COMMENTARY
the benchmark rates have crossed the
2% mark for the first time since 2008.
It noted,
the labor market has continued to strengthen,
and that economic activity has been rising
at a strong rate. Job gains have been strong,
on average, in recent months, and the unemployment rate has stayed low. Household
spending and business fixed investment
have grown strongly. (US Fed 2018)
Parthapratim Pal, Partha Ray
Parthapratim Pal (parthapal@iimcal.ac.in)
and Partha Ray (pray@iimcal.ac.in) are with
the Indian Institute of Management Calcutta,
Kolkata.
12
This monetary tightening by Fed is a
key factor which is leading to a general
appreciation of the dollar across all major
currencies. Other policies like loose fiscal policy and increasingly protectionist
trade measures are also helping the rise
of the dollar (Ahmed and Thorne 2018).
But, the downfall of the rupee is not
limited to the dollar. In fact, the rupee
has indeed depreciated with respect to
all four major currencies since April 2018
(Figures 1A and 1B). However, it is
important to highlight that the recent
slide of the rupee has been sharper than
most other currencies from the emerging market with the exception of the
Argentinian peso or the Turkish lira. In
fact, this year, the rupee has depreciated
Figure 1: Nominal Exchange Rate of INR with
Respect to Major Currencies
(A) Daily Nominal Value of Rupee vis-à-vis Some Major
Currencies of the World
Dollar Strengthening
60
There is a view that the depreciation of
the rupee has been the result of a general
appreciation of the dollar across all currencies. This appreciation of dollar is a
fallout of the tightening of monetary
policy by the Federal Reserve (Fed) in
recent times. During the financial crisis
of 2006–08, most developed countries,
including the US adopted an expansionary and accommodative monetary policy
which led to a nominal depreciation of
the dollar. But, over the last year, the
US economy has been showing signs of
healthy growth. The job figures are
pointing towards historically low unemployment figures and the gross domestic product (GDP) is poised to grow
close to 3% in 2019 (IMF 2018). Consequently, the US Fed has started pushing
up the reference interest rates and with
the recent increase on 26 September,
70
US dollar
Japanese yen
80
Euro
90
7 Sept 2018
21 Sept 2018
24 Aug 2018
10 Aug 2018
13 July 2018
27 July 2018
1 June 2018
15 June 2018
4 May 2018
6 Apr 2018
29 June 2018
Pound sterling
100
18 May 2018
T
he exchange rate of the Indian
rupee has always been an emotive
issue in India and has often tended
to have generated more heat than light.
The current episode of the downfall of
the rupee is no exception. After all, the
movement of the Indian rupee/United
States (US) dollar exchange rate from
less than `65 in early April 2018 to
almost `73 by the end of September 2018
has turned out to be substantial. Owing to
the underlying issues, opinions in this
context have a tendency to differ substantially. Is it entirely due to the global
instability created by US President Donald
Trump’s sabre-rattling of the trade war
with China? Is it a result of the beginning of tightening monetary policy cycle
in the US? Is it a reflection of the contagion of the crisis in Turkey? Or, is it an
outcome of the inherent weaknesses of
the Indian economy with high imports
of gold and huge dependence on oil?
(B) Relative Movement of Rupee vis-à-vis Some Major
Currencies of the World (base = 4 April 2018 =100)
95
Pound sterling
100
105
US dollar
110
Japanese yen
Euro
115
6 Apr 2018
17 Apr 2018
26 Apr 2018
9 May 2018
18 May 2018
29 May 2018
7 June 2018
18 June 2018
27 June 2018
6 July 2018
17 July 2018
26 July 2018
6 Aug 2018
16 Aug 2018
29 Aug 2018
7 Sept 2018
19 ept 2018
Assessing the trends in India’s
balance of payments, it is argued
that a combination of substantial
trade deficit and a significant
current account deficit financed
predominantly by fickle portfolio
investments could have made the
rupee vulnerable to the moods
of the global capital market.
India’s huge dependence on oil
imports along with high gold and
electronic imports could also have
played their roles in making the
exchange rate volatile.
20 Apr 2018
Recent Downfall of
the Indian Rupee
Vertical axes values are in reverse order.
Source: Reserve Bank of India (RBI).
OCTOBER 13, 2018
vol lIiI no 41
EPW
Economic & Political Weekly
COMMENTARY
dollar is sharp, and there are mounting
pressures both from the current and the
capital accounts, which are posing serious
challenges for policymakers.
Figure 2: Nominal Effective Exchange Rate and Real Effective Exchange Rate of India
(Six country trade weight-based index, base = April–March 2016–17 = 100)
106
104
Widening Current Account Deficit
NEER
102
100
98
96
REER
Aug 2018
June 2018
Apr 2018
Feb 2018
Dec 2017
Oct 2017
Aug 2017
June 2017
Apr 2017
Feb 2017
Dec 2016
Oct 2016
Aug 2016
Apr 2016
June 2016
Feb 2016
Oct 2015
Dec 2015
Aug 2015
Apr 2015
June 2015
94
Upward/downward movement of the graph shows appreciation/depreciation of INR vis-à-vis the currency basket.
Source: RBI.
February 2016 to April 2017, it appears
that both the NEER and the REER were
showing an appreciating trend. (iii) From
April 2017 to December 2017, the trend
of the first period was repeated, that is,
the NEER declined but the REER remained
stable. (iv) Since December 2017, there
has been a steady decline of both the
REER and the NEER.
What is also notable from the graph
is that despite the sharp decline of
the REER, its value in August 2018 is
still higher than what it was during
February–June 2016. It is possible that in
real terms, the present slide of rupee may
be partly due to a correction of a phase
of nominal and real appreciation it experienced in 2016. However, the current
depreciation of rupee with respect to
by 12% against the dollar which makes it
the worst performer among the Asian
countries (Patnaik 2008).
Nominal and Real Rates
But, what is influencing the value of the
rupee? Is there any disjoint between the
real and nominal exchange rates of the
rupee? The monthly six-country trade
weight-based nominal and real effective
exchange rates (NEER and REER) of India
since April 2015 (Figure 2) were examined and admittedly, the REER and the
NEER have not always moved together
since April 2015. Several phases can
be discerned.
(i) For the period from April 2015 to
January 2016, the NEER depreciated but
the REER remained largely stable. (ii) From
Table 1: Select Items of India’s Current Account in Balance of Payments
2015–16
Q2
Q3
Q1
Merchandise
-34.2 -37.2
Invisibles
28
o/w: Services
Q4
Q1
2016–17
Q2
Q3
Q4
($ billion)
2017–18
Q2
Q3
Q1
Q4
2018–19
Q1
-34 -24.8 -23.8 -25.6 -33.3 -29.7 -41.9 -32.5 -44 -41.6 -45.7
28.6 26.9 24.4
23.4 22.1 25.3
27 25.5 30.3 28.6
29.9
17.8
15.7 16.3 17.8 18.5 18.3 18.4 20.7 20.2
18.7
17.8
18 16.1
27.1
o/e Software services
17.5
18.1 18.6 17.3
17.6 17.6 18.0 17.5 17.5 18.0 18.2 18.6
18.4
o/w Private transfers
16.3
16.4
15.3 15.1
14.2
17.2
Current account
-6.1 -8.6
-7.1 -0.3
-0.4 -3.5 -8.0 -2.6 -15.0 -7.0-13.7 -13.1 -15.8
14
14 14.4 14.6 15.8 16.2 16.4
Source: RBI.
Table 2: Current Account Balance of Select Countries
(% of GDP)
2010
2011
2012
2013
2014
2015
2016
2017
3.9
1.8
2.5
1.5
2.2
2.7
1.8
1.4
1.2
Malaysia
10.1
10.9
5.2
3.5
4.4
3.0
2.4
3.0
2.4
Thailand
3.4
2.5
-0.4
-1.2
3.7
8.0
11.7
10.8
9.3
Russia
4.1
4.7
3.2
1.5
2.8
5.0
2.0
2.6
4.5
China
2018 (P)
Brazil
-3.4
-2.9
-3.0
-3.0
-4.2
-3.3
-1.3
-0.5
-1.6
Turkey
-5.8
-8.9
-5.5
-6.7
-4.7
-3.7
-3.8
-5.5
-5.4
India
-2.8
-4.3
-4.8
-1.7
-1.3
-1.1
-0.7
-2.0
-2.3
P: IMF projections.
Source: World Economic Outlook Database, IMF, April 2018.
Economic & Political Weekly
EPW
OCTOBER 13, 2018
vol lIiI no 41
But, is the downfall of the rupee a mystery?
After all, traditionally India has been a
current account deficit economy and the
current account deficit has increased
sharply over the last few quarters. While
the average quarterly current account
deficit for the four quarters of 2015–16
was around $5.54 billion, the average
current account deficit for the last three
quarters (2017–18: Q3, 2017–18: Q4 and
2018–19: Q1) had reached $14.2 billion
(Table 1). This rapid rise of current
account deficit in the last three quarters
can be largely attributed to the rapidly
growing deficit in merchandise trade.
While the balance of trade in services has
remained strongly positive, it has been
showing a stagnating trend since Q1 of
2015–16. Net private transfers (mostly
remittances) have remained resilient over
the same period. Stability of remittances perhaps indicates that despite a widening current account deficit, there was
no widespread build-up of expectations
of depreciation of the rupee. Generally,
an expectation of depreciation among
the expatriates can lead to a temporary
drop or even reversal in remittances
flow. This has happened before in India.
Despite a growing current account deficit, such a trend is not evident from the
data this time.
How does India’s current account deficit
look vis-à-vis other comparator economies? It is well known that most of
India’s East Asian neighbours, led by
China, tended to follow an export-led
growth and industrialisation strategy,
and consequently, countries like China,
Malaysia and Thailand have current account surplus (Table 2). Russia, of course,
has current account surplus because of
oil. Among other BRIC (Brazil, Russia,
India, and China) countries both Brazil
and India have current account deficit.
Two key points need to be noted here.
First, notwithstanding recent deterioration in India’s current account deficit, the
situation is not as bad as the one during
the period of taper tantrums. Second,
13
COMMENTARY
Figure 3: Imports of Petroleum, Electronic Goods and Gold
(million $)
Petroleum
Gold
May 2017
June 2017
July 2017
Aug 2017
Sept 2017
Oct 2017
Nov 2017
Dec 2017
Jan 2018
Feb 2018
Mar 2018
Apr 2018
May 2018
June 2018
July 2018
Feb 2017
Mar 2017
Apr 2017
Dec 2016
Jan 2017
Sept 2016
Oct 2016
Nov 2016
Mar 2016
Apr 2016
May 2016
June 2016
July 2016
Aug 2016
Jan 2016
Feb 2016
45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0-
Electronics
Total imports
Source: Ministry of Commerce.
Figure 4: Oil and India’s Trade Deficit
(B) India’s Oil Trade Deficit (million $) and Price of Indian
Basket ($/barrel)
0
120
Oil trade deficit
100
-2,000
-2,000
million $
Oil
-4,000
80
-4,000
60
-6,000
-6,000
-8,000
-8,000
$/barrel
(A) Oil, Non-oil in Merchandise Trade Deficit of India
(million $)
0
40
0
Apr 2014
Sept 2014
Feb 2015
July 2015
Dec 2015
May 2016
Oct 2016
Mar 2017
Aug 2017
Jan 2018
June 2018
Oct 2017
Apr 2018
Oct 2016
Apr 2017
-10,000
Apr2016
Oct 2015
Oct 2014
Apr 2015
Apr 2014
-10,000
20
Price of Indian basket
Non-oil
The composition of Indian Crude Basket represents average of Oman and Dubai for sour grades and Brent (Dated) for sweet
grades in the ratio of crude processed during previous financial year.
Source: Database on Indian Economy, RBI. Data on oil prices from Petroleum Planning and Analysis Cell, Ministry of
Petroleum and Natural Gas.
India’s situation is clearly not comparable to Turkey.
Is Oil the Villain?
This worsening merchandise trade balance is driven by massive increase in the
oil import bill, followed by imports of
electronics, gems and jewellery (including gold) (Figure 3). It is important to
note here that in all these three categories, there are some imports which are
not meant for the domestic market.
Some amount of imported crude oil and
gold (and precious stones) is used eventually for exports. On the other hand, in
the case of electronics imports, a percentage of intermediate goods are used as
components in domestically manufactured final products.
A further decomposition of the merchandise trade data for the period April
2014 to August 2018 shows that India’s oil
trade deficit improved from April 2014 to
about February 2016 on account of favourable international oil prices. During January and February of 2016, oil prices were
at a record low level, touching $28.08/
barrel and $30.53/barrel respectively.1
14
As oil prices went up, India’s oil trade
deficit also moved in tandem (Figure 4A).
Interestingly, there is a strong (negative)
correlation between the international
oil prices and India’s oil trade balance
(Figure 4B). Rising oil price poses a big risk
for the Indian economy. As the Economic
Survey 2017–18 pointed out,
It is estimated that a $10 per barrel increase
in the price of oil reduces growth by 0.2–0.3
percentage points, increases WPI inflation by
about 1.7 percentage points and worsens the
current account deficit by about 9–10 billion
dollars. (GoI 2017)
This increase in oil prices is likely
to persist because some of the world’s
major oil suppliers are facing sanctions
from the US. These two countries, namely
Venezuela and Iran, are major suppliers
of oil in the world. Oil exports from
Iran will come under US sanctions from
4 November 2018 and oil supply from
Venezuela is also dwindling at a rapid
rate. Iran is one of the largest suppliers
of oil in the world and it is the third
largest source of oil import for India. If
oil supply from Iran comes to an end,
then there is likely to be even more
pressure on international oil prices. The
Organization of the Petroleum Exporting Countries (OPEC) has indicated that
it is not going to increase production to
compensate for the loss of supply from
Venezuela and Iran. The Oil Market
Report for September 2018 by the International Energy Agency (IEA) indicates
that the demand for oil is going to be
resilient in the near future. Given these
developments in the global oil market,
it is expected that oil prices will stay
at a fairly high level in the short to
medium term.
How would the current account deficit
continue to be in the near future? Overall, the current account deficit is expected
to remain high. There are reports that
India’s current account deficit, which is
around 1.9% of GDP in 2017–18, is expected
to rise to around 2.8% in 2018–19 (Sikarwar
2018). To reduce the trade deficit, the
government has increased tariff rates for
several products, including some electronic items. These are non-essential items
according to the government. However,
as tariff rates for free trade agreements
(FTAs) have not been changed, it is unlikely
that this increase in most-favoured-nation
(MFN) tariff rate will bring down the
volume of imports. But, it may lead to a
shift in the source of import from the
non-FTA countries towards the countries
with which India has FTAs. Rupee depreciation, however, can be a more universal
deterrent for imports as it affects imports
from all sources. It also benefits exports
by making domestic goods cheaper in
terms of international currency. However,
by raising domestic prices of imports,
rupee depreciation can also lead to inflationary pressures. It increases prices of
all imported goods, including oil and
other intermediate goods, and thereby,
can adversely affect the competitiveness of the country. The net effect will
depend on import intensity and the price
elasticity of demand for India’s exports.
Outflow of Short-term Capital
Since the liberalisation of capital flows
in 1991, India has always faced a current
account deficit but inflows of capital have
allowed the country to have a stable
balance of payments (BoP). However, it
appears that this time a rising current
OCTOBER 13, 2018
vol lIiI no 41
EPW
Economic & Political Weekly
COMMENTARY
Figure 5: Monthly FII Flows in Equity and Non-equity (Debt and Hybrid)
(` crore)
60,000
40,000
may also be responsible for the withdrawal of FIIs from the Indian market.
Equity
RBI’s Intervention
20,000
0
-20,000
-40,000
Debt and Hybrid
Jan 2016
Feb 2016
Mar 2016
Apr 2016
May 2016
June 2016
July 2016
Aug 2016
Sept 2016
Oct 2016
Nov 2016
Dec 2016
Jan 2017
Feb 2017
Mar 2017
Apr 2017
May 2017
June 2017
July 2017
Aug 2017
Sept 2017
Oct 2017
Nov 2017
Dec 2017
Jan 2018
Feb 2018
Mar 2018
Apr 2018
May 2018
June 2018
July 2018
Aug 2018
Sept 2018
-60,000
Source: Securities and Exchange Board of India.
Figure 6: India’s Forex Reserves and RBI’s Intervention
(B) India’s Forex Reserves ($ billion)
430
420
410
400
390
380
370
360
350
Jan 2017
Feb 2017
Mar 2017
Apr 2017
May 2017
June 2017
July 2017
Aug 2017
Sept 2017
Oct 2017
Nov 2017
Dec 2017
Jan 2018
Feb 2018
Mar 2018
Apr 2018
May 2018
June 2018
July 2018
Aug 2018
Sept 2018
Jan 2017
Feb 2017
Mar 2017
Apr 2017
May 2017
June 2017
July 2017
Aug 2017
Sept 2017
Oct 2017
Nov 2017
Dec 2017
Jan 2018
Feb 2018
Mar 2018
Apr 2018
May 2018
June 2018
(A) Sales and Purchases of Dollar by the RBI: Outstanding Net
Forward Sales (-) / Purchase (+) at End of Month ($ million)
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
Source: RBI.
account deficit is also being accompanied
by capital outflows. The bigger problem
is that most of the factors driving these
imbalances (like the oil prices, global
tensions and the US monetary policy)
are not under India’s control. And given
such a perfect storm, it is only natural
for the rupee to depreciate.
Perhaps, in consonance with the increasing monetary policy rate cycle in
the US, the foreign portfolio investment
(FPI) flows have become markedly more
volatile in the last few quarters. If we
look at the period from September 2017
to September 2018, the net foreign institutional investor (FII) flows have been
negative in seven months and the FIIs
have taken out more than `35,700 crore
from India (Figure 5). In September 2018,
more than `21,000 crore have been withdrawn by the FIIs on a net basis.
In general, emerging markets are facing outflows of capital due to increased
tension about trade wars, external imbalances and commodity prices. Increasing monetary tightening by the Fed, the
rising rate of interest in developed
countries, and the revival of growth in
such economies are other possible reasons as to why capital is flowing out
from emerging markets. As a result of
gradual tightening of the Fed policies,
“risk-free” return from the US government
Economic & Political Weekly
EPW
OCTOBER 13, 2018
securities is increasing. This is prompting many global investors to look for
a “safe haven” in the US, given the rising
uncertainties of the global economy. In
case of India, expectations about rupee
depreciation, and rising instability of its
financial and banking sectors are probably playing a role. Average corporate
performance in the last few quarters
N
IO
S
AN
P
EX
While the Reserve Bank of India (RBI)
does not target any particular level of
exchange rate, it is well known that the RBI
tends to intervene in the forex market
in order to reduce the volatility.2 While
intervention data on a monthly basis are
available at a lag, the latest available
data pertain to June 2018. Until June,
the pace of the net intervention appeared
to be modest (Figure 6A). There are unconfirmed reports that in recent times
the RBI could have turned less aggressive in defending the rupee. This could
have been prompted by an objective to
allow the rupee to be closer to its REER.
India’s forex reserves, however, are on a
downward trend since late April 2018
and stood at a little above $400 billion
as of end September 2018 (Figure 6B).
The Way Ahead
Where does the analysis lead us to? Three
comments are in order. First, there is no
mystery in the recent downfall of the
rupee as it was predominantly triggered
by global factors. Second, India’s huge
dependence on oil imports and significant propensity for gold and electronic
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vol lIiI no 41
15
COMMENTARY
imports have turned out to be its Achilles heel. Third, while the situation demands serious attention, it is not as bad
as in 2013 (Lakshmi 2013).
The RBI on 5 October 2018 decided not
to react to exchange rate depreciation
and kept the policy rate unchanged. This
is in line with RBI’s philosophy of flexible
inflation targeting and not to target any
specific level of exchange rate. Viral
Acharya, the RBI Deputy Governor in
charge of the monetary policy reportedly
said, “managed float is what roughly RBI’s
policy is and what the RBI’s foreign exchange operations pursue” (Rebello 2018).
Although this does not seem to be a
doomsday situation, India for long has
been caught up with the tensions of the
impossible trinity, whereby a country
can have at the most two of the following three objectives, namely a fixed exchange rate, monetary policy independence and flexibility of capital accounts.
The tension, in the case of India, is all
the more pronounced in view of the following features of India’s BoP: a substantial merchandise trade deficit that is not
being adequately compensated by software, and private remittances and the resultant current account deficit that is
getting predominantly financed by fickle
portfolio capital flows (being dictated by
gravitational forces of risk-adjusted returns in the global capital market), and
moderate but steady foreign direct investment. Any change in the global investment climate can seriously jeopardise
this delicate balance. While these are
more structural issues, and may call for a
relook at India’s growth strategy as well
as its approach to capital account liberalisation, it should suffice to state that the
rupee will continue to be under pressure
whenever the mood of global capital
market changes, for it happened in 2013
and it can happen in 2018 as well!
Notes
1
2
The prices are for the “Indian basket” of crude
oil which is a derived basket comprising sour
grade (Oman and Dubai average) and sweet
grade (Brent Dated) of crude oil.
It is instructive to refer to the former Governor
Jalan (2003) who said, “RBI does not have a
fixed ‘target’ for the exchange rate which it
tries to defend or pursue over time; RBI is prepared to intervene in the market to dampen
excessive volatility as and when necessary;
RBI’s purchases or sales of foreign currency are
undertaken through a number of banks and
are generally discrete and smooth; and market
operations and exchange rate movement should,
in principle, be transaction-oriented rather
than purely speculative in nature.”
References
Ahmed, Saqib Iqbal and James Thorne (2018): “Trump
and the US Dollar: Actions Speak Louder Than
Words,” Reuters, 21 July, https://www.reuters.
com/article/us-usa-trump-dollar-analysis/trumpand-the-u-s-dollar-actions-speak-louder-thanwords-idUSKBN1KA2KK.
GoI (2017): Economic Survey 2017–18, Vol 1, Department of Economic Affairs, Ministry of Finance,
Government of India, p 18, paragraph 1.52.
IMF (2018): “United States: 2018 Article IV Consultation Staff Report,” International Monetary Fund,
Washington, DC: https://www.federalreserve.
gov/monetarypolicy/fomcpresconf20180926.
htm.
Jalan, Bimal (2003): “Exchange Rate Management:
An Emerging Consensus?,” speech by the
Governor, Reserve Bank of India at the 14th
National Assembly of the Forex Association of
India on 14 August, https://www.rbi.org.in/
scripts/BS_SpeechesView.aspx?Id=133].
Lakshmi, Rama (2013): “India in Uproar Over Rupee’s
Fall,” Washington Post, 20 August, https://www.
washingtonpost.com/world/india-in-uproar-overrupees-fall/2013/08/20/975cad98-08c9-11e389fe-abb4a5067014_story.html?noredirect=on&
utm_term=.1f348b9a0dd1t.
Patnaik, Ila (2018): “The Rupee Is Falling and India
Should Let It,” 10 September, https://www.
bloomberg.com/view/articles/2018-09-10/therupee-is-one-of-asia-s-worst-performing-currencies-this-year.
Rebello, Joel (2018): “Let Rupee Find Its Comfort
Level: Viral Acharya,” Economic Times, 6 October, https://economictimes.indiatimes.com/
markets/let-rupee-find-its-comfort-level-viralacharya/articleshow/66093679.cms.
Sikarwar, Deepshikha (2018): “Minimum Import Price
among Options to Curb Non-essential Goods,”
Economic Times, 17 September, https://economictimes.indiatimes.com/news/economy/
policy/minimum-import-price-among-options-tocurb-non-essential-goods/articleshow/65835916.
cms.
US Fed (2018): Press Release, Federal Reserve,
26 September, https://www.federalreserve.gov/
monetarypolicy/fomcpresconf20180926.htm.
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is a public charitable trust registered under the Bombay Public Trusts Act, 1950. Donations to Sameeksha Trust enjoy tax exemption under
Section 80G of the Income Tax Act, 1961. We welcome donations to the corpus not less than Rs 1,000 per individual. Donations in foreign
currency and donations from political parties are not accepted. We welcome donations from non-resident Indians (NRIs) and persons of
Indian origin (PIOs), but only in Indian currency and through regular banking channels. All donors must provide details of their Permanent
Account Number (PAN) and a covering letter, stating that this donation is to the corpus of the Sameeksha Trust. Please note that a covering
letter and photocopy of the PAN card is mandatory.
If you need more information on how to support us, please email us at edit@epw.in and we shall be happy to provide you with details.
— From the Trustees of Sameeksha Trust and the Editor of EPW
16
OCTOBER 13, 2018
vol lIiI no 41
EPW
Economic & Political Weekly