Chapter 1 INTRODUCTION 1) Objectives of the Study:

1) To know about the trend of Indian Rupee and it exchange rate against us $ historically. 2) To understand the concept of devaluation 3) To understand the causes and the steps taken by government on the major devaluations that took place in India.

4) To study the real implications of the depreciation of the rupee on the Indian economy.

2) Introduction of Indian Rupee:

The Indian rupee ( ) is the official currency of the Republic of India. The issuance of the currency is controlled by the Reserve Bank of India.

The Indian rupee symbol (officially adopted in 2010) is derived from the Devanagari consonant "" (Ra) with an added horizontal bar. The symbol can also be derived from the Latin consonant "R" by removing the vertical line, and adding two horizontal bars (like the symbols for the Japanese yen and the euro). The first series of coins with the rupee symbol was launched on 8 July 2011.

The Reserve Bank manages currency in India. The Reserve Bank derives its role in currency management on the basis of the Reserve Bank of India Act,

1934. Recently RBI launched a website Paisa-Bolta-Hai to raise awareness of counterfeit currency among users of the INR.

3) Currency depreciation:
Currency depreciation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system. It is most often used for the unofficial increase of the exchange rate due to market forces, though sometimes it appears interchangeably with devaluation. Its opposite, an increase of value of a currency, is currency appreciation.

The depreciation of a country's currency refers to a decrease in the value of that country's currency. For instance, if the Rupee depreciates relative to the euro, the exchange rate (the Rupee price of euros) rises - it takes more Rupee to purchase 1 euro (1 EUR=70 INR). When the Rupee depreciates relative to the Euro, the Rupee becomes more competitive because the price of Indian goods when exchanged to Euro will be cheaper leading to a larger Indian export. On the other hand, European countries that denominates its goods and services in Euros will have lost competitiveness to the Rupee. The price of European products denominated in Euros will thus become more expensive in India.

4) How currency appreciates:

Any currency appreciates whenever its demand increases i.e. its value in the world market increases. The increase in demand can occur in these 3 ways:

1. When a countrys exports are high, its currencys demand increases for transactional purposes.

2. Whenever Central Bank increases the interest rates, the demand for that currency increases as people will try to exchange other currency for that one to deposit it into the banks and get higher returns.

3. Whenever the employment and per capita income in a country increases, the demand for goods and services increases and thus the demand for that countrys currency in local market.

Chapter 2 INDIAN RUPEE DEPRECIATION

1) Indian Rupee Depreciation (2011):

Though the initial slide in the Indian Rupees [INR] value in the third quarter of Financial Year [FY] 2011-12 was considered to be temporary, the continued fall in the last part of the quarter had caused enough tension in the circles of the Indian Economy. With a lot of experts forecasts pouring into the media reports and the economic commentators giving their view on TV channels all across the country, it is important to understand the dynamics associated with the INR movement. While most of the reports and commentaries are trying to question on where the rupee is heading, some of them are even rising due concern on what the impact would be on the Indian Economy and on the Indian industry. This report discusses the reasons behind the latest depreciation spree of the INR. Though any economics text book would give a number of reasons on why a domestic currencys value falls with respect to other currencies, this report focuses mostly on the recent developments of the economic situation, both

nationally and internationally, and relates them to the INR depreciation story. This report also discusses the effects that the INR depreciation produces both in the shorter and the longer term perspectives. TABLE 1. CARDRATES FOR VALUES LESS THAN USD 10,000 OR EQUIVALENT.

Currency

31-Mar-11

31-Mar-12 15.02 54.43 52.56 57.81 9.51 69.75 83.47 6.78 63.81 9.27 42.91 13.98 7.96 41.67 52.20 6.93

AED 12.77 AUD 46.89 CAD 46.77 CHF 49.40 DKK 08.72 EUR 64.07 GBP 73.00 HKD 5.89 JPY 54.87 NOK 8.27 NZD 34.53 SAR 12.17 SEK 7.27 SGD 36.07 USD 45.40 ZAR 06.80 Source: INDUSIND BANK LIMITED FOREX TREASURY.

2) Causes behind INR Depreciation:

Since the transition from fixed exchange rate regime to market determined exchange rate regime in March, 1993, the INR value with respect to the United States Dollar [USD] had decreased manifold. The primary reasons that catalyzed the INR fall could be the increased trade between other countries. Post liberalization, the country witnessed an ever-increasing flux in the foreign inflows particularly due to the enticing growth potential of the country. But this effect

could not overpower the gap between import and exports [called the Trade Deficit]. The offsetting effect of foreign inflows strengthened till mid-2008 (the rupee was once comfortably trading at 39.15 INR/USD) when the banking crisis unfolded in the US leading to recession. Though commentators say that emerging economies like India and China were the least hit by the recession (in terms of output), the crisis took its toll on the INR. With the flight of foreign funds to safer haven currencies and better investment opportunities, the INR had no other choice but to fall. But the recent round of depreciation of the INR is peculiar in some aspects. Though there was another crisis that hit the world markets, i.e. the Eurozone crisis, there was considerable lag in the effect, with the Eurozone crisis started looming as early as late-2010, the INRs depreciation is felt only in August 2011. Major causes behind this depreciation can be listed as follows: 1. Outflow of funds (and/or) Impeded inflows. 2. Increasing Current Account Deficit [CAD]. 3. Capital Account flows. 4. Recovery of USD and Japanese Yen [JPY] the long term safe haven currencies. 5. Lack of intervention from RBI. 6. Continued Global uncertainty. 7. Persistent inflation. 8. Interest Rate Difference. 9. Lack of reforms. 10. Other Causes.

Let us examine each of the factors extensively.

i) Outflow of funds and/or Impeded inflows:

The Eurozone sovereign debt crisis had awoken the worst of fears in the economies. There was an increased uncertainty prevailing in the financial markets. Political & economic heads were guessing that this crisis could lead to far worse situation than the US Banking crisis (Evans-Pritchard, 2011); the investors are pushing the panic buttons. Given the falling growth of GDP in India (Economic Review by RBI, September 2011), high inflation, policy paralysis exhibited by the central government, investors are trying their level best to pull out their money out of Indian economy and investing it in places where they feel safer. Since March 2010, Reserve Bank of India [RBI] hiked the interest rates 13 times and thus compromising on growth. EXHIBIT 1: Bar chart showing the monthly data of inflation and interest rates in India (May-October, 2011)

Source: RBIs data warehouse, Trading economics.

Exhibit 1 shows the monthly data of inflation and interest rates in India [nominal]. During the financial years 2007-2008, when Indias growth peaked, it first seemed that the inflation is one of the side effects of overheating due to fast growth in the economy. But the inflation persisted and RBIs interest rates hikes seemed futile since the inflation was due to supply falling short rather than the demand rising. Both inflation and RBIs action reduced the colour of the vibrant economy once India displayed in 2007-2008.

Any increase in the investment by foreign entities in the form of external debt through External Commercial Borrowings [ECB] would strengthen the rupee. EXHIBIT 2: Graph showing the monthly values of External Commercial Borrowings (ECB) in India (January-November, 2011)

Source: RBIs data warehouse

Exhibit 2 shows that the ECBs by Indian corporates are on a decline, thus not substantially contributing to the INRs strength.

EXHIBIT 3: Exhibit showing the quarterly values of Foreign Investment Flows in India

Source: Public Debt Management Quarterly Report (July-September 2011), Ministry of Finance, November 2011 If we look at Exhibit 3, which shows the foreign inflows data from 1st Quarter 2009 to 2nd Quarter 2011, a clear fall in the inflows can be seen, which could be attributed to the crisis in the international financial markets and the lowered investor morale. Speaking of foreign inflows into Indian security portfolios, which fell to a negative in Q2 of FY 2011-12 [Exhibit 3], the state of Indian security market has been turning out to be the worst performer among all Asian markets. Sensex fell more than 22% from above 20000-mark in January to just above 16000 in August. Though stock market performance cannot be used to accurately gauge the economy, it is a widely accepted belief that stock market performance reflects investor confidence and market sentiments. The economy which once used to be so enticing even in the securities market has now turned bearish due to poor

performance of Indian companies shown by reduced revenues and thinner margins, if not negative ones. All the above factors are either catalyzing outflow of foreign funds or are leading to impediment of foreign inflows.

ii) Increase in Current Account Deficit:

India historically has been importer, by and large. The Net Exports [NX], i.e. the difference between the rupee volume of exports and imports, has always been negative. The recent spurt in the oil and wheat prices widened the gap between imports and exports and thus resulting in a spike in the current account deficit. It must be noted that the price elasticity of demand for these commodities is very low in a country like India which implies that the current account deficit can never be brought down till the international prices get lowered. EXHIBIT 4: Graph showing the crude oil prices of Indian basket in India (January 2008 July 2011)

Source: Economic Review by RBI, 25th August 2011

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The Economic Review by RBI, September 2011 shows that the crude oil prices of the Indian basket has substantially increased [Exhibit 4] and explains how this effectively translates into an increase in the trade deficit of India. EXHIBIT 5: Exhibit showing the Capital Account Deficit (CAD), Capital Flows, and Balance Of Payments in India (April 2010 September 2011)

Source: RBIs data warehouse

The same report says that the sustainable CAD [Current Account Deficit] is between 2.7% to 3.0% under the conditions of around 7% growth, around 3% cost of external liability, around 5% [of GDP] foreign inflows. Though the economy maintained the 7% growth, its low foreign inflows led to lower CAD threshold, placing the deficit in an unacceptable position. The CAD trends could be seen in Exhibit 5. iii) Capital Account flows: Deficit countries need capital flows and surplus countries generate capital outflows. India needs dollars to finance its current account deficit. Institutional investors investing in India are directly impacted by the global market

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uncertainty. In 2008 India had a net outflow of $14billion of FIIs and INR depreciated from 39 level to 52 against dollar. A volatile currency is never good for a foreign investor as it increases the transaction risk. Thus the relation becomes a vicious cycle, thereby further magnifying the volatility. Though RBI has intervened through open market operations to arrest the downfall of INR (managed float) but the reserves of $290billion dont provide enough room to make a significant impact.

iv) Recovery of the US Dollar and the Japanese Yen:

Exhibit 6 shows the rising Japanese Yen [JPY] in 2011. Though the argument that a rise in USD and JPY is responsible for the INR depreciation is a weak one given the volatility in both the currencies, it broadly sums up the investor mentality to take positions that strengthen these currencies. EXHIBIT 6: Graph showing the Japanese Yen to US Dollar Exchange rate (JanuaryDecember 2011)

Source: Bank of Japan Time-Series Data Search

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Even after Moodys downgrade of the US, the US economy is attracting inflows due to the majority opinion that it is safer than most other economies. The aftermath of the earthquake in Japan led to increased infrastructure investments from outside Japan, thus strengthening the Japanese Yen. The inflated USD and JPY put the INR in a poor light in terms of value. v) Lack of intervention from RBI:

The initial volatility of the rupee was expected to be temporary in effect. Even with a lot of market expectations that there would be frequent RBI intervention to control the falling INR, since August 2011, RBI never attempted in any kind of major intervention to save the falling rupee. The RBI supported the non-intervention policy by advocating that any knee-jerk reaction would put the economy in bad light and undermine the capability of the economy fighting off short term obligations and fluctuations. Finally after being pushed to the wall, RBI intervened on 15th December by selling USD in the currency market, but the effect was short lived and rupee rebounded to earlier values. The timing of RBI could have been more correct. vi) Continued Global uncertainty: Owing to uncertainty prevailing in Europe and slump in international market, investors prefer to stay away from risky investments (flight to security). This has significantly affected the portfolio investment in India. Credit rating agencys downgrade of India to BBB- with a negative outlook, the last of the investment grade has not helped the cause. Any outward flow of currency or decrease in investment will put a downward pressure on exchange rate. This

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Global uncertainty has adversely impacted the domestic factors (current and capital account etc.) and caused the depreciation of rupee. vii) Persistent inflation: India has experienced high inflation, above 8%, for almost two years. If inflation becomes a prolonged one, it leads to overall worsening of economic prospects and capital outflows and eventual depreciation of the currency. The Real Effective Exchange Rate (REER) index (6 currencies- Euro, Yen, Pound Sterling, US Dollar, Hongkong Dollar and Renminbi) has fallen by 13.84% during the last one year while the nominal rate has depreciated by 24%. REER index measure includes the level of inflation differences across nations; it reflects a country's competitiveness in international trade. Thus the trend suggests that the country's competitiveness (measured by REER) has not improved as much as the decline in nominal exchange rate points out mainly because of increase in domestic costs. Under normal circumstances inflation is tamed by increasing interest rates, but since India already has high interest rates, it does not leave that option open, as it may lead to further slowdown in growth. viii) Interest Rate Difference: Higher real interest rates generally attract foreign investment but due to slowdown in growth there is increasing pressure on RBI to decrease the policy rates. Under such conditions foreign investors tend to stay away from investing. This further affects the capital account flows of India and puts a depreciating pressure on the currency.

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ix) Lack of reforms: Key policy reforms like Direct Tax Code (DTC) and Goods and Service Tax (GST) have been in the pipe line for years. A retrospective tax law (GAAR) has already earned a lot of flak from the business community. Attempts are being made to control the subsidy bills but fiscal deficit continues to hover around 5% of GDP. The government announced FDI in retail but had to hold back amidst huge furore from both opposition and allies. This has further made investors sentiment negative over the Indian economy. x) Other Causes: a) Withdrawal of FIIs: Foreign institutional investors withdrawal from domestic economy is the one big reason for this depreciation. The Greece Crisis and its rescue package made investor to think about their investments. Changes in the finance minister and political leaders (in EURO-ZONE) is also a factor.

b) Strengthening of Dollars: The Euro-Zone crisis has weakened the Euro significantly against the US Dollar. In other words dollar is getting stronger in the world markets. Obviously the investors are considering US as safe place to invest in. The major areas are Gold, greeback and treasury.

c) Other Capital Flows:

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On month by month basis, Foreign Direct Investments (FDI), External Commercial Borrowings (ECBs) and Foreign Currency Convertible Bonds (FCCBs) recorded a slowdown in Financial year 2011.

d) Indian Politics: Number of Indian scams distracted governments concentration away from Economy. All these scams make the bad image of India in the global market. Mr. Manmohan Singh may be willing to implement good things for economical reform. But the real power woman Sonia Gandhi do not wish for open economy system. The fall of Rupee vs. Dollar has created the same conundrum what the rupee appreciation caused in year 2007. However, the impact has reversed this time with exporters making appreciated revenues and the importers feeling the heat. The increased demand for dollars vis--vis the India rupee has led to a sharp depreciation with rupee falling close to 18% from the Aug 2011 levels, and hitting an all time low of 54.32/USD on 15th December 2011, making it the worst performing Asian currency of the year. Taking a closer look at these issues, the fall in rupee can be attributed primarily to 3 broad factors.

Firstly, the grim global economic outlook, essentially due to the European debt crisis. Due to turbulence in European markets, investors are considering dollars as a safe haven for their investments in the longer run. This led to an increased demand for dollars vis--vis the supply for rupee

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and thus the depreciation. Another line of thought could be that while investors are shifting from European markets, why are they not investing in the Indian markets? The Indian economic scenario for the entire 2011 has been plagued by high rate of inflation, hovering above 8%, and extremely low growth in manufacturing sector. The HSBC-PMI (Purchasing Managers index) fell to 51 in the month of December 2011. The cumulative effect of these factors is leading to a shift in investor sentiments towards dollar market.

Secondly, the fall in rupee can be largely attributed to the speculations prevailing in the markets. Due to a sharp increase in the dollar rates, importers suddenly started gasping for dollars in order to hedge their position, which led to an increased demand for dollars. On the other hand exporters kept on holding their dollar reserves, speculating that the rupee will fall further in future. This interplay between the two forces further fuelled the demand for dollars while sequestering its supply from the market. This further led to the fall in rupee.

Lastly, there has been shift of FIIs (Foreign institutional investors) from the Indian markets during the current financial year 2011. FIIs leads to a high inflow of dollars into the Indian market. As per a recent report, the share of Indias FII in the developing markets has decreased considerably from 19.2 % in 2010 to 3.8% in the year 2011. As FIIs are taking their investments out of the Indian markets, it has led to an increased demand for dollars, further leading to a spiraling rupee.

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Chapter 3 IMPACTS OF INR DEPRECIATION

1) Impact of Depreciation of Indian Rupee: The INRs depreciation would have both positive and negative effects of the economy. The first major impact of the falling rupee can be seen on the rising import bill. India imports close to 70% of its net fuel requirements. This means the companies importing oil have to shell out more rupees for the same dollar invoices. The price of oil has gone down from $118 per barrel to $109 per barrel, not much benefit can be derived since exchange rate too shoot up from Rs. 44 to Rs. 52.7 a dollar. This has severely impacted the bottom line of these companies as well as the subsidy bill of the Indian government. Huge buying of dollars from the market in order to meet the import bill has further added to the existing woes. Additionally, the falling rupee has added further to the inflationary pressures, as imports have become costlier and thus increasing the prices of key commodities such as oil, imported coal, minerals, and metals. However the falling rupee has substantially appreciated the revenues for the exporters, who receive more rupees for their dollar receipts. These industries include the IT Services industry, textiles and other export oriented industries. Increasing imbalance in trade i.e. increasing imports over exports is bound to have severe impact on countrys fiscal deficit, which is pegged to increase by 0.8 percentages to 5.4% of GDP from the originally estimated value of 4.6% of GDP.

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In order to identify the effects, we must understand whether the fall in the INR would be of short, medium or longer term in nature. The following premises relate this fall [of the INR] to a more medium-term nature: Foreign inflows will not start increasing till the economy starts picking up, or the investors feel confident to invest in the economy, which is expected to happen only in the long term. Trade deficit is caused by petrol and wheat prices internationally. Given the price inelasticity of demand for these commodities, the trade deficit may not get narrower in the shorter term. USD and JPY would keep on appreciating in the shorter term until a point when the investors realize that there are better investment opportunities outside US and Japan. The higher interest rates in India would create an interest rate differential when compared to the international interest rates. This differential attracts inflows into the Indian economy in the form of debt offerings, which would happen once the investors start feeling the differential in the medium-term is too large. RBIs measures seem futile in the shorter term as is seen in its intervention on 15th December, 2011. The effect of these measures could only be felt in the long-term This medium-term nature of the INR fall is strong enough to affect the dynamics of the Indian economy. The following effects can be observed over a 4 to 6 month range: i. ii. Exports would be on a rise, over a wide range of sectors. Imports would be on a decline, which seemingly get costlier.

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iii. iv. v. vi. vii.

The cost of external debt would rise. The price of petrol has gone up. Higher input costs. Foreign travel is set to get costlier. Studying in foreign universities may get costly.

Let us discuss each of the above points extensively, i) The rise of exports: Domestic currency depreciation, by nature, leads to increased exports. As the INR gets cheaper to the agents external to the country, goods produced on Indian soil become cheap. The INR depreciation in late 2008 saw the export of commodities like cotton, sugar and metals reaching a new high. This may repeat again in the late 2011 and early 2012. ii) Imports to become costlier: As the domestic currency depreciates, the low purchasing power of the currency leads to costlier imports which will have adverse effects to the Indian industries. They are: Consumption goods barley, tea and textiles which form a major part of the consumption basket get costlier which drives the inflation up. Investment goods (or) capital goods like machinery and plant equipment would show a leap in their prices. Governments bill on sanctioned and upcoming infrastructural projects would inflate and industries reduce their purchases of capital goods. This would have a bearing on the growth of

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the economy, where domestic investment would also be discouraged leading to reduction in the growth of the economy iii) Rise in the external debt value: The relaxation of the ECB norms led to increased borrowing for investment in the country. The external debt raised, through Foreign Currency Convertible Bonds [FCCB] or through direct means, by the state and the Indian firms would suddenly appear inflated due to decreased INR value. Long term debt may get spared from these fluctuations; the impact is severely felt in the case of short term debts which are up for repayment. iv) The price of petrol has gone up: The price of petrol has gone up substantially. Also the price of diesel and LPG could spike. When the price of fuel goes up, the cost of transportation goes up and when the cost of transportation goes up, the cost of goods goes up and thus inflation goes up. As we have a current account deficit, rupee depreciation has an inflationary impact. v) Higher input costs: Companies which are dependent on raw material imports or have imported components could see profitability and market capitalization take a beating. This is because its profitability may get hit by higher input costs. vi) Foreign travel is set to get costlier: Foreign travel is set to get costlier. One would have to keep more rupees on hand to purchase dollars to fund foreign travel.

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vii) Studying in foreign universities may get costly: Studying in foreign universities may get costly. This is the same in the case of foreign travel; more rupees would be needed to fund foreign education. Several electronic goods which depend on imports and royalty payouts may get more expensive. NRIs and exporters would be happy and can be expected to remit more dollars as they would get a higher price. Companies like IT software, Pharma and BPO would gain from the dollars that they earn by providing goods and service abroad. As seen above, devaluation of the rupee is inflationary in nature, as we are net importers. There is a need by the Government to devise policies and tools to stem the fall of the rupee. In this context it is important to examine the tools (short term and long term) that may be available:1) Government can buy Indian Rupees from the foreign exchange market by selling its dollars. This would however reduce the foreign exchange reserves which are needed to fund our imports. Hence this is not a sustainable solution. 2) Government can mandate banks to increase their Cash Reserve Ratio and Statutory Liquidity Ratio which means banks would have to deposit more rupees with the Reserve Bank. Alternately the central banks can issue bonds for the public. By these measures the central bank would reduce the liquidity in the system and try and make the rupee dearer. However, these measures have the effect of increasing interest rates which hurts profitability of companies and thus adversely affecting economic growth. When economic growth gets limited, the

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production of goods and services too gets unfavorably impacted giving rise to inflation. 3) The Government can ask companies who have dollar accounts to bring in the dollars back into the country and convert them into rupee accounts. This would increase demand for the rupee which in turn would stem the slide of the rupee. 4) The Government can make it easier for companies to borrow in dollars from abroad. Companies would get more rupees for every dollar borrowed. This would help them finance their working capital requirements. If the rupee regains its strength over a period of time, the borrower could have to return lesser rupees. However, if the rupee further slides then business would be at a disadvantage. Hence businesses would take this route based on their outlook of the rupee. 5) The Government can attract NRI dollar deposits by offering attractive interest rates. 6) Government can reschedule / delay in paying off its dollar debts with the hope that the rupee would regain strength subsequently. Thus at a later day lesser rupees would have to be coughed up to repay the debts. 7) The Government can increase the limit of FII investment in debt papers. This would certainly bring hot money seeking quick gains. Some flow of hot money would be useful. 8) Government can liberalize foreign investments in insurance, aviation and retail, infrastructure sector, agro-based businesses as well as may reduce subsidy

23

from various sectors. This would be one of the better moves as it would bring in serious long term money from abroad. 9) The Government could frame policies to restrict the import of gold by raising custom duty and thereby making investment in gold less attractive. 10) The Government could action some long standing economic reforms to induce both domestic and international investments. This would help in increasing production and productivity of the economy. Higher production along with productivity would help in increasing supply of goods and services and thereby reduce inflation. This would be a better and sustainable method for tackling both the rupee crisis as well as inflation. Economic reforms would bring in Foreign Direct Investment. Economic growth can improve investor confidence and this ultimately bringing back a higher trajectory of GDP growth. The depreciation of the rupee has an immediate impact on India in many ways, as discussed above. It is important to understand the macro-economic situation and the ways and means by which the Government can battle the challenges and try to steady the economy. 2) The rope that can pull INR out1. Measures by RBI:

RBI has been extremely cautious in its intervention during the entire rupee depreciation crises. RBI has however reacted with timely interventions by selling dollars intermittently to tame sharp fall in the currency. The outflow of dollar

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reserves from RBI coffers has been extremely cautious, mostly due to the dwindling foreign exchange reserves. The foreign exchange reserves of India in December 2011 stood at 270 billion USD. Recently RBI has intervened with key policy initiatives such as intervening in the forward contracts policy. As per new RBI policy the cancelled forward contracts cannot be rebooked. Exporters in order to rake in more profits, were booking forward contracts, then cancelling the contracts, and again rebooking at better rate. This process led to a further depreciation in rupee and fuelled speculations. Also, RBI intermittently put trading limits for the banks in the foreign exchange market in order to tame the speculative forces.

Looking at the current economic outlook, the currency crises seems to stay for a much longer period this time around. However, a structuring of Greek debt coupled with higher inflows from FIIs can lead to an arrest in the falling rupee.

a. Using Forex Reserves: RBI can sell forex reserves and buy Indian Rupees leading to demand for rupee. But using forex reserves poses risk also, as using them up in large quantities to prevent depreciation may result in a deterioration of confidence in the economy's ability to meet even its short-term external obligations. And not using reserves to prevent currency depreciation poses the risk that the exchange rate will spiral out of control. Since both outcomes are undesirable, the appropriate policy response is to find a balance. Recent data shows that RBI had indeed intervened by selling forex reserves selectively to support Rupee.

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Table 2. Forex Reserves of India. Period 2010 - 11 2011 - 12 Source:RBI b. Raising Interest Rates: The rationale is to prevent sudden capital outflows and ultimately lead to higher capital inflows. But Indias interest rates are already higher than most countries. This was done to tame inflationary expectations. So further raising interest rates would lead to lower growth levels. c. Make Investments Attractive- Easing Capital Controls: RBI can take steps to increase the supply of foreign currency by expanding market participation to support Rupee. RBI can increase the FII limit on investment in government and corporate debt instruments. It can invite long term FDI debt funds in infrastructure sector. The ceiling for External Commercial Borrowings can be enhanced to allow more ECB borrowings. 2. Measures by Government: Government should take some measures to bring FDI and create a healthy environment for economic growth. Key policy reforms that should be initiated includes rolling of Goods and Services Tax (GST), Direct Tax Code (DTC), FDI in aviation and retail, Companies Bill and diesel decontrol. Efforts should be made to invite FDI but much more needs to be done especially after the holdback Forex Reserve (In millions of US $) 304,818.00 294,398.00

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of retail FDI and recent criticisms of policy paralysis. The government took steps recently to loosen rules for portfolio investment in the Indian market, indicating its desire to sustain external inflows. The measure to increase External Commercial Borrowings (ECB) to $10bn will help in borrowing in dollar at a less cost. It may take similar steps to encourage FDI as well, helping sustain external funding. 3) Is India the only loser? The ongoing euro zone crisis and declining demand in the developed nations has created risk-aversion in the markets. It explains why China's growth has decelerated so acutely and also India's. It also tells us that it is the global factor that is primarily responsible for India's economy running into rough weather not coalition politics, lack of leadership, corruption, assembly elections or any of the things we have been hearing about. Table 3. Different Currency Fluctuation. Currency INR Brazilian Real Russian Rouble Chinese Yuan 1st June 2011 44.8448 1.57794 27.9248 6.47807 27th June 2012 57.135 2.07165 32.9582 6.35759 % Change -21.51080774 -23.83172833 -15.2720719 1.895057718

Source: www.x-rates.com Above data shows that INR is not the only currency depreciating. Except for China almost every developing country has shown a deprecating pressure on their currency. Not everyone can be blamed for poor monetary policy or ineffective governance.

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Table 4. FII. 2012 Jan Feb Mar Apr May Jun Source:SEBI The FII investment data for 2012 shows that India had huge capital inflows for the first two months and started declining only after the euro zone crisis reared its head again. This shows that the absence of reforms alone cannot account for the sheer magnitude of the slowdown. The fact that we have had a comparable slowdown only at the peak of the subprime crisis does suggest that external conditions must be primarily responsible this time as well.Through interest rate and inflation data we tried to formulate a model to calculate expected spot rate and compared it with actual spot rates and it was found that in 2010 and 2011 these rates were very close to each other, but in 2012 there is massive 20% difference(almost same as INR depreciation in last year) in these rates. FII Net Investments (Rs Crores) 26328.90 35227.90 1792.50 -4896.60 3222.00 4066.70 Avg. Exchange Rate 51.20 49.20 50.40 51.78 54.39 55.99

June 26, 2009 June 26, 2010 June 26, 2011 June 26, 2012

Table 5. Interest Rate and Exchange Rate. Interest Rate Exchange Rate India US Actual Spot Rate (Rs / USD) Expected Rate 0.0475 0.0025 48.1 0.0525 0.0025 46.365 46.23 0.075 0.0025 44.995 45.16 0.08 0.0025 57.016 45.61

Source: www.global-rates.com

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INR appreciated by 2.69%, the biggest ever single day gain on 29th June just after the announcement of Eurozone rescue plan by the leaders of 27 European Union. All the above mentioned reasons are a testimony to the fact that global economic factors are playing a bigger role than any domestic economic or political condition.

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Chapter 4 CONCLUSION
1) Conclusion:

The Indian Rupee has depreciated significantly against the US Dollar marking a new risk for Indian economy. Grim global economic outlook along with high inflation, widening current account deficit and FII outflows have contributed to this fall. RBI has responded with timely interventions by selling dollars intermittently. But in times of global uncertainty, investors prefer USD as a safe haven. To attract investments, RBI can ease capital controls by increasing the FII limit on investment in government and corporate debt instruments and introduce higher ceilings in ECBs. Government can create a stable political and economic environment. However, a lot depends on the Global economic outlook and the future of Eurozone which will determine the future of INR. The INR depreciation has several implications to its effect. First, it sends out signals that the points out to the weakening economy. Balance of Payments [BOP], which is the sum of the current and the capital account flows in and out of the economy, is a major indicator of the economys prospects. A far less BOP would surely mean that investors prefer other economies to India when it comes to investment. A negative BOP is sustainable only with large foreign exchange reserves are at RBIs disposal (to control the rupee). This particularly is dangerous when combined with high interest rates in the domestic economy as RBI could not do anything to plug the flows out of the economy but to move to a wait and watch mode. The effect of such weak economic fundamentals like high

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interest rates and negative BOP of the economy would stop attracting investors and may hurt the growth prospects of the country. India is a country with large foreign exchange reserve assets of USD 316,210 million (Foreign Exchange Reserve Data, IMF, 2011) which is one of the largest in the world. Generally, countries with rising fiscal deficit would access their foreign exchange reserves to reduce their fiscal deficit. On the other hand, the same foreign exchange reserves could be used to reduce the volatility in the domestic currency. In the case of India, the depreciating rupee tied the hands of Government and restricted its access the foreign exchange reserves. Any attempt to access the reserves to contain the fiscal deficit would undermine the efforts of RBI in controlling the INRs volatility. The INR depreciation brings in a whiff of fresh air to some sectors, especially the IT sector. It has been already discussed that the exports would increase due to INR depreciation, Indias software exporters like Infosys, TCS and Wipro had a colourful 2nd Quarter in FY 2011-12. All of these companies partly attributed their profits to the falling rupee. On the other hand, the debt revaluation by companies with high foreign debt in the form of direct lending, ECBs or through FCCBs would have a negative effect on their income statements. Come 3rd Quarter results of FY 2011-12, we could see many companies revaluing their foreign debt due to depreciated rupee. Indian companies like Jet Airways, Reliance Communications, Bharti Airtel, Tata Steel which hold large amounts of foreign debt are expected to include losses due to debt revaluation in their earnings statement.

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Looking at the high growth sectors like infrastructure and automobile, these sectors have a loss to bear due to the weak rupee. Prices of capital goods in case of infrastructure, machine and spare parts in case of automobile industries would reach a new high due to the weak rupee thus reducing their margins. It must be noted that a large chunk of Indias growth are due to the flourishing production of these sectors. Any negative effect on these sectors would have an impact on the growth of Indian economy. Another issue of concern is the non-plan expenditure of Indian Government in the form of oil subsidy. As the press quotes the Oil Secretary saying, Every time the rupee depreciates by Rs. one against the US dollar, Rs. 8,000 crore is added to the fuel subsidy bill, the rupee has depreciated from Rs 46 to a US dollar to roughly Rs 52 per US dollar, thereby adding Rs 50,000 crore [to the subsidy]". This argument can also be applied to subsidies given to imported food grains. These inflated subsidy bills would increase the budget deficit due to increased non-plan expenditure.

2) The way ahead:

Since INR depreciation is exposing the weak economic fundamentals of the economy, it is high time for the Government to step up through a slew of measures that are expected out of it. In order to sustain long term growth, the Government at the centre must clear the impending key policy defining bills in the Parliament. Vexed are the investors, thanks to the deficiency in implementation of long standing bills on issues like the FDI in retail, Direct Tax

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Code, Capital Account Convertibility etc. Key policy measures should be implemented like increasing the FII limit on investment in Government & corporate debt instruments, raising the ECB ceiling imposed on Indian corporates etc. Though RBI is trying its level best in controlling inflation, due to the inherent supply-driven nature of the inflation, monetary controls remain as futile attempts. Systemic inefficiencies, like improper supply chains, must be immediately addressed by the Government to stall inflation. RBI has already done the damage by ruthlessly increasing the base rates and thus compromising the growth and discouraging investments. In order to control currency depreciation, any central bank is expected to hike the interest rates. Since the prevailing interest rates have already reached a high, RBI is helpless in managing the exchange rates through interest rate hike. Another option left with RBI is to use its foreign exchange reserves to sell dollars in the currency market to improve the value of INR. Though RBIs argument of non-intervention is justified, it must strike the right balance between intervention and controlled-intervention. Generally foreign exchange reserves deplete as a result of daily operations of central banks in the wake of domestic currency depreciation. But, in the Indian context, foreign exchange reserves are still containing healthy amounts in it and can be accessed for INR control and stalling volatility. Considering all the above factors, is the way ahead gloomy for the Indian rupee? Well, nothing can be told so surely in this uncertain environment. The

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market sentiments truly drove the INR to the edge. The INR may correct itself and settle in a lower value than that is prevailing currently as the market sentiments fade out. On the other hand, tight monetary control by the RBI which led to high interest rates widened the interest rate differential thus inviting inflows. Overselling of rupee than that is necessary might have caused the slide in the value of INR. If the rupee starts rebounding, it would definitely start yielding high results due to the low base effect. So, if the rupee is actually oversold, investors who are confident about the resilient Indian economy might put their money on the rupee since no other asset would give such high returns in this current scenario. But there are conditions attached to the argument - rupee must bounce back and foreign inflows must find their way back into the Indian economy.

3) Summary:
After studying the various demand and supply factors, I have arrived at three likely scenarios: i) First Scenario Rupee Depreciation: This scenario is likely to occur if oil prices continue to rise or if FII money exits because of a crisis of confidence. Based on past evidence, even a relatively orderly outflow of USD 15 billion of FII money over a year could result in the INR depreciating by 2230%. This would imply an exchange rate in the range of INR 5560 to USD 1. It could get even worse if the flight of capital were to take place over a shorter period, which would cause massive concern among businesses and the government, since it would imply a higher cost of petrol,

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diesel, and petroleum products in India, leading to even higher food prices and Consumer Price Index. The current account deficit would balloon and the rising inflation could create a vicious cycle. ii) Second Scenario Rupee Appreciation: This scenario is likely to occur if the FII money continues to flow in and FDI levels improve. The stock markets will climb and there will be a rise in demand for INR. An appreciating Rupee will make imports cheaper and lead to better managed deficits and inflation. It must be pointed out that Rupee appreciation would erode Indias cost advantage in the export sector and negatively affect the booming ITES sector as well as the textile sector and this in turn would invite government intervention. This is what happened just before the onset of the 2008 financial crisis when the USD-INR touched 39 and the Indian government repeatedly intervened in the currency markets to halt the appreciation of the Rupee. iii) Third Scenario Status Quo: This is the most benign scenario. The exchange rate continues to move in its current range and appreciates over the long term as the economy continues to develop and India strengthens its position in the global markets. The governments efforts to improve agricultural infrastructure bear fruit in the longer term and inflation declines. The rate fluctuations do not cause any major disruption in the trade environment. According to my analysis, during the next two years the probability of the first scenario (depreciation of Indian Rupee by 20%) is the highest (about

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50%) while the other two scenarios have an equal probability of approximately 25% each. In other words, there will be pressure on the Rupee unless steps are taken to fix structural issues described in this article. The Indian government and RBI are well aware of this risk and are definitely hoping for the third scenario, in which India essentially grows its way out of trouble over a couple of decades and where they only have to intervene occasionally to smoothen out excess volatility. As Subir Gokarn, a deputy governor of RBI recently said, Intervention is not costless, it simply transfers the cost from one constituency of the economy to another.

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REFERENCES 1) DATA BASE:

Keeping in view the objective of the study, the data have been taken from the reputed published sources. Notable among these are: Causes of Indian Rupee Depreciation in 2011; Exchange Rate Policy and Modelling in India; Foreign Exchange Reserve Data, IMF; The costs of coupling: the global crisis and the Indian economy; Economic Survey, etc. The data published in reputed journals and books have also been used.

2) REFERENCES:
Aggarwal Anmol. Rupee Depreciation: Probable Causes and Outlook. STCI Primary Dealer Ltd 21 Dec 2011:1-9. Sumanjeet Singh (2009). Depreciation of the Indian Currency: Implications for the Indian Economy. AIUB Bus Econ Working Paper Series, No 2009-04, Johri Devika, Miller mark. Devaluation of the Rupee: Tale of Two Years, 1966 and 1991. State, Market & Economy 84-90. Swati Bhatt (2011). Big dangers from a declining rupee. The NEW York times Chaturvedi, G C (2011, 12 December). Speech at 10th Petro India Conference. Retrieved 5th December, 2012 from http://articles.economictimes.indiatimes.com/2011-12-12/news/30507541_1_fuelsubsidy-subsidised-diesel-rupee-depreciates Dua, Pami and Ranjan, Rajiv (2010, 25 February). Exchange Rate Policy and Modelling in India. Development & Research Group, Study No: 33. Retrieved 5th December, 2012 from http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DRS33250210.pdf Economic Review by RBI (2011, 25 August). Retrieved 5th December, 2012 from http://www.rbi.org.in/scripts/AnnualReportPublications.aspx?Id=999

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Evans-Pritchard, Ambrose (2011, 16 September). Gordon Brown fears euro crisis worse than Lehman as 1930s beckon. The Telegraph. Retrieved 5th December, 2012 from http://www.telegraph.co.uk/finance/financialcrisis/8768575/Gordon-Brown-fearseuro-crisis-worse-than-Lehman-as-1930s-beckon.html Foreign Exchange Reserve Data, IMF (2011, 29 November). Retrieved 5th December, 2012 from http://www.imf.org/external/np/sta/ir/IRProcessWeb/data/ind/eng/curind.htm#I Ghosh, Jayati and Chandrasekhar, C.P. (2009, 8 May). The costs of coupling: the global crisis and the Indian economy. Cambridge Journal of Economics (2009), Volume 33, Issue 4 Pp : 725-739. Retrieved 5th December, 2012 from http://cje.oxfordjournals.org/content/33/4/725.full Gokarn, Subir (2011, 3 December). An assessment of recent macroeconomic developments. Retrieved 5th December, 2012 from http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=636 Misra, B Swarup (2011, 19 December. Why RBIs hands are tied in checking Re fall. The Hindu. Retrieved 5th December, 2012 from http://www.thehindubusinessline.com/opinion/columns/article2729307.ece moneycontrol.com (2011). Retrieved 5th December, 2012 from http://www.moneycontrol.com/stocksmarketsindia/ Sushant Supriya (2011), Causes of Indian Rupee Depreciation in 2011. Retrieved 5th December, 2012 from http://sushantsupriya.com/2011/12/17/causes-of-indianrupee-depreciation-in-2011/ http://ramtej.blogspot.in/2012/01/initial-slide-in-indian-rupeesinrvalue.html#!/2012/01/initial-slide-in-indian-rupees-inrvalue.html Reserve Bank of India (RBI).

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