect
may not be substantial, and usually takes a long time to occur. Therefore
Firms should start finding new ways to hedge against currency risk. In
U.S Gold is used as a hedging instrument for the same purpose, but
other way round. (Refer: “The Rising Rupee”, Statesmen, 11th Oct,2007)

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 Bibliography:
Newspaper Referred:

 Business Standard

 Business Line (e news paper)

 Financial Express

 Statesmen

Websites Referred:

 www.ficci.org

 www.businessline.com

 www.rbi.org.in

 www.ndtvprofit.com

 www.hindu.com

 www.indianexpress.com

 www.theindianstreet.com

 www.vernimmen.com

 www.ceoexpress.com

Magazines Referred:

 Business World

 Business line

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