indian rupee essay

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Internationalisation of rupee: Why and what are the benefits?

Currently, the us dollar, the euro, the japanese yen and the pound sterling are the leading reserve currencies in the world. china's efforts to make its currency renminbi has met with only limited success so far..

India is aiming to make the rupee a global currency. Pushing for a roadmap towards the internationalisation of the rupee, the Reserve Bank of India’s (RBI) inter-departmental group (IDG) on Wednesday said with India remaining one of the fastest-growing countries and showing remarkable resilience in the face of major headwinds, the rupee has the potential to become an internationalised currency.

These recommendations are significant, in light of the economic sanctions imposed by the US on Russia for invading Ukraine and the growing clamour for finding an alternative to the US dollar for international transactions.

What does internationalisation of the rupee mean?

Internationalisation is a process that involves increasing the use of the rupee in cross-border transactions.

It involves promoting the rupee for import and export trade and then other current account transactions, followed by its use in capital account transactions. These are all transactions between residents in India and non-residents. The internationalisation of the currency, which is closely interlinked with the nation’s economic progress, requires further opening up of the currency settlement and a strong swap and forex market.

More importantly, it will require full convertibility of the currency on the capital account and cross-border transfer of funds without any restrictions. India has allowed only full convertibility on the current account as of now.

Currently, the US dollar, the Euro, the Japanese yen and the pound sterling are the leading reserve currencies in the world. China’s efforts to make its currency renminbi has met with only limited success so far.

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The relevance

Currently, the US dollar is said to enjoy an ‘Exorbitant Privilege’, which refers to the innumerable benefits that accrue to the US on account of all other countries of the world using the US dollar as their currency in most of their international transactions, among global currencies.

The dollar’s position is supported by a range of factors, including the size of the US economy, the reach of its trade and financial networks, the depth and liquidity of US financial markets, and a history of macroeconomic stability and currency convertibility. Dollar dominance has also benefited from the lack of viable alternatives.

According to the RBI’s working group, the obvious challenger to the US dollar dominance is the Chinese Renminbi. However, its ability to rival the US dollar will depend on future policies in both the US and China and the ability of the Chinese economy and its financial system to demonstrate the same long-term resilience, integrity, transparency, openness and stability, which are characteristics of the US economy.

In the wake of the sanctions imposed on the Russian government, its public sector and even individuals linked to the government, many countries have become cautious of the price they may have to pay if they are subjected to similar sanctions by the Western governments. China, Russia and a few other countries have become more vocal in questioning the US dollar-dominated global currency system.

They would like to reduce their reliance on the US dollar and its financial markets as well as their dependence on dominant international payment mechanisms based on the Society for Worldwide Interbank Financial Telecommunications (SWIFT) messaging system.

While the Asian crisis of 1997-1998 underscored the necessity of emerging market economies having strong foreign exchange reserves to manage external shocks, in an increasingly polarised world, it no longer seems a sufficient defence against the threat of economic sanctions.

The RBI-appointed group feels that it is imperative for India to continue exploring alternatives to both the USD and the Euro.

Advantages of internationalisation of the rupee

The use of the rupee in cross-border transactions mitigates currency risk for Indian businesses. Protection from currency volatility not only reduces the cost of doing business, it also enables better growth of business, improving the chances for Indian businesses to grow globally.

While reserves help manage exchange rate volatility and project external stability, they impose a cost on the economy. Internationalisation of the rupee reduces the need for holding foreign exchange reserves. Reducing dependence on foreign currency will make India less vulnerable to external shocks.

As the use of the rupee becomes significant, the bargaining power of Indian businesses would improve, adding weight to the Indian economy and enhancing India’s global stature and respect.

The recommendations

The working group, headed by RBI Executive Director Radha Shyam Ratho, has recommended a slew of short to long term measures to accelerate the pace of internationalisation of the rupee.

For the short term, the group has suggested adoption of a standardised approach for examining the proposals on bilateral and multilateral trade arrangements for invoicing, settlement and payment in the rupee and local currencies, encouraging the opening of the rupee accounts for non-residents both in India and outside India and integrating Indian payment systems with other countries for cross-border transactions.

It suggested strengthening the financial market by fostering a global 24×5 rupee market and recalibration of the FPI (foreign portfolio investor) regime.

Over the next two to five years, the group has recommended a review of taxes on masala (rupee-denominated bonds issued outside India by Indian entities) bonds, international use of Real Time Gross Settlement (RTGS) for cross-border trade transactions and inclusion of Indian Government Bonds in global bond indices.

For the long term, the group has recommended that efforts should be made for the inclusion of the rupee in IMF’s (International Monetary Fund) SDR (special drawing rights). The SDR is an international reserve asset created by the IMF to supplement the official reserves of its member countries. The value of the SDR is based on a basket of five currencies — the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.

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Internationalisation of the rupee: Explained, pointwise

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• 1 Introduction
• 2 What is currency internationalisation?  
• 3 What is the rationale for internationalisation of the rupee? 
• 4 What are the recommendations of RBI panel? 
• 5 What are the benefits? 
• 6 What are the macroeconomic risks? 
• 7 What are the challenges? 
• 8 What are the initiatives taken? 
• 9 What should be the future course of action? 

Introduction

  India is aiming to make the rupee a global currency. Recently, the Reserve Bank of India (RBI) released the report of Inter-Departmental Group (IDG) on Internationalisation of Indian Rupee, which has made several recommendations for internationalizing the rupee. The group was constituted by the RBI to review the current position of the rupee as an international currency and to frame a roadmap for internationalisation of the rupee. The recommendations are significant, considering the economic sanctions imposed by the US on Russia for invading Ukraine and the growing demand for dedollarization. Given Indian economy’s status as one of the fastest-growing large economies and its ability to withstand challenges, the rupee has the potential to become an internationalized currency.  

What is currency internationalisation?  

Currency internationalization refers to the use of a country’s currency outside its borders for transactions involving residents and non-residents.  

An international currency performs all three functions of money. As a unit of account, it is used to invoice foreign trade and denominate international financial instruments by private actors and to express exchange rate relationships by government.  

As a medium of exchange, it is used by private actors to settle international economic transactions or by governments for exchange market intervention and balance of payments (BoP) financing .  

As a store of value, it acts as a reserve currency and at a private level, it is held as capital assets .  

Internationalisation of the rupee involves promoting the rupee for import and export trade and then other current account transactions followed by its use in capital account transactions.  

Currently, the US dollar, the Euro, the Japanese yen and the British pound are the leading reserve currencies in the world.  

China’s efforts to make its currency renminbi has met with only limited success so far.  

What is the rationale for internationalisation of the rupee?  

Increased linkages: Internationalisation of the currency is closely interlinked with the nation’s economic progress . Economic growth and development over the past few decades have led to a g reater integration of the Indian economy with the global economy in terms of trade and capital flows . India’s foreign exchange reserves have grown from USD 290.5 billion in August 2012 to USD 560.4 billion in August 2022. During this period, India’s Foreign Direct Investment (FDI) has increased from 46.6 billion dollars to 84.8 billion dollars; imports have increased from 489.3 billion dollars to 612.6 billion dollars, and exports have grown from 306.0 billion dollars to 421.9 billion dollars. Therefore, the rupee has the potential to become an internationalized currency.  

Declining share of the dollar: The international monetary and financial system has moved towards being multipolar . Various bilateral and regional economic cooperation agreements have emerged. The  share of the dollar in foreign exchange reserves of countries is steadily declining. Other currencies are increasingly used in trade invoicing and settlement.  

Geopolitical: In the wake of the sanctions imposed on Russia , many countries have become cautious of the potential costs if they are subjected to similar sanctions by the Western governments. China, Russia and a few other countries have become more vocal in questioning the US dollar-dominated global currency system.  

What are the recommendations of RBI panel?  

Short term recommendations  

• Designing a template and adopting a standardised approach for examining the proposals on bilateral and multilateral trade arrangements for invoicing, settlement and payment in the rupee and local currencies.  
• Making efforts to enable rupee as an additional settlement currency in existing multilateral mechanisms such as ACU.  
• Encouraging opening of rupee accounts for non-residents both in India and outside India.  
• Integrating Indian payment systems with other countries for cross-border transactions.  
• Recalibrating the foreign portfolio investor (FPI) regime and rationalizing/harmonizing the extant Know Your Customer (KYC) guidelines.  

Medium term   recommendations  

• A review of taxes on Masala bonds .  
• International use of Real Time Gross Settlement (RTGS) for cross border trade transactions and inclusion of rupee as a direct settlement currency in the Continuous Linked Settlement (CLS) system.  
• Examination of taxation issues in financial markets to harmonise tax regimes of India and other financial centres.  

Long term recommendation  

• Efforts should be made for inclusion of the rupee in IMF’s (International Monetary Fund) SDR (special drawing rights) basket.    

What are the benefits?  

For private sector  

The benefits of currency internationalisation accrue largely to a country’s private sector.  

Firstly , the internationalisation of currency limits the exchange rate risks for local exporters and importers. It is because domestic firms may be able to raise invoices and settle their exports/imports in their local currency. It shifts exchange rate risk to their foreign counterparts or customers.  

Secondly , it permits domestic firms and financial institutions to access international financial markets without assuming exchange rate risk.  

Thirdly , the internationalisation of domestic currency will offer new profit opportunities for domestic financial institutions to grow in the global financial market.  

Lastly , it will reduce the cost of doing business . It will motivate the existing exporters to increase their exports and investors to invest more in the exporting businesses. New players will find it attractive to enter the exports market. Overall, it will have a positive impact on economic growth and atmanirbhar Bharat program of India.  

For government  

First, c urrency internationalization allows a country’s government to finance its budget deficit by issuing domestic currency debt in international markets rather than issuing foreign currency instruments.  

Second, i t also allows a government to finance part of its Current Account Deficit (CAD) without using its official reserves. The current account deficit may also be financed by private capital flows from abroad, especially from the banking system, as financing in domestic currency becomes integrated globally.  

Third , the internationalisation of a currency reduces the requirement for the authorities to maintain large foreign exchange reserves in foreign currencies to manage external vulnerabilities.  

Fourth , it leads in lowering the impact of sudden stops and reversals of capital flows and enhances the ability to repay external sovereign debt .  

As the international use of the rupee becomes significant, the bargaining power of Indian businesses would improve, adding weight to the Indian economy and enhancing India’s global stature and respect.  

What are the macroeconomic risks?  

Internationalisation of a currency may result in a potential increase in volatility of its exchange rate in the initial stages. This would have monetary policy implications as the obligation of a country to supply its currency to meet the global demand may come in conflict with its domestic monetary policies, popularly known as the Triffin dilemma .  

Also, it may increase the impact of an external shock due to the free flow of funds into and out of the country and from one currency to another.  

Thus, it would make the conduct of monetary policy more complex.  

What are the challenges?  

International demand for the rupee is very low. The daily average share for the rupee in the global foreign exchange market is about 1.6%,  

The rupee is not fully convertible in the capital account and India’s share of global exports of goods is just about 2%. This reduces the necessity for other countries to hold rupees.  

What are the initiatives taken?  

Indo-Nepal Remittance Facility Scheme : This Scheme was launched by the RBI in May 2008 as an option for cross-border remittances from India to Nepal. The Scheme leverages the NEFT ecosystem.  

Bilateral Swap Arrangements (BSA): India currently has a BSA with Japan as a line of support in case of any balance of payments issue. Under the South Asian Association for Regional Cooperation (SAARC) swap agreement, the requesting central bank can make withdrawals in dollar, Euro and also in rupee.  

Developments in the GIFT City: Gujarat International Finance Tec-City (GIFT City) was set up as India’s first International Financial Service Centre (IFSC). It has the potential to develop as a international financial centre for Rupee products and more specifically Rupee derivatives, given the fact that the Rupee derivatives are among the most traded contracts globally.  

Indo-Iran Agreement: An agreement was signed between India and Iran for undertaking eligible trade transactions using rupee.  

Asian Clearing Union (ACU): RBI had proposed the use of local currencies of members for settlement of ACU transactions and inclusion of rupee as one of the settlement currencies under the ACU.  

Rupee as a Designated Foreign Currency in Sri Lanka: This have paved the way for rupee-based bilateral trade between Sri Lanka and India.  

Use of Indian Payment Infrastructure: RBI making efforts to increase the global outreach of the UPI system to facilitate cross-border transactions. Various other initiatives have also been undertaken to facilitate cross-border payments, especially personal remittances like the Money Transfer Service Scheme (MTSS).  

Other initiatives: RBI has enabled external commercial borrowings in rupees. The recent Foreign Trade Policy (FTP) 2023, proposes invoicing, payment, and settlement of trade in Indian rupees. RBI has permitted rupee settlement of external trade through Special Rupee Vostro Accounts (SRVAs). A total of 18 countries have been allowed to open SRVAs. (A vostro account is held by a bank on behalf of a bank in another country).  

What should be the future course of action?  

The RBI should pursue a deeper and more liquid rupee bond market to enable foreign investors and Indian trade partners to have more investment options in rupees.  

Indian exporters and importers should be encouraged to invoice their transactions in rupee . For this, the trade settlement formalities for rupee import/export transactions should be optimised.  

Additional currency swap agreements (as with Sri Lanka) would further allow India to settle trade and investment transactions in rupees.  

Tax incentives must be given to foreign businesses to utilise the rupee in operations in India.  

Efforts must be made to make the rupee an official currency in international organisations , thereby giving it a higher profile and acceptability.  

The Tarapore Committees ’ (in 1997 and 2006) recommendations must be pursued including a push to reduce fiscal deficits lower than 3.5%, a reduction in gross inflation rate to 3%-5%, and a reduction in gross banking non-performing assets to less than 5%.  

Gradually, the rupee must be made more freely convertible. This would allow foreign investors to easily buy and sell the rupee, enhancing its liquidity and making it more attractive.  

Sources: Indian Express , The Hindu , Livemint , Business Standard, RBI report.  

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Depreciation of Indian Rupee

Last updated on January 17, 2023 by ClearIAS Team

The country’s stock market has seen $4 billion in foreign funds withdrawn, which has caused the currency to weaken. Due to this decline in the currency, the Indian rupee has had Asia’s worst performance. First, let us try to understand what  Depreciation of Currency is.

Table of Contents

Depreciation of Currency

Depreciation of currency refers to the decline in the value of a nation’s money in relation to one or more foreign reference currencies, most frequently occurring through an unofficial, floating exchange rate regime.

By making its goods and services more accessible to consumers, a country’s export activity may be boosted by a controlled currency devaluation. However, a country’s currency depreciation could spread to its neighbours.

Rupee depreciation in India means that the value of the rupee relative to the US dollar has decreased. It means that the rupee is today less strong than it was.

A dollar, for instance, used to be equal to 70 rupees; today, it is equal to 77, indicating that the rupee has declined in value relative to the currency and that it now costs more rupees to buy a dollar.

Numerous variables, such as lax monetary policy and excessive inflation, contribute to currency depreciation. Sudden currency devaluation, particularly in developing countries, frequently raises investor fears, and the majority of these currencies suffer similarly.

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Let us move on to the various reasons for the Indian Rupee’s present depreciation.

Reasons for the Indian Rupee’s present depreciation

• Due to greater imports, India’s trade deficit grew to an all-time high of over $23 billion in November.
• This expanding trade gap is caused by the increase in oil costs.
• Policy differences between the Federal Reserve and the RBI: the strengthening of the US currency in reaction to the Federal Reserve’s low-interest rates and predictions of improved US economic development (the US central bank).
• In order to increase its reserves and be ready for any future turbulence, the Reserve Bank of India has been continuously purchasing US dollars.
• Due to a capital exodus from stocks, the benchmark S&P BSE Sensex Index has decreased by almost 10% from its all-time high set in October 2021.
• Currently, worries about the omicron virus type are unsettling the world markets.
• The conflict between Russia and Ukraine, rising crude oil prices, and tightening global financial conditions are some of the primary worldwide causes that have caused the Indian rupee to decline versus the US dollar.
• Significant demand for dollars from oil importers due to the high price of crude oil and worries about the widening trade deficit has also been major drivers of the sharp decline in the value of the Indian rupee.
• The increase in interest rates by the U.S. Federal Reserve (central bank), the European conflict, and worries about China’s economic development as a result of the Covid-19 rise all contributed to a sell-off in the global equity markets, which in turn caused the rupee to weaken.
• High crude prices and the slump in equities markets are both contributing to the dollar’s negative outflow.
•  The RBI’s efforts to tighten the monetary policy in response to growing inflation have also resulted in devaluation.

Impact of the Depreciation of the Indian Rupee

The rupee’s depreciation is a double-edged sword for the Reserve Bank of India.

• Theoretically, a weaker currency should increase India’s exports, but given the current state of global uncertainty and the country’s weak demand, this may not be the case.
• It raises the possibility of imported inflation and may make it challenging for the central bank to sustain historically low-interest rates for a more extended period of time.
• Over two-thirds of India’s domestic oil needs are satisfied by imports. Among the major importers of edible oils in India. A weaker currency will drive up the cost of imported edible oil and increase food inflation.
• Imports will cost more because importers will have to pay more for the same amount of dollars when the dollar appreciates versus the rupee. Additionally, importers must pay more because most foreign trade is conducted in US dollars.
• Therefore, a falling rupee will make imports more expensive, putting further strain on household budgets in a nation where the economy is dependent on imports.
• Since India imports, more than 85% of the oil and 50% of the gas it uses, the oil and gas industry will be the one that suffers the most.
• Imported solar cells and modules are significantly reliant on Indian solar installations. Future bids would have higher tariffs and project expenses.
• Through rising import costs, a falling rupee immediately affects India’s trade balance and inflation.
• Costlier imports will increase both the trade and current account deficits, putting pressure on the currency rate. The nation’s current account deficit will increase.
• Increased import costs are also contributing to domestic inflation.
•  Depreciation benefits export-related companies like pharma and IT.
• The rupee will lose value and foreign exchange reserves as the current account deficit inevitably grows.
• When overall prices rise (inflation) as a result of rising costs for wages and raw materials, this phenomenon is referred to as cost-push inflation, also referred to as wage-push inflation.
• It’s possible that businesses won’t be able to fully pass on increased prices to consumers, which would have an impact on government dividend payments and raise concerns about planned fiscal deficits.
• As India imports a lot of raw materials, this could affect consumers by raising the cost of completed items.
• It will cost more rupees for travellers and students studying abroad to purchase dollars from banks.
• A weaker rupee could cause foreign investors to stop investing in Indian markets, which would lead to a drop in stock and equity mutual fund investments.

Role of the Reserve Bank of India

• The RBI keeps a close eye on the foreign currency market and steps in when there is too much volatility.
• Recent actions by the RBI to ensure foreign currency inflow and support the rupee include lowering restrictions on foreign ownership of government bonds and raising the borrowing limits for businesses. However, bond yields in the USA have yielded higher rates of return than any Indian investment.
• Additionally, the RBI has suggested the rupee settlement method, which would allow overseas businesses to make payments in rupees rather than US dollars.
• This should lower the demand for US dollars in international trade and stabilise their value.

Also read: Rupee Devaluation or Depreciation: How does it affect Export and Import? – Clear IAS

What are the measures to prevent Rupee Depreciation? They are discussed below.

Steps to Prevent Rupee Depreciation

The following steps can be taken to reduce rupee depreciation.

• Allowing foreign central banks, sovereign wealth funds, and endowment funds to invest in government bonds.
• Increasing the cap on foreign investment.
• The RBI has the option to sell some of its foreign currency reserves in order to manage the weakening rupee, and it is already doing so.
• Boost the weak industrial growth.
• Increased export incentives and decreased imports
• Keep your foreign currency spending to a minimum.
• The RBI may take action to encourage capital inflows into NRI accounts in order to increase the amount of money going into those accounts.
• When NRIs start making deposits in India, they’ll be selling their dollars and exchanging them for rupees, which will help the cause.
• The RBI can speak with banks to persuade them to give non-residents greater interest rates on deposits and short-term bonds.
• In a buy/sell exchange, dollars are withdrawn while Indian rupees are injected into the banking system.The swap will help the RBI, however in a limited way, control currency rates.

Options open to policymakers and the RBI

• The RBI cannot and should not attempt to stop the rupee from sinking indefinitely.
• India’s foreign exchange reserves will eventually run out if it defends the rupee because international investors have considerably more sway in the financial world.
• The majority of analysts think that allowing the rupee to weaken and serve as a natural shock absorber to the unfavourable terms of trade is the wiser course of action.
• The government should limit its borrowing, and the RBI should concentrate on reducing inflation as required by law.
• Corporations’ inclusion in important global indices like MSCI and FTSE: The government should promote the inclusion of some of the large market cap companies (both in the public and private sectors).
• As investors are unlikely to be underweight on India, this will assist raise the weight of Indian equities in these indices, partially offsetting foreign portfolio outflows.
• Inclusion of India into bond indices. The government might potentially hasten India’s entry into bond indices like the Barclays Global Bond Index and the J.P. Morgan Emerging-Market Bond Index.
• Additionally, causing foreign inflows will have a favourable effect on interest rates.
• By taking these steps, the RBI will be able to maintain its FX war chest at a comfortable level and have the necessary tools at its disposal should there be a further weakness.
• The maintenance of the interest rate differential between the United States and India, together with timely interventions on the foreign exchange market by the central bank to control volatility, will prove beneficial in protecting the rupee’s value versus the dollar.

The currency’s decline is probably going to make exports more competitive, which benefits the economy. The rupee has remained more resilient than in other earlier crises, such as the Global Financial Crisis of 2008 and the Taper Tantrum of 2013.

The rupee has lost value when compared to the US dollar, but it has gained value when compared to other major currencies like the euro and the Japanese yen. However, India is now dealing with high inflation, and more depreciation could make problems worse. As the value of the rupee continues to fall, there is a potential that the central bank would interfere once more.

Article Written By: Atheena Fathima Riyas

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The Problem Of The Rupee Its Origin And Its Solution

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Book Source: Digital Library of India Item 2015.84521

dc.contributor.author: Dr. Ambedkar. B. R dc.date.accessioned: 2015-06-30T18:53:40Z dc.date.available: 2015-06-30T18:53:40Z dc.date.digitalpublicationdate: 2005-03-30 dc.date.citation: 1923 dc.identifier.barcode: 2030020001032 dc.identifier.origpath: /data7/upload/0169/009 dc.identifier.copyno: 1 dc.identifier.uri: http://www.new.dli.ernet.in/handle/2015/84521 dc.description.scannerno: 1 dc.description.scanningcentre: RMSC, IIIT-H dc.description.main: 1 dc.description.tagged: 0 dc.description.totalpages: 348 dc.format.mimetype: application/pdf dc.language.iso: English dc.publisher.digitalrepublisher: Digital Library Of India dc.publisher: P.s. King And Son, Limited dc.rights: Not Available dc.source.library: Osmania University dc.subject.classification: Social Sciences dc.subject.classification: Economics dc.subject.classification: Finance dc.title: The Problem Of The Rupee Its Origin And Its Solution

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Indian Rupee Essay

The Indian exchange rate strategy has systematically developed over the years with its advancement reflecting the advance in the Indian economy and presentation of changes in the monetary framework. India's par value of the Rupee since independence in 1947 till around 1971 was viewed as fixed and was indexed to the U$ or gold with Pound Sterling acting as the intervention currency. The indexation of the Rupee and Pound Sterling was made significantly stronger with the Rupee being straightforwardly connected to the Sterling after the collapse of the Bretton Woods System in 1971. Besides, India's central bank, the Reserve Bank of India (RBI), wanted to guarantee the safety of the Indian Rupee and felt that pegging the cash to single foreign currency is unsafe and can prompt unpredictability. Consequently, the RBI in 1975 agreed that the Rupee ought to be pegged to a basket of currencies. However, the determination of currencies which pegged the basket was RBI's right. This was somewhat a managed money framework wherein RBI would mediate to keep the estimation of Rupee pegged at a specific level.

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From 1975 to 1991, this framework proceeded, and RBI dealt with the different incentive with lots of limitations and imperatives on embraced foreign trade dealings.

India confronted what is known as the Balance of Payments emergency in 1991, where India struggled to pay for its imports due to inadequate forex reserves. This forced the Indian government to devalue the currency to save the economy. Numerous entry barriers were discarded, and the currency was devalued in 2 stages first by 9% and then by 11%.

Afterward, continuous change to a market-linked exchange rate was embraced and right now, the market powers dictate the estimation of Indian Rupee.

Nonetheless, the RBI still embraces open market tasks and intercedes in the market to keep a precarious ascent or fall in the estimation of Rupee and to diminish instability every once in a while. Hence the Indian Rupee administration framework by RBI is a case of a managed drift wherein the esteem is dictated by market powers; however, government mediation is there to diminish great instability.

a) 1 GBP = 1.416 USD according to the data in the excel sheet.

b) According to data from the excel sheet, the three-month interest rate on GBP IS 0.14703 and 0.15765 on USD.

CIP = (1 + ixdx) = sf1+ixfx where, ixdx = interest rate in domestic currency, ixfx = interest rate on foreign currency, s = current spot foreign exchange rate and f = forward foreign exchange rate. Rearranging the formula we have;

F = s 1 + ixdx1+ixfx=1.41621 + 0.157651+0.14703=1.4293 as the forward rate.

c) With the Brexit, it is expected that the Sterling Pound will depreciate against the USD and hence it will be wise for the investor to buy the Sterling pound currencies and later convert the money into USD to earn more.

d) According to data from the excel sheet, the highest and lowest GBP rates against the USD are 1.3193 USD and 1.3087 USD respectively. Therefore, profit = (1.3193 - 1.3087) = 0.01 USD rounded off to 2 dp.

e) According to data from the excel sheet 1 GBP = 8.9176 CNY

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EDITORIAL ANALYSIS: The Free Fall of the Rupee

Source: The Hindu

• Prelims: Indian Economy, Interest rate, IMF etc
• Mains GS Paper III: Fiscal policy, Monetary policy, Impact of free fall of the rupee.

ARTICLE HIGHLIGHTS

• The Indian rupee hit an all time low against the S. dollar this week weakening past the 79 rupees to a dollar mark and selling as low as 79.05 against the dollar on Wednesday.
• Many analysts expect the rupee to weaken further in the coming months and move past the 80 rupees to dollar mark.
• In fact, the International Monetary Fund (IMF) expects the rupee to weaken past the 94 rupees to a dollar markby FY29.

INSIGHTS ON THE ISSUE

Depreciation :

• Currency depreciation is a fall in the value of a currency in a floating exchange rate system.
• Rupee depreciation means that the rupee has become less valuable with respect to the dollar.
• It means that the rupee is now weaker than what it used to be earlier.
• For example: USD 1 used to equal to Rs. 70, now USD 1 is equal to Rs. 77, implying that the rupee has depreciated relative to the dollar i.e. it takes more rupees to purchase a dollar.

Impact of Depreciation of Indian Rupee:

• Depreciation in rupee is a double-edged sword for the Reserve Bank of India.
• Weaker rupee should theoretically give a boost to India’s exports, but in an environment of uncertainty and weak global demand, a fall in the external value of rupee may not translate into higher exports.
• It poses risk of imported inflation, and may make it difficult for the central bank to maintain interest rates at a record low for longer.
• India meets more than two-thirds of its domestic oil requirements through imports.
• India is also one of the top importers of edible oils. A weaker currency will further escalate imported edible oil prices and lead to a higher food inflation.

What is happening with the rupee?

• The Indian rupee has been witnessing a steady decline this year, losing more than 6% against the U.S. dollar since the beginning of 2022.
• India’s forex reserves have also dropped below $600 billion, plunging by more than $50 billion since September 3,2021, when forex reserves stood at an all time high of $642 billion.
• The drop in India’s forex reserves is believed to be largely due to steps taken by the Reserve Bank of India to support the rupee.
• RBI officials, however, have noted that the drop in forex reserves is due to a fall in the dollar value of assets held as reserves by the RBI.
• The aim of the RBI’s policy is to allow the rupee to find its natural value in the market but without undue volatility or causing unnecessary panic among investors.
• State run banks are usually instructed by the RBI to sell dollars in order to offer some support to the rupee.

What determines the rupee’s value?

• The value of any currency is determined by demand for the currency as well as its supply.
• When the supply of a currency increases, its value drops.
• In the wider economy, central banks determine the supply of currencies, while the demand for currencies depends on the amount of goods and services produced in the economy.
• In the forex market, the supply of rupee is determined by the demand for imports and various foreign assets. So, if there is high demand to import oil, it can lead to an increase in the supply of rupees in the forex market and cause the rupee’s value to drop.
• The demand for rupees in the forex market, on the other hand, depends on foreign demand for Indian exports and other domestic assets.
• When there is great enthusiasm among foreign investors to invest in India, it can lead to an increase in the supply of dollars in the forex market which in turn causes the rupee’s value to rise against the dollar.

What is causing the rupee to lose value against the dollar?

• Since March this year, the U.S. Federal Reserve has been raising its benchmark interest rate causing investors seeking higher returns to pull capital away from emerging markets such as India and back into the U.S.
• This, in turn, has put pressure on emerging market currencies which have depreciated significantly against the U.S. dollar so far this year.
• Even developed market currencies such as the euro and the yen have depreciated against the dollar and the dollar index is up more than 9% so far this year.
• Some analysts believe that the RBI’s surprise decision to raise rates in May could have simply been to defend the rupee by preventing any rapid outflow of capital from India.
• India’s current account deficit,which measures the gap between the value of imports and exports of goods and services, is expected to hit a 10 year high of 3.3% of gross domestic product in the current financial year.
• Foreign investors are unlikely to plough capital into India when investment yields are rising in the U.S.
• Yields on U.S. 10 year Treasuries, for instance, have risen from around 5% in mid 2020 to over 3% now.
• Consistently higher domestic price inflation in India. Higher inflation in India suggests that the RBI has been creating rupees at a faster rate than the U.S. Federal Reserve has been creating dollars.

Way Forward

• Analysts believe that, over the long run, the rupee is likely to continue to depreciate against the dollar given the significant differences in long run inflation between India and the U.S.
• At the moment, as the U.S. Federal Reserve raises rates to tackle historically high inflation in the country, other countries and emerging markets in particular will be forced to raise their own interest rates to avoid disruptive capital outflows and to protect their currencies.
• The RBI too has been trying to rein in domestic consumer price inflation, which hit a 95 month high of 7.8% in April, by raising rates and tightening liquidity.
• As interest rates rise across the globe, the threat of global recession also rises as economies readjust to tighter monetary conditions.

  QUESTION FOR PRACTICE

Why are countries increasing their interest rates? What are the ways in which the RBI has tried to cushion the fall of the rupee?

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Explained: Why Indian Rupee Falling, What Does It Mean For The Economy And Market

The Indian Rupee hits a record low with the currency valued at 78.2825 against the US Dollar as it slips another 0.6% after a trail of falls over the last few months. This is the first time the rupee has crossed the 78-mark valuation as compared to the American bill, falling by 5% since the start of the year. Beginning at a 78.14 today after it closed at a 77.84 on Friday, the rupee is burdened with multiple external factors and a lack of suitable domestic effort to control the same.

The situation has tremendously affected the overall economy and stock and bond market, leading to higher and costlier imports and a lower investment.

Why the fall in rupee?

The global geopolitical crisis at the peak of the Russian invasion of Ukraine has affected emerging markets globally with a 4-7% downfall in currencies. Indian currency has similarly faced a 4% depreciation ever since the Ukrainian crisis began in February 2022. 

The unending crisis and supply disruptions together with a stronger dollar index, surge in oil prices and dollar efflux from equity and bond markets have increased the cost of the capital, leading FIIs to pull out their investments and weakening the rupee.

American monetary policies offering better interests widens the gap between foreign funds and affects the oil prices as well. The rising dollar index reflects that the USD is outperforming other currencies like Pound, Franc, Euro, Yen and Rupee. When the dollar rises it affects the pricing of all related commodities like the American shares and oil barrels and depreciates the value of currencies like the Indian rupee .

How the fall affects Foreign Investment?

Foreign investment in the Indian equity market is an important determinant of the strength of the rupee. Whenever these investors become net sellers, Indian currency depreciates.

The Foreign Institutional Investors (FII) have shelled shares worth 3,793 crores this Friday pulling out 2,15,000 crores out of the Indian market this year, which is equivalent to their total investment over the last twelve years. This is caused due to the rising interest rates around the world which instigates the FII to pull out money from risky markets like India where the rupee is depreciating continually. The stronger Dollar index also discourages these investors from investing in emerging markets as the US is considered a safe haven for such investors compared to markets like India.

How will this affect the economy?

A weakened rupee makes imports costlier and affects the production costs, leading to rise in prices of goods and services and inflation in the market. The fall in foreign investment adds to inflation leading to higher and costlier imports against the exports, which is reaching out of the RBI’s comfort zone of 2-6 per cent.

India is dependent on oil imports to meet its energy requirements as oil prices increase it adds to the import costs for India. The stronger dollar against rupee makes oil imports costlier and the higher oil prices also affect the prices of all commodities. Globally brent crude oil prices went up by $12 over the last one month, leading to a 10-year high in the crude basket price. 

How does this affect the stocks and bond markets?

The effect of decline in Indian rupee has resonated at both the domestic equity markets where the top 30-stock Sensex was trading at 1,461.54 points or 2.69 per cent lower at 52,841.90, while the National Stock Exchange operated Nifty dropped 418.95 points or 2.59 per cent to 15,782.85.

The benchmark S&P BSE Sensex Index slipped about 2.8% as FII withdrew about $24 billion from the domestic stocks this year. Sovereign bonds also declined, with the yield on the benchmark 10-year bond rising by as much as nine basis points to 7.61%, while that on the four-year bond surged by 13 points. Traders will look forward to the release of inflation data later on Monday.

Measures to mitigate the impact of fall?

The Reserve Bank of India has sufficient reserves to manage the fluctuations, whereas hedging is a viable option for the importers to protect themselves, given the current hedging cost of 4% might limit the benefits.

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Indian Economy

Make Your Note

RBI allows Trade Settlements in Rupee

• 14 Jul 2022
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For Prelims: Foreign Trade, Currency Depreciation & Appreciation, Global Sanctions, Balance of Payments

For Mains: Effect of global sanctions on economy of India, Benefits and challenges of settling trade in Rupee, Intervention of government in economy

Why in News?

Recently, the Reserve Bank of India (RBI) has put in place a mechanism to facilitate International Trade in Rupees (INR), with immediate effect.

• However, banks acting as authorised dealers for such transactions would have to take prior approval from the regulator to facilitate this.
• As per the broad framework for cross-border trade transactions in INR under Foreign Exchange Management Act, 1999 (FEMA) , all exports and imports under this arrangement may be denominated and invoiced in rupee (INR) and the exchange rate between the currencies of the two trading partner countries may be market determined.

What is Rupee Payment Mechanism?

• Indian importers undertaking imports via this mechanism will make payment in INR which will be credited into the Special Vostro account of the correspondent bank of the partner country, against the invoices for the supply of goods or services from the overseas seller.
• Indian exporters using the mechanism will be paid the export proceeds in INR from the balances in the designated Special Vostro account of the correspondent bank of the partner country.
• Before allowing any such receipt of advance payment against exports, Indian banks need to ensure that available funds in these accounts are first used towards payment obligations arising out of already executed export orders/export payments in the pipeline.
• Balance in Special Vostro Accounts can be used for: payments for projects and investments, export/ import advance flow management, and investment in Government Treasury Bills, Government securities , etc.
• If a company exports or imports, transactions are always in a foreign currency (excluding with countries like Nepal and Bhutan) .
• So, in case of imports, the Indian company has to pay in a foreign currency (mainly dollars and could also include currencies like pounds, Euro, yen etc.).
• The Indian company gets paid in foreign currency in case of exports and the company converts that foreign currency to rupee since it needs rupee for its needs, in most of the cases.

What are the Benefits of this Mechanism?

• It will promote growth of global trade and wil l support the increasing interest of the global trading community in INR.
• As a result of the trade facilitation mechanism introduced by the RBI we see the payment issues with Russia easing.
• The move would also reduce the risk of forex fluctuation , especially looking at the Euro-Rupee parity.
• Amid ongoing rupee weakness, this mechanism aims at reducing demand for foreign exchange, by promoting rupee settlement of trade flows.

What Initiatives has India taken for International Trade?

• Payments made to and by Indian residents and USSR residents will be done only in those specified accounts by debiting/crediting.
• FTA is a pact between two or more nations to reduce barriers to imports and exports among them.
• Under a free trade policy, goods and services can be bought and sold across international borders with little or no government tariffs, quotas, subsidies, or prohibitions to inhibit their exchange.
• The concept of free trade is the opposite of trade protectionism or economic isolationism.
• India has joined a US-led initiative to set up an Indo-Pacific Economic Framework (IPEF) and this move would help boost economic ties further.
• The US has consistently been India’s largest market for services exports, but the recent overseas sales of merchandise goods to that country overtook China , making it the largest bilateral trading nation of India.

UPSC Civil Services Examination, Previous Year Questions (PYQs)

Q. With reference to Balance of Payments, which of the following constitutes/constitute the Current Account? (2014)

• Balance of trade
• Foreign assets
• Balance of invisibles
• Special Drawing Rights

Select the correct answer using the code given below:

(a) 1 only (b) 2 and 3 (c) 1 and 3 (d) 1, 2 and 4

Explanation:

• The Balance of Payments (BoP) is composed of two main aspects: Current Account and Capital Account.
• The Current Account of BoP measures the inflow and outflow of goods, services, investment incomes and transfer payments. Trade in services (invisibles), trade in goods (visibles), unilateral transfers, remittances from abroad, and international aid are some of the main components of the Current Account. When all the goods and services are combined, together they make up the Balance of Trade (BoT) of a country. Hence, 1 and 3 are correct.
• Capital Account of BoP records all those transactions, between the residents of a country and the rest of the world, which cause a change in the assets or liabilities of the residents of the country or its government.
• Loans and borrowing by private or public sectors, investments, and changes in the forex reserves are some of the examples of the components of the Capital Account. Hence, 2 and 4 are not correct.
• Therefore, option (c) is the correct answer.