RBI_Rupee Plunge_ProjectsMonitor Rupee value turned volatile in forex markets particularly since later part of May, registering sharp depreciation against major foreign currencies. Thus, in terms of RBI reference rates, rupee lost 19.28 per cent between 2 May-30 August against US$, 19.16 per cent against GBP, 19.79 per cent against JPY and 18.56 per cent against Euro. Mirroring near-term prospects, the premium for $ for one month forward zoomed to 10.29 per cent and for six months forward to 9.46 per cent by 16 August, from their respective levels of 6.63 per cent and 5.90 per cent at the end of June. The premium for $ has eased to 10.02 per cent for one month and 8.12 per cent for six months delivery as of 23 August. The measure of rupee depreciation against the major global currencies over just around four months, which is record fall for a comparable period since the currency crisis of 1991 has unnerved the government which was already rattled by a retarding economy. India Inc with a steeply enhanced global exposure too is struggling finding ways to cope with such abnormal conditions in the forex market.

The purpose of the study is to examine the issues behind a record volatility and a steep depreciation in rupee value in such a short period of 4 months only, particularly vis-à-vis US$.

Merchandise trade
Trade deficit in merchandise according to DGCIS was placed at $12.3 billion in July, lower compared to $17.5 billion a year ago. Trade deficit in earlier months had run higher, compared to respective year ago levels, and the escalation in deficit had come down from $3.7 billion in April to $3.2 billion in May and $1 billion in June. The cumulative deficit over April-July was 62.4 billion against $59.7 billion in the similar period a year go. Thus, broadly we can say that with escalation in trade deficit on the decline, merchandise trade does not seem to have caused major demands on capital flows.

Service trade
The net receipt from trade in services like Telecommunications, computer and information services, travel, business services, etc has improved from $5.4 billion in April to $5.8 billion in May and $6.1 billion in June, taking the total for Q1 to $17.4 billion. There is no reason to believe that the yield has gone down in subsequent months. Services broadly take care of one-third of deficit in the merchandise trade.

Workers’ remittances, classified as secondary income in BoP, had brought in $62 billion average in last two fiscals. Per quarter, netting under this head is around $15-16 billion in recent years. These levels were probably maintained, or might have even gone up in the current fiscal especially in view of better realization in terms of rupee.

The drain on account of primary income in the form of profit/dividend repatriation totaled $21 billion in the fiscal 2013, with a quarterly average of around $5-6 billion.

All-in-all, we can expect current account deficit of around $24 billion in the first quarter of the current fiscal, against $15-16 billion in Q1 of 2013. The increase is primarily on account of higher trade deficit during April-June, which declined in July, following rebound in exports.

Capital flows
Portfolio investment by FIIs saw net outflow of $5.8 billion during April-August. While equity investment saw a net increase of $1.3 billion, debt exposure dropped $7.1 billion. The sharpest drain was in June, which saw $1.8 billion outflow in equity and $5.7 billion in debt, adding to $7.5 billion outflow for the month. The subsequent two months saw decline in outflow: July saw an outflow of $3 billion and August $2.5 billion. Earlier, April-May had seen around $ 7 billion inflow, which happened in both equity and debt instruments.

Net FDI into the country has been assessed at $6.7 billion during April-June, substantially bettering $3.8 billion in this quarter of the fiscal 2013. FDI into the country totaled $7.6 billion ($5.9 billion), while FDI overseas by Indian companies was placed at $ 0.921 billion ($2.094 billion).

ECB/FCCB approvals totaled $1,953 million during June 2013 and $5,564 million during April-June, against $10,939 million during January-March and $8,099 million in the first quarter of 2012-13.

Net inflow under NRI deposits was assessed at $5,497 million ($6,553 million) during April-June. The receipt could have grown much faster in July-August due to much better returns with appreciating USD.

Trends in BoP during the current year (US$ million)
Item
Period covered
2013-14
2012-13
Balance in Goods trade (DGCIS)
April-July
-62,448
-59,696
Balance in Service Trade
April-June
17,409
14,982
FDI into the country
April-June
7,623
5,915
FDI overseas
April-June
921
2,094
ECB/FCCB Approvals
April-June
5,564
8,099
FII investment
April-August
-5,850
4,339
Equity
April-August
1,273
3,449
Debt
April-August
-7,123
890
NRI Deposits
April-June
5,497
6,553
Forex assets with RBI (Change)
April-23 August
-9,243
-2,196

Forex Reserves
Forex assets with RBI declined rather sharply by around $9 billion by 23 August in the current fiscal to $250 billion. The fall could be broadly intervention by the apex bank in the form of net sale of USD in the forex market to contain rupee depreciation. Most of the decline occurred in May, probably in the second half of the month

Government Response
The rupee plunge in forex market was largely treated as short term, calling for short term response. Guided by the imperative to maintain external value of rupee and containing volatility in forex markets, RBI took several measures in July-August to restrict liquidity in the financial system that could feed speculation in the forex markets. The measures also reflected the apex bank’s worries about the impact of rupee depreciation on domestic inflation as a result of pass- through of enhanced cost of imports.

  • MSF rate and bank rate were hiked by two percentage points on 15 July; simultaneously ceiling was put on borrowing by banks under LAF at Rs.75000 crore (1 per cent of NDTL) and sale of GoI securities worth Rs.12000 crore in the open markets was announced to mop up the existing liquidity.
  • Certain restrictions were announced on 22 July on import of various forms of gold by nominated banks/nominated agencies/ premier or star trading houses/SEZ units, etc whereby they would have to ensure that at least one fifth of every lot of import of gold was exclusively made available for the purpose of export. Further, they would have to make available gold for domestic use only to entities engaged in jewellery business/bullion dealers supplying gold to jewelers.
  • The overall limit for access to LAF by each individual bank was reduced on 23 July to 0.5 per cent of its NDTL outstanding as on the last Friday of the second preceding fortnight. Further. Cash Reserve Ratio (CRR) was hiked to 99 per cent of the requirement on daily basis, from 70 per cent earlier.
  • With a view to containing capital outflow, the limit for Overseas Direct Investment (ODI) under automatic route for all fresh ODI transactions was reduced by RBI from 400% of the net worth of an Indian Party to 100% of its net worth on 14 August. This reduced limit would also apply to remittances made under the ODI scheme by Indian Companies for setting up unincorporated entities outside India in the energy and natural resources sectors. This reduction in limit, however, would not apply to ODI by Navratna PSUs, ONGC Videsh Limited and Oil India in overseas unincorporated entities and incorporated entities, in the oil sector. However, any genuine requirement beyond these limits will continue to be considered by RBI under the approval route.
  • The limit for remittances made by Resident Individuals, under the Liberalised Remittance Scheme (LRS Scheme) was reduced by RBI on 14 August, from USD 200,000 to USD 75,000 per financial year. While current restrictions on the use of LRS for prohibited transactions, such as, margin trading and lottery would continue, use of LRS for acquisition of immovable property outside India directly or indirectly would not be allowed.
  • On the basis of assessment of current market conditions, RBI opened a forex swap window to meet the entire daily dollar requirements of three public sector oil marketing companies (IOC, HPCL and BPCL) on 28 August. Under the swap facility, the apex would undertake sell/buy USD-INR forex swaps for fixed tenor with the oil marketing companies through a designated bank. The swap facility would remain in place until further notice. This is not outright sale of USD, and OMCs would have to return the bought USD after the predetermined periods.
  • RBI also came out with various short duration instruments like 7-day, 28-day, 48-day and 56-day cash management bills as also OMO in government securities to mop up excess liquidity in the financial system.

As a part of measures towards containing the current account deficit, the government also took some measure including raising on 12 August the customs duty on gold and platinum from 8 per cent to 10 per cent and on silver from 6 per cent to 10 per cent. It also took several growth friendly measures including those for faster clearance of mega infrastructure projects, fuel subsidy reform etc

RBI measures appear to have contained rupee erosion and volatility to some extent only, as they did not address basic factors behind the depreciation in rupee value which had touched a bottom of 68.36 per USD on 28 August, against a low of 53.74 on 2 May. However, having cramped liquidity the measures led to hardening of interest rates initially for short term, with a potential to spill over to medium and long term durations.

Overall Assessment
Conceptually, like any merchandise, USD value in the foreign exchange market should evolve out of its demand-supply, present and future factoring forward/future options and perceptions about likely levels. In the present scenario, It appears that what triggered the sharp and sudden rupee depreciation (and USD appreciation) was the markets’ reaction to certain unexpected external developments, particularly, the indication by the US Federal Reserve Bank that it would soon ‘taper’ its quantitative easing as the US economy was recovering. This led to a reversal of capital flows from emerging economies; other global factors such as tensions over Syria added to uncertainly on crude oil prices. Indian economy was found more vulnerable because of huge current account deficit and stickiness of several large imports. Governance deficit and a retarding economy were also treated bearishly and RBI and government response targeting rupee instead of improving economy growth prospects led to liquidity crunch and hardening of lending rates that have the potential to further hurt the growth.

As for hard data on probable proximate causes for rupee fall, pull out of $9,248 million by FIIs from the domestic debt markets over June-August period was one reason and disinvestment of around $3.8 billion from equity segment was the other reason. Debt sector outflow was fallout of expected reversal of US QE. Other indicators did not display much abnormality. Current account deficit was apparently not unusual, though there could be some lag in receipt of USD or there could be some unevenness in USD demand. Thus, probably guided many times by irrational response to an indicator without taking into account all relevant statistics, foreign exchange markets probably acted more bearishly to a likely US reversal of QE, which quickened the rupee’s plunge. Our globalized economy would have to face the aftereffects of any short-term or long-tern turmoil in the world markets.

Problems, particularly on domestic front are no doubt formidable, but positivism as against skepticism and negativism that has aggravated problems and harmed the prospects further, should help the recovery in the real economy. The government should let the rupee find its level by keeping market intervention limited to seek its orderly movement; irrationality in market perceptions would gradually get corrected, leading to stability in rupee value. Also, an improving US economy aided by positive pointers in other developed economies, should have beneficial effect on the real economy of developing countries including India which should outweigh by a wide margin bearish possibility of a few basis points rise in interest rates. By the way, economy fundamentals have remained sound and this should help clearing misgivings on currency prospects in the forex market.


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