Current affairs

The Crash of the Rupee


For last few days, Indian Rupee has been continuously sliding down against the US Dollar. Two days back, it reached the lowest level of more that 53 Rupees against one dollar. Many knowledgeable persons and Economists have been expressing themselves on this subject. I came across many opinions about why the Rupee if falling or what would be the effect of this fall on the lives of the common man or is there any way by which this Rupee fall can be stopped, and many such questions. Even after reading many a points of view, I was not really able to pin point the cause and effect of this fall. I would therefore attempt here, to give an explanation, about the cause and effect of this Rupee fall, as envisioned by me.

The economics of any entity, he may be,  an individual, a company or even a nation, naturally depends upon his income and the expenditure incurred by him. Mr. Micawber, a memorable character from Charles Dickens’s classic novel, David Copperfield, explains this basic truth in this novel in the following way.

” My other piece of advice, Copperfield,’ said Mr. Micawber, ‘you know. Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.” This Micawber principle may hold true for day to day income and expenditure. It is certainly not valid, when for example, we want to buy an apartment or a car.

How much loan can be raised by an entity such as a person or a company, depends upon its credibility in the financial market. For companies, a way is available to increase their credibility. Companies can sell part ownership of the company, known as equity, in form of a share and raise money. Since this money is neither repayable nor any interest is needed to be paid, it becomes the core capital of the company and commercial loans can be raised by the companies on the basis of this share capital. This equity facility is not available to an individual. In case of a country like India, the similar logic holds good.

Let us see some figures about India, for the financial year 2004-05.

 

Exports

81000 Million US $

Imports

1,19000 Million US $

Trade balance

-38000 Million US $

Invisible Income

32000 Million US $

Current account balance

-6000 Million US $

 

(The invisibles mentioned above include, money spent by tourists, remittances by NRI and also software and allied exports. )

 

In the very same year, total money invested in India by entities outside, was 32600 Million US$. This means that this much foreign exchange was received by the Reserve bank of India in that year. Because of this Dollar inflow, even when there was a current account deficit, actual Dollar reserves with RBI increased. This has been happening for last decade or so and has enabled RBI to maintain a foreigh exchange reserve of about 300 Billion US$.

I have mentioned above figures for year 2005 just to highlight the fact that India needs substantial foreign investment inflow every year to make up for the current account deficit. If this Dollar inflow gets reduced due to some reason or other, we do not have any other means to make up the deficit. Compared to China, since Chinese exports are always higher than the imports, Chinese do not have a current account deficit and do not feel the same kind of pressure on Yuan as India is facing.

There has been indications this year of a huge monetary problem in Europe. This has directly resulted into the sentiments of investors investing into India. Since making up of India’s current account deficit depends primarily on the investment Dollar inflows, any feeling that India’s current account deficit is going to expand this year, directly results into investor sentiments and outflow of investment Dollars tends to grow. This has resulted into increased demand for Dollars and less supply, a situation, which is leading to large depreciation in the value of the Rupee.

The Dollar investment that comes in India is of two type. First is the direct investment in projects. This is a long term investment and only helps the balance of payments. Other type of investment at best, is only temporary and includes portfolio investments and external commercial borrowings. Even at the slightest hint of trouble, this investment can just vapourize. In the year mentioned above, project investmet was only 3000 Million US$ and balance 29000 Million US$ was portfolio investment. Over last decade, the figures have similar pattern, though scale is much higher.

It should be clear from above discussion that if monetary crisis in Europe deepens further, the Dollar portfolio investments coming into India are likely to shrink further and further. This would result in Indian economy facing more severe shortage of Dollars, which would result in Rupee depreciating even further. More expensive Dollar means higher rupee prices for crude oil. This would make gasoline, diesel more expensive leading to higher transportation and production costs. This is one of the reason of very high inflation experienced by the consumers in recent times and I am afraid that it would continue to worsen even more rapidly.

Perhaps realizing this grave danger to the economy, Government of India decided to enhance Foreign direct investment in organized retailing to 51 % so that Dollar flows could improve. However due to rigid stance adopted by the opposition parties, this measure has failed to materialize so far. I am afraid that Government may soon find out that all avenues to find a possible solution to the problem might close down and it would have to just watch the situation helplessly. Under such circumstances Rupee is likely to slide down even further, leading to hyper inflation.

15 December 2011

 

 

 

 

 

 

 

Advertisements

About chandrashekhara

I am a retired electronics engineer. I am interested in writing, reading books. Other hobbies include Paper models, wooden fret work and social networking.

Discussion

No comments yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

My New e-Book

To read Click the picture

e book- Looking Glass World

To read click on the image

Search Old Posts

Archives

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Join 410 other followers

%d bloggers like this: