Why Rupee is falling and measurs to contain its depreciation.

Recently depreciating of rupee becomes the major point of concern for Indian economy. The USD/INR exchange rate depreciated 9% during this Monsoon Session, hitting a record low of INR 68 to a dollar on August 28 .At the same time it is also depreciated 11% against the British Pound and 8% against the Euro during this session, thus forces government in general and RBI in particular  to take some harsh fiscal and monetary steps to arrest its downturn.

  Impact of Depreciation of Rupee on Indian Economy    

1) High Inflation --->  affecting the price of imported goods, especially of oil. --> thus high Current Account Deficit CAD

2) However, it will boost exports--> improving the Current Account Deficit (CAD),but overall impact is low due to global recession and poor available infrastructure.

  Reasons  for the decline in the value of the Rupee    

• Large Current Account deficit: The current account (net exports of goods and services, remittances, and net dividend payments) has been in a deficit continuously for the last eight years. Falling growth rate of Indian exports, coupled with a sharp rise in imports, especially of crude oil and gold, have increased this deficit.

• Weakening capital inflows: The capital account (the net flow of funds through equity investments and borrowings) surplus has been used to finance the current account deficit for many years.  Capital inflows have reduced due to the improving economic situation in the US and other developed countries.Investors are exiting developing markets in expectation of the US Federal Reserve increasing the interest rates, impacting the currencies of emerging markets, like India, Brazil, Russia, Indonesia, Turkey and South Africa.

• Inflation: Part of the depreciation is attributable to the adjustment of the rupee exchange rate to the inflation differential, i.e. India’s relatively high rate of inflation versus other economies.

 Steps taken by the RBI and the government of India to stabilize the currency markets

Issue	Details
Capital Outflow	The RBI reduced the limit for outbound investment and remittances from India.
Encouraging Capital Inflows	RBI has removed administrative restrictions on investment schemes offered by banks to non-resident Indians, and removed ceiling on interest rates on deposit accounts held by NRIs.The government liberalised the FDI limits for 12 sectors, including oil and gas.A Bill is pending in the Parliament to revise the FDI limit to 49% in the insurance sector. RBI increased the current overseas borrowing limit for banks from 50% to 100%, and allowed it to be converted into rupees and hedged with the RBI at concessional rate. RBI also allowed banks to swap fresh NRI dollar deposits with a minimum duration of 3 years with the RBI.
Limiting Imports and encouraging exports	The Finance Ministry increased the customs duty on importing precious metals including gold and platinum.20% of every lot of import of gold must be exclusively made available for the purpose of export.
Oil Import Needs	RBI decided to provide dollar liquidity to three public sector oil marketing companies (IOC, HPCL and BPCL) to help them meet their entire daily dollar requirements.Government is also considering increasing its import of crude oil from Iran, and pay for it directly in Indian rupees.
Trade Deficit	Ministry of Commerce is exploring the possibility of using local currency for trade with major trading partners.RBI allowed exporters and importers more flexibility in management of their forward currency contracts.
Curbing Speculative  in currency	RBI increased the short-term emergency borrowing rates for banks. The daily holding requirements under the Cash Reserve Ratio for banks have been modified.
International Cooperation	Government increased its currency swap limit with Japan from USD15 billion to USD50 billion. The BRICS nations also agreed on a USD100 billion foreign currency reserve pool as part of their plan to create a BRICS New Development Bank.  India will contribute $18 billion to this fund from its reserves.

Source: Reserve Bank of India; PRS.

The government targets to limit the fiscal deficit to 4.8% of GDP, and the CAD to under USD70 billion in 2013-14.  More recently, the new RBI Governor, upon taking office on September 4, 2013, re-affirmed the central bank’s commitment to sustain confidence in the currency and to gradually liberalize the financial market.

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Credits:PRS Blog