The
sharp depreciation of the Indian rupee from around
Rs.44 to the dollar at the beginning of September
to close to Rs.50 to the dollar through much of November
gives cause for concern on many counts (Chart 1).
To start with, while it does little to increase India's
exports given similar depreciation in the currencies
of India's competitors, it is bound to increase the
foreign exchange outflow on account of imports and
worsen the trade balance. Second, by increasing the
rupee value of dollar debt service commitments of
Indian corporations, which have risen substantially
in recent years, it is bound to affect the viability
of these firms at a time when demand growth is clearly
slowing. Third, increases in the rupee prices of imports
of an economy that is more import-dependent after
liberalisation would keep rupee inflation up despite
lower growth. And finally, sharp and persistent depreciation
of this kind creates the possibility of a speculative
attack on the rupee that can only make matters worse.
Chart
1 >> Click
to Enlarge
All this makes an analysis of the factors underlying
the rupee's decline imperative. What is clear is that
the depreciation of the currency is not the result
of any reticence or failure on the part of the Reserve
Bank of India to intervene in the market to stabilise
the rupee. As its Mid-Term Review of Macroeconomic
and Monetary Developments declared, among the measures
adopted in the wake of the global financial crisis
was the decision that the Reserve Bank ''would continue
to sell foreign exchange (US dollar) through agent
banks or directly to augment supply in the domestic
foreign exchange market or intervene directly to meet
any demand-supply gaps.'' That this decision was implemented
emerges from Chart 2, which shows that while as recently
as April the RBI was purchasing large quantities of
dollars and adding them to its reserves, its net sales
of the dollar between June and September was as much
as $14.1 billion. Indications are that sales have
been as high or even higher in the two months since
then.
Chart
2 >> Click
to Enlarge
In fact, ever since the week ending October 3, in
most weeks the foreign exchange assets held by the
Reserve Bank of India have declined rather sharply,
indicating that the central bank has been accommodating
demands for foreign exchange at the expense of reserves.
Overall, the decline in reserves between the end of
March 2008 and November 7, 2008 has been $58.4 billion,
which is a substantial proportion of the $310-plus
billion India had when reserves were at their peak.
What therefore seems to be creating the uncertainty
that leads to rupee depreciation is not the non-availability
of the dollar, but evidence that normal foreign exchange
inflows are far short of the requirements needed to
finance outflows, leading to a sharp fall in reserves.
One factor responsible for the excess of outflows
over inflows is of course the exodus of foreign institutional
investors. But this does not seem to be the whole
explanation. Total outflows from equity investments
by FIIs between April and November 2008, which is
seen as underlying the stock market collapse, amounted
to $10.7 billion (Chart 4), or less than a fifth of
the decline in reserves during this period.
This leaves outflows on account of trade related payments,
which would indeed have gone up because the shrp increase
in the price of oil. The average price of India's
crude import basket touched $142 a barrel on July
3, 2008. Over the period April-August, 2008 the average
price of the basket stood at US $ 120.4 per barrel
(having ranged between US $ 105.8 – 132.2 per barrel).
This was 76.6 per cent higher than the US $ 68.2 per
barrel recorded during April-August, 2007.
Chart
3 >> Click
to Enlarge
Chart
4>> Click
to Enlarge
This does seem to have affected India's trade deficit
over the April-August 2008 period, when it stood at
$49.3 billion, as compared with $34.6 billion during
the corresponding period of the previous year (Table
1). This widening of the deficit was on account of
the oil trade deficit which rose from $12.3 to $20.5
billion, whereas the non-oil deficit actually shrank
from $13.5 billion to $9 billion.
Table
1:
India's Merchandise Trade: April-August |
|
(US $ billion) |
|
|
|
ITEMS |
2007-08 R |
2008-09 P |
|
Exports |
60.1 |
81.3 |
|
|
(19.3) |
(35.3) |
|
Oil Exports * |
4.7 |
9.0 |
|
|
(6.2) |
(91.5) |
|
Non-Oil Exports * |
26.0 |
39.1 |
|
|
(5.5) |
(50.3) |
|
Imports |
94.6 |
130.5 |
|
|
(34.2) |
(38.0) |
|
Oil Imports |
28.8 |
46.1 |
|
|
(42.7) |
(28.3) |
|
Trade Balance |
-34.6 |
-49.3 |
|
Oil Trade Balance * |
-12.3 |
-20.5 |
|
Non Oil Trade Balance * |
-13.5 |
-9.0 |
|
* : Figures pertain to April -
June |
|
R : Revised, P: Provisional |
|
Note: Figures in parentheses show
percentage change over the previous year. |
|
Source : DGCI & S |
Table
1 >> Click
to Enlarge
It
must be noted, however, that the merchandise trade
deficit does not does not really capture the excess
demand for foreign currency emanating from the current
account, because of the importance of invisible inflows
in the form of remittances and software and IT-enabled
export revenues in India's balance of payments. Quarterly
balance of payments figures, which are thus far available
only for the April-June 2008 period (Table 2), show
that while the merchandise trade deficit increased
by close to $11 billion between April-June 2007 and
April-June 2008, the current account deficit rose
by only around $4.5 billion, because of the benefit
of increased net invisible incomes.
Moreover, the drain of foreign exchange reserves during
the period when the rupee was depreciating would have
been far less affected by the merchandise trade deficit
because of the sharp decline in oil prices. By September
10, the average price of Indian crude imports had
fallen below the $100-a-barrel level, and this figure
fell below $44 a barrel by November 24. This would
have moderated the trade deficit, making the current
account deficit much less of a factor generating an
excess demand for dollars and applying downward pressure
on the rupee.
In the circumstances, the drain of reserves and the
depreciation of the rupee appear to be the result
of one of two factors or a combination of both. The
first is a possible sharp fall in inflows of capital
other than foreign institutional equity investment
into the economy. The balance of payments data referred
to above, point to a decline in aggregate (direct
and portfolio) foreign investment from $10.1 billion
during April-June 2007 to $5.9 billion during April-June
2008, and a decline in foreign debt flowing into the
country from $7 billion to $1.6 billion across these
two periods. Given the fall out of the financial crisis,
there is sufficient reason to believe that this tendency
would have not just continued but intensified in the
period after June 2008. If this shortfall in capital
inflows accounts for the excess demand for foreign
exchange, it implies that the weakness of India's
balance of payments and of the Indian rupee stem from
their fact that their earlier ''strength'' was not
earned, but merely the result of a capital surge into
the country. With that surge having reversed itself
the drain of reserves and the depreciation of the
currency seems to have followed.
Table
1:
India's Overall Balance of Payments |
|
ITEMS |
$ Millions |
|
|
|
|
|
|
April - June 2008 P |
April - June 2008 PR |
|
A. Current Account |
|
|
|
1.
Merchandise |
-31,574 |
-20,701 |
|
2.Invisible
(a+b+c) |
0,850 |
14,400 |
|
Total Current Account (1+2) |
-10,724 |
-6,301 |
|
B.
Capital
Acccount |
|
|
|
1. Foreign Investment (a+b) |
5,909 |
10,116 |
a) Foreign Direct
Investment |
10,117 |
2,658 |
|
b) Portfolio Investment |
-4,208 |
7,458 |
|
2.Loans (a+b+c) |
4,083 |
9,035 |
|
a) External Assistance |
351 |
241 |
b) Commercial Borrowings
(MT<) |
1,559 |
6,990 |
|
c) Short Term to India |
2,173 |
1,804 |
|
3. Banking Capital (a+b) |
2,735 |
-919 |
|
4. Rupee Debt Service |
-30 |
-43 |
|
5. Other Capital |
518 |
-843 |
|
Total Capital Account (1to5) |
13,215 |
17,346 |
|
C.
Errors & Omissions |
-256 |
155 |
|
D.
Overall Balance |
2,235 |
11,200 |
|
ii) Foreign Exchange Reserves |
-2,235 |
-11,200 |
|
(
Increase - / Decrease +) |
|
P: Preliminary
PR: Partially Revised |
Table
2 >> Click
to Enlarge
A second factor accounting for
the sharp depreciation of the rupee could be speculative
activity in the foreign exchange market based on expectations
that the currency's decline is inevitable. But in
a liberalised foreign exchange market such speculation
is bound to occur, especially when indications are
that India's balance of payments strengths were ephemeral
and were being quickly reversed. In the event, even
large reserves, which are still substantial and adequate
to finance more than a year's worth of imports seem
insufficient to stall the rupee's fall.
