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In such a scenario, how could India have escaped unhurt? The global
crises saw Indian stock markets crash, but as soon as the United
States funneled in $700 billion into the American economy to revive
dying markets, India too saw some stability. However, the forex
market was a totally different ball game.
So why is the rupee falling against the dollar, when the global financial
crisis should impact the United States the most?
There are several reasons. Analysts say these are the reasons for
the fall of the rupee. . .
The Reasons For The Fall Of The Rupee
The main reasons behind the fall of the rupee are an increased
demand for dollars due to a spurt in crude oil prices and the flight of
foreign funds from the Indian market. Demand for rupees,
simultaneously, has dipped because capital inflows are down.
The American sub-prime crisis that shook the global financial
markets has seen unprecedented bailouts and infusion of dollars into
the US economy. This infusion has been at a cost of many an
emerging market, from where funds have been pulled out to plough
back into America. India has been one of the worst hit countries on
this count, as foreign funds took flight, thereby making dollars scarce.
The sudden and colossal demand for the US greenback has seen it
strengthen, while the rupee's exchange rate has depreciated
dramatically during the same period.
India's stock market regulator, the Securities and Exchange Board
of India, has said that foreign investors sold more Indian shares than
they bought.
Global funds are said to have sold Indian shares to the tune of over
$9 billion more than they have bought this year. As demand for dollars
from importers increased and the US Treasury poured in almost $700
billion into the US economy to bail out drowning financial giants, the
Indian market saw an outflow of a huge amount of dollars leading to a
spurt in the dollar price against the rupee.
The growing Indian trade deficit and the large fiscal deficit are also
contributing to the fall of the rupee.
The higher price of imported goods, especially oil that is now ruling
at over $107 per barrel, has also led to an increase in domestic
inflation and a fall in the value of the Indian currency. High inflation
and a strong growth in the Indian economy have already forced the
RBI to raise interest rates.
The demand-supply balance and the fundamentals are against the
rupee
India has seen a large amount of outflows from its financial
markets. India is a heavy importer of oil and the current spurt in crude
oil prices has impacted the rupee too.
Also, the decline in the value of the rupee has coincided with RBI
discontinuing its direct sales of dollars to oil firms in early July.
One more reason for the fall of the rupee, as propounded by some
economists, is the overseas non-deliverable forward (NDF) market that
is not sanctioned by the Reserve Bank of India.
As the rupee falls, foreign investors will want bigger returns for
their money to compensate for the higher risk. This means that the
Indian government, companies and individuals will have to pay more
for the money they borrow: in other words, higher interest rates.
A major problem with a falling rupee is that it will increase the
Indian government's burden of repaying and servicing foreign debt.
Another problem is that it might discourage foreign institutional
investment from pouring funds into the Indian markets.
Indian companies which could borrow from the overseas markets at
cheaper rates to finance their import and export needs will be badly
affected.
The Reserve Bank of India can sell dollars in the open market to bring
down the value of the US greenback, albeit slightly.
Normally, the RBI uses its Monetary Policy to defend the rupee's value.
Short-term interest rates changes do impact the value of the rupee
against other currencies. But, the RBI has mostly used the policy to
stabilise internal conditions, like steps to control rising inflation.
However, if the Indian stock markets boom -- like they did in the last
couple of years -- more and more global funds would begin to invest in
India thereby strengthening the rupee as the demand for the dollar in
the local markets drops.
What has the RBI done?
The Indian currency, however, has in the last two trading sessions
risen sharply against the dollar under the hope that foreign investors
will soon buy into the Indian stock markets.
With risk aversion among foreign investors declining, the Indian rupee
is likely to strengthen.
A temporary aberration?
Commerce Minister Kamal Nath has termed the Indian rupee's fall
against the dollar as a 'temporary aberration,' but said that the lower
value of the rupee will help boost export growth.
But even as foreign funds withdrew money from the Indian markets
and the oil prices kept going up, India's huge foreign currency
reserves -- pegged at $289 billion that is enough to cover for almost a
year's worth of imports -- have helped a lot, for even if FIIs take away
funds India will not face a solvency crisis like it did in the early 1990s.