India: The Causes Behind The Struggle of The Rupee

May 17th, 2012
in econ_news

Econintersect:  The Rupee has declined by 12.4% since early February and by 5.8% in just the last 30 days.

"The rupee dropped as low as 54.46 per dollar, breaching its previous record low of 54.30 in December. It was last trading at 54.34/36 compared to a close of 53.79."

The Economic Times, 16 May 2012

Many causes are behind this situation; mainly, the rupee falling was a consequence of the European Union Crisis that has led to an increase for investments in the USA and a shrinking of foreign investments in India.  In general, investors prefer to put their money wherever the economy is more stable.  Thus, Asian economies such as that of India are being negatively impacted.

Follow up:

The fall of the rupee is a result of a global risk aversion that keeps on limiting the flow of capital to the country.  Additionally, India’s current account deficit and fiscal deficit (the highest among Asian peers) increase the bad image of the country’s economy to foreign investors. Nowadays, India is characterized by its lack on macroeconomic conditions. The country has very unfriendly taxes imposed on foreign investors and this is blocking the money flow to the country.

As mentioned, earlier this week, in an article in The Economic Times about the causes behind the fall of the rupee, during the time between December 2011 and January 2012 the rupee experienced a recovery due to an increase in foreign investments. In addition, investors recognize that India has potential. As stated on a previous article by this year:

"According to Evans Data's Global Developer Population and Demographic Survey1 conducted in 2011, India is among the rising technology powerhouses and by 2015, India will surpass the United States with more than 3.5 million professional software developers."

There is an ongoing debate about whether or not the RBI (Reserve Bank of India) should intervene this time. On the one hand, people argue that the RBI should be drastic on import policies. For example, as stated by The Economic Times,

“The RBI will impose more "drastic" controls on the rupee to shore up investor confidence, Suresh Kumar Ramanathan, CIMB Investment Bank's regional rates and foreign exchange strategist in Kuala Lumpur, said.
"From here, expect some form of drastic controls on INR," he added. The measures may include raising the bar on how much dollars exporters need to convert to rupees, Ramanathan said, adding that RBI may also target repatriations or outflows."

On the other hand, some analysts argue that the RBI should not intervene, and it should let the market forces drive it to its equilibrium. As mentioned by The Economic Times,

“Frequent currency intervention by the central bank would further sap rupee liquidity from the economy at a time when the country is facing a severe cash crunch in its banking system.”

Finally, another cause of the decline of the rupee are the imprudent subsidies that mislead people and accustomed them to spend their income in a way that would not be profitable for the country.  Similarly, oil subsidies are too high and need to go down, according to The Economic Times article.  However, the government cannot pass such a huge burden to consumers or the economy would be even worse off.  The problem with oil relies on the scarcity that the country faces for it, as well as, the inelastic demand for the resource.   In other words, no matter how high the price is, oil is necessary for India and demand will not be affected. However, the rupee will face the consequences.

Written by: Andrea Rangel

Sources and References:

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