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Devaluation of the Indian Rupee

The Indian Rupee has fallen in value against a basket of currencies since independence in 1947. In recent years, the Indian Rupee has continued to depreciate in value.

Indian Rupee value against US Dollar

INR-USD_v2.svgIn 1990, you could buy $1 for 16 Indian Rupees. By 2013, the value of a Rupee had fallen, so that you would need 65 Indian Rupees to buy $1.

Another way of thinking about it:

  • In 1990 1 Indian Rupee = $0.06
  • In 2013 1 Indian Rupee = $0.016

This shows there has been a substantial fall in the value of the Indian Rupee against the US dollar.

When there is a devaluation in the Indian Rupee it means that Indian exports become cheaper, but imports are more expensive for Indians to buy.

In particular, a devaluation in the Rupee is bad news for Indians who need to import raw materials, such as oil and gold.

Causes of Devaluation in Rupee

Lack of competitiveness / inflation. The long term decline in the value of the Rupee reflects India’s relative decline in competitiveness. In particular, India  has a higher inflation rate than its international competitors. In November 2013, Indian inflation reached 11.24%. Therefore, there is relatively less demand for the rising price of Indian goods; this reduction in demand causes a fall in the value of the Rupee.

Current account deficit. A consequence of poor competitiveness and high demand for imports is a current account deficit. This means India is purchasing more imports of goods and services than it is exporting. A large current account deficit tends to put downward pressure on a currency. This is because more currency is leaving the country to buy imports than is coming in to buy exports.

In the first quarter of 2013 the Current Account Deficit was 18.1 billion. The deficit was over 6.7% in last quarters 2012, the deficit has fallen to 1.2% in Q3 2013. However, the Economist notes that 75% of the deficit reduction is artificially related to reducing imports of gold through government restrictions. (See: Indian economy 2014) Therefore, there is still an underlying trade deficit, India will need to work on through increasing exports and competitiveness.

A current account deficit can be financed by capital inflows (on the financial account). But,  recently, India has been struggling to attract sufficient long-term capital investment. Some major companies have recently pulled out of foreign direct capital investment. This puts more downward pressure on the Rupee.

Oil Prices

India is a net importer of oil. It has to buy oil in dollars. Therefore, rising oil prices worsen India’s current account and also weaken the Rupee. More Indian’s Rupee’s have to be spent on buying oil.

Impact of Devaluation in Indian Rupee

Inflationary pressures. India is trying to control inflation, which has been running into double digits. But, devaluation makes itself makes it harder to control inflation. The devaluation increases the price of imports, such as oil and fuels, leading to cost push inflation. Also, devaluation is considered an ‘easy’ way of restoring competitiveness, therefore devaluation may reduce the incentives for exporters to work on improving long-term competitiveness. Finally, devaluation can help boost domestic demand. Exports will rise and consumers will switch to domestic producers rather than imports. This can cause demand-pull inflation.

Economic growth

A devaluation can boost domestic demand and short-term economic growth. However, this is not necessarily helpful for the Indian economy. India’s economy needs to concentrate on boosting productivity and long term productive capacity, rather than relying on boosting domestic demand. The rapid devaluation has also caused a loss of confidence in international and domestic investors. With a history of quick depreciation, foreign investors will be more nervous of investing in India. The devaluation and inflationary impact will also discourage domestic investors, e.g. firms worried about future oil prices. This reduction in investment is damaging to long-term economic growth.

Devaluation spiral

The concern is that high Indian inflation causes devaluation, which in turn feeds into more cost-push inflation. Thus it becomes a difficult to escape out of this unwelcome negative spiral of inflation-devaluation-inflation.

Policies to stem devaluation in Rupee

  • Supply side policies to improve competitiveness
  • Reduce dependency on foreign oil, through domestic and renewable energy.
  • Monetary policy to tackle inflation and reduce domestic demand. But, will conflict with lower economic growth and lead to higher unemployment.
  • Financial controls, e.g. limiting the amount of gold imports to reduce the current account deficit.

 Related posts

Related posts on devaluation

Note on terminology: In strict terms, we should refer to the depreciation in the Indian Rupee. A devaluation means a fall in the value of a fixed exchange rate. But, in practical terminology, the distinction between depreciation and devaluation is often blurred.

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Threats and opportunities of Chinese growth on UK economy

Readers Question: Hello I recently saw a programme How China Fooled the World – with Robert Peston and I was wondering what threats and opportunities does the growth of economies like China and India provide to the UK economy?

According to the IMF, in 2010, the Chinese economy was $5,878 billion – second only to the US economy. If we use GDP at purchasing power parity (PPP), the size of the Chinese economy is estimated to be even larger, at around $10,119 billion.

China also has a growth rate, averaging close to 10% a year. Even if there is a slowdown in this record rate of economic growth, China is forecast to become the dominant world economy within 10 or 20 years. India is another sleeping giant. Although India’s growth rate is slower than China it is the second most populous country and is still catching up with the rest of the world.

Opportunities of Chinese / Indian growth on UK economy

Low cost of manufactured goods. One major consequence of economic growth in China is that the UK has benefited from lower prices of many manufactured goods, imported from China. If you have ever wondered how Pound shops can sell so many goods for £1 – the answer is directly importing from China. China’s success in keeping costs low has created a downward pressure on prices. This helps to keep inflation in the UK low and improve living standards for UK consumers.

Growing consumer class. So far China’s growth has mostly concentrated on export led growth, leading to a large current account surplus. However, the next stage of Chinese economic development will likely see a growing consumer class who wish to purchase more luxury goods and services. This provides a significant opportunity for UK exporters of goods and services. Because of the size of the Chinese economy, there is strong latent demand. This could benefit UK exporters of  high value added goods, such as nuclear technology, chemicals, cars (see: what UK exports). Also, there will be growing demand for UK services, such as university education / learning English. So far China’s growth has been somewhat one-sided – we have seen UK manufacturing firms squeezed out of business, but the other side of the equation is that British firms will have a strong growing market in China.

Lower costs of production. Another big advantage of the development of the Chinese and Indian economy is that it provides UK firms with potential lower costs of production. For example, many UK service centres have been shifted to English speaking centres in India. This dramatically reduces labour costs, leading to lower costs for telephones e.t.c. Also, an English firm which innovates a new product can use the low cost manufactured process of China to bring the product to the market at a competitive price. This is speeding up the globalisation of production. Increasingly we see a product produced in different sections of the world. e.g. the most famous is probably ‘Apple – designed in California, produced in China.’

Alternative to US / Europe. Traditionally, the UK economy has been reliant on exports to the EU and US. With the EU and US economy relatively stagnant, growth in exports to non-EU countries suggests the economy will become more diversified and less reliant on the EU trading block.  (see: UK exports to non-EU countries)

 

Threats of Chinese growth

Increased competition for raw materials. Chinese growth has come at a cost of seeing rising price of raw materials. For example, during the recession of 2008-13, we saw periods of rising oil prices. This is unusual – usually during a recession in the West, oil prices fall. But, due to the growing demand from China and Asia, oil prices have been rising. This has squeezed living standards in the West. We faced both recession and rising prices. As the China and India economy grows, the pressure on raw materials is likely to exacerbate. Continue Reading →

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Indian economy in 2014

I have quite a few readers in India, so I’d like to have a brief look at the Indian economy and it’s prospects for the coming year. After spending so much time looking at the (rather depressing) economics of austerity in Europe and UK, it makes a welcome change to look at a developing economy with a different set of challenges and problems.

China_india_gdpGDP per capita (in 1990 Geary-Khamis dollars) (data range 1950-2003)

Indian economy in summary

For those not familiar with the Indian economy. In the post-independence era 1947 – 91, India was a mixed economy with a high degree of state intervention – including nationalisation and price controls. The economic performance was mixed, but generally disappointing. Since 1991, the economy has pursued a general approach of free market liberalisation and greater investment in infrastructure. This helped the Indian economy to achieve a rapid rate of economic growth and economic development. The economy has become more open, with significant growth in exports and imports. The economic growth has led to a boom in investment, real estate and a growth of the financial sector. To many, India is the second China and the economy has the potential to become one of the largest in the world.

However, at the present time, the Indian economy faces several challenges.

  • In the past couple of years, there has been a fall in the rate of growth causing concern that the period of high growth is coming to an end. (growth fell to a low of 4.4% in 2013 – bear in mind, India’s rising population mean GDP per capita is less impressive than just real GDP growth)
  • India has struggled to keep inflation low. In 2013, inflation was nudging near 10%, hurting the living standards of the poor who are particularly vulnerable to the price of food. High inflation is also harming confidence for investment.
  • Current account deficit. India’s growth has been at the cost of a persistent current account deficit (which reached over 6% of GDP in 2012). India needs to import crude oil, machinery and many other raw commodities. It’s export sector has struggled to match the growth of imports.
  • Rupee devaluation. The large current account deficit has caused the Rupee to fall, despite very low interest rates in US and Europe.
  • Inequality / poverty. Parts of the Indian economy have made rapid growth, but it has proved difficult for the fruits of economic growth to filter through to all areas of the economy, especially isolated rural areas where there is poor infrastructure.
  • Government budget deficit. Despite years of economic growth, the government has found it difficult to balance the budget. The budget deficit is 4.8% of GDP in the year 2012–13. Public sector debt is 68.05% of GDP, one of highest for a developing economy. Tax collection is still limited by tax evasion and corruption (tax collection only accounts for 9% of GDP – one of lowest in the world). The government is committed to reducing the budget deficit, but this may be at cost of social welfare programmes.

More detail on the Indian economy

Economic growth

Indian economic growth is predicted to be around 5% by March 2014. From European standards, this sounds very impressive. But, is much lower than the rate of nearly 10% achieved in much of the recent decade. Growth of 5% reflects the fact there is much spare capacity and scope for improvement. Without a high rate of growth, the concern is that it will lead to unemployment and discourage future investment. Politicians have been predicting upturns in the rate of economic growth for a long time, hoping it would come in the next quarter. Unfortunately, this has raised and then broken expectations. However, growth did finally picked up to 4.8% in Q3 2013. (higher than previous quarter of 4.4%)

Inflation

Inflation is a real problem for the Indian economy. It has proved stubbornly high. Inflation reached 11.24% in November 2013 – the highest for years. Inflation did fall back to 9.92% in Dec, but there is concern about the stubbornness of high inflation, despite the relatively sluggish growth. The chief of the Reserve Bank of India, Raghuram Rajan has made control of inflation his highest priority and has increased interest rates twice since his appointment in September. Rajan argues that price stability is key to India’s long term prosperity. However, the concern is that inflationary pressures tend to be due to supply side factors (e.g. rising vegetable prices) and the use of monetary policy may be limited in solving this. For Rajan to tackle cost push inflationary pressures using interest rates may damage prospects for growth without tackling the underlying inflationary causes. To tackle supply constraints which are behind the cost-push inflation will prove much more difficult.

Continue Reading →

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Indian Economy 2012

An Overview of the Indian economy in 2012 and its prospects for the future. (Depressed by events in Europe, a look at an economy with a very different economic outlook).

Summary

In the past few years, the Indian economy has been growing rapidly – (e.g.  8.5%2010-11). However, this growth has led to an increase in inflation of 6%. In response to higher inflation, the RBI of increased interest rates and this has caused a slow down in the rate of economic growth.

Indian Rupee

Inflationary pressures and falling competitiveness have contributed to a steady decline in the value of the Rupee. This depreciation in the Rupee is cause for concern because

  • It increases the price of imported raw materials, e.g. oil (thereby contributing to imported inflation)
  • Discourages foreign investment, worried about decline in value of currency.

Fiscal Deficit

Despite high economic growth, the government’s fiscal deficit stands at 5.5% of GDP. This is very high given the state of the economic cycle. With high economic growth, this level of government borrowing has the effect of crowding out the private sector. Public sector debt is 71% of GDP (2011 est) and the credit rating is BBB. It leaves the fiscal deficit vulnerable, should there be a sharp slow down in economic growth.

The Indian Central Bank (Reserve Bank of India) RBI, make commercial banks hold 24% of their core deposits in government bonds. This is ostensibly for a safety valve and improved liquidity, others feel it is to help keep government bond yields low. But, if government bond yields are kept low, it can reduce the incentive for the government to tackle politically popular issues like spending and tax.

Now, would be a good time for India to tackle its budget deficit, but it is uncertain if the political will is there.

Monetary Policy

In response to higher inflation, the Indian Central Bank have increased interest rates in an attempt to control inflation. (The main repo rate is currently 8.5% BBC) These interest rate rises have had the impact of reducing the economic growth rate. Many now predict the growth rate to fall to 6% in 2012. However, the interest rate increases have failed to tackle inflation, partly because of rising commodity prices which put upward pressure on cost-push inflation.

Article on Reserve Bank of India at Economist

Global Trade

India is more insulated to global trade than many other countries. It has strong domestic demand and is more self-sufficient than countries in Europe. However, in an era of globalisation it is still influenced by economic prospects in the rest of the world. It’s main trading partner, such as China (12% of imports) and South East Asia are still performing well. The slowdown in the Eurozone will have some adverse effect on India, but it shouldn’t be a major factor unless there is a very serious credit crunch. India’s biggest export market is the US (12% of exports) Recovery in the US should help demand for manufactured goods.

More worrying is the persistent Indian current account deficit. Despite a falling Indian Rupee, the current account has shown little signs of improvement.

Goldman Sachs forecast the Indian Current account could widen to 4.2% of GDP in 2012 (FT)

Another worrying aspect of the Indian current account deficit is the fact it is being financed by short term capital flows rather than long term investment.

Boom and Bust Cycle

The Indian economy is characterised by strong domestic demand, growing inflation, falling value of currency and current account deficit. This is reminiscent of the Asian crisis of the late 1990s. If India experienced a sustained outflow of capital, it could cause an even quicker deterioration in the value of the Rupee, causing inflation and necessitating higher interest rates which would reduce growth.

However, if capital flows into India can be sustained, there is still much to be optimistic about. India  has great potential for growth, especially if it could:

  • Deal with corruption and encourage greater liberalisation of the economy (Indian economy BBC)
  • If the government reduced its budget deficit and enabled more private sector investment
  • If the RBI continue to keep inflationary pressures under check.

Unemployment and Poverty

Despite several years with growth averaging 7%, unemployment in India is still in double digits (11% Jan 2012). Also, the economic growth still needs to filter down to the rural and urban poor. As estimated 41% of the population live below the poverty line of $1.25

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