The question being asked yesterday was “why is the rupee falling against the dollar”. The answer is very simple. The demand for American dollars was more than that of the Indian rupee leading to the rupee rapidly losing value against the dollar.
This situation is likely to continue in the days to come with the demand for dollars in India being more than their supply. And this will have a huge impact on the dollar-rupee exchange rate, which crossed 60 rupees to a dollar for the first time yesterday.
Here are a few reasons why the demand for dollars will continue to be more than their supply in the days to come.
a) The United Nations Conference on Trade and Development (UNCTAD) recently pointed out that the foreign direct investment in India fell by 29% to $26 billion in 2012. When dollars come into India through the foreign direct investment(FDI) route they need to be exchanged for rupees. Hence, dollars are sold and rupees are bought. This pushes up the demand for rupees, while increasing the supply of dollars, thus helping the rupee gain value against the dollar or at least hold stable. In 2012, the FDI coming into India fell dramatically. The situation is likely to continue in the days to come. The corruption sagas unleashed in the 2G and the coalgate scam hasn’t done India’s image abroad any good. In fact in the 2G scam telecom licenses have been cancelled and the message that was sent to the foreign investors was that India as a country can go back on policy decisions. This is something that no big investor who is willing to put a lot of money at stake, likes to hear.
Opening up multi-brand retailing was government’s other big plan for getting FDI into the country. In September 2012, the government had allowed foreign investors to invest upto 51% in multi-brand retailing. But between then and now not a single global retailing company has filed an application with the Foreign Investment Promotion Board (FIPB), which looks at FDI proposals.
This scenario doesn’t look like it is changing as likely foreign investors struggle to make sense of the regulations as they stand today. Dollars that come in through the FDI route come in for the long run as they are used to set up new industries and factories or pick up a stake in existing companies. This money cannot be withdrawn overnight like the money invested in the stock market and the bond market.
b) There has been a lot of talk about the Reserve Bank of India(RBI) selling bonds to Non Resident Indians (NRIs) and thus getting precious dollars into the country. The trouble here is that any NRI who invests in these bonds will carry a huge amount of currency risk, given the rapid rate at which the rupee has lost value against the dollar. Lets understand this through a simple example. An NRI invests $100,000 in India. At the point he gets money into India $1 is worth Rs 55. So $100,000 when converted into rupees, amounts to Rs 55 lakh. This money lets assume is invested at an interest rate of 10%. A year later Rs 55 lakh has grown to Rs 60.5 lakh (Rs 55 lakh + 10% interest on Rs 55 lakh). The NRI now has to repatriate this money back. At this point of time lets say $1 is worth Rs 60. So when the NRI converts rupees into dollars he gets $100,800 or more or less the same amount of money that he had invested. His return in dollar terms is 0.8%. The real return would be much lower given that this calculation doesn’t take the cost of conversion into account. Hence, the NRI would have been simply better off by letting his money stay invested in dollars. This is the currency risk. To make it attractive for NRI investors to invest money in any such RBI bond, the interest on offer will have to be very high.
c) While the supply of dollars will continue to be a problem, the demand for them will continue to remain high. A major demand for dollars will come from companies which have raised loans in dollars over the last few years and now need to repay them. As the Business Standard reports “Beginning 2004, the central bank(i.e. RBI) has approved nearly $220 billion worth of external commercial borrowings and foreign currency convertible bonds (FCCB), at the rate of a little over $2 billion a month. Nearly two-thirds of this amount was approved in the past five years. Much of this ECB will come up for repayment this financial year, putting further pressure on the rupee.”
A lot of companies have raised foreign loans over the last few years simply because the interest rates have been lower outside India than in India. These companies will need dollars to repay their foreign loans as they mature. The other thing that might happen is that companies which have cash, might look to repay their foreign loans sooner rather than later. This is simply because as the rupee depreciates against the dollar, it takes a greater amount of rupees to buy dollars. So if companies have idle cash lying around, it makes tremendous sense for them to prepay dollar loans. The trouble is that if a lot of companies decide to prepay loans then it will add to the demand for the dollar and thus put further pressure on the rupee.
d) India’s love for gold has been one reason behind significant demand for the dollar. Gold is bought and sold internationally in dollars. India produces very little gold of its own and hence has to import almost all the gold that is consumed in the country. When gold is imported into the country, it needs to be paid for in dollars, thus pushing up the demand for dollars. As this writer has argued in the past there is some logic for the fascination that Indians have had for gold. A major reason behind Indians hoarding to gold is high inflation. Consumer price inflation continues to remain high. Also, with the marriage season set to start over the next few months, the demand for gold is likely to go up. What can also add to the demand is the fall in price of gold, which will get those buyers who have not been buying gold because of the high price, back into the market. All this means a greater demand for dollars.
e) India has been importing a huge amount of coal lately to run its power plants. Indian coal imports shot up by 43% to 16.77 million tonnes in May 2013, in comparison to the same period last year. Importing coal again means a greater demand for dollars. The irony is that India has huge coal reserves which are not being mined. The common logic here is to blame Coal India Ltd, which more or less has had a monopoly to produce coal in India. The government has tried to encourage private sector investment in the sector but that has been done in a haphazard manner leading to the coalgate scam. This has delayed the bigger role that the private sector could have played in the mining of coal and thus led to lower coal imports. The situation cannot be set right overnight. The major reason for this is that the expertise to get a coal mine up and running in India has been limited to Coal India till now. To develop the same expertise in the private sector will take time and till then India will have to import coal, which will need dollars.
f) The government’s social sector policies may also add to a huge demand for dollars in the time to come. The procurement of wheat by the government this year has fallen by 33% to 25.08 million tonnes. This will not have any immediate impact given the huge amount of grain reserves that India currently has. But as and when right to food security becomes a legal right any fall in procurement will mean that the government will have to import food grains like wheat and rice, and this will again mean a demand for dollars. This is a little far fetched as of now, but is a likely possibility and hence cannot be ignored. These are fundamental issues which will continue to influence the dollar-rupee exchange rate in the days to come and do not have easy overnight kind of solutions. Of course, if the Ben Bernanke led Federal Reserve of United States, decides to go back to printing as many dollars as it is right now, then a lot of dollars could flow into India, looking for a higher return. But then, that is something not under the control of Indian government or its policy makers.
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