Indian Rupee: Historical Fluctuations Prepared by: Peter Frerichs, MPA Consultant Contents I. Introduction to the Rupee ……………………………………………………………3 II. Fluctuation Factors…………………………………………………………………...4 III. Indian Reform Periods………………………………………………………………..7 IV. Rupee in 21st Century…………………………………………………………………8 V. Reserve Bank of India…………………………………………………………….….11 VI. Projections……………………………………………………………………….…...13 VII. Appendix……………………………………………………………………………..16 VIII. References…………………………………………………………………..……..…18 I. Introduction to the Rupee ______________________________________________________________________________ Defining India’s monetary regime with regard to the rupee’s exchange rate with the dollar can be a convoluted process. Designations such as de facto or non-traditional have been used to describe the unique relationship the Reserve Bank of India (RBI) maintains with the U.S. greenback. Yet, after cutting through mountains of extraneous terminology, unique to India’s floating exchange rate with the euro or the yen, the RBI has neither a fixed nor a floating policy with the dollar. Rather, the RBI maintains a managed exchange rate with the dollar, buying and selling foreign currencies with the ultimate goal of keeping the rupee stable.1 Intervention, according to the RBI, is necessary to manage exchange rate volatility between the two currencies.2 There is no fixed target rate, and market forces are left to decide the fate of exchange post intervention. In June 2007 the RBI was quoted as stating that controlling and suppressing inflation was their primary focus.1 Taming inflation however is a complex issue, reaching into social and political arenas that consequently end up affecting and moving the exchange rate just as well. The RBI like any other entity of the state is understandably affected by the political economy, thus the movement of the rupee is far from determinate on economic factors alone. Appendix A, Graph 1 details the rupee’s movement against the dollar from 1990 to the present. A steady rate of depreciation had been the norm for over a decade with the lowest point over the eighteen year period being in January 1990, Rs16.9:US$1. In fiscal year (FY) 1993/94 the rupee maintained an average annual rate of Rs31.37:US$1.3 By FY 2002/03 it had dropped to 1 Robinson, Simon. (2007, July 16). The Message in India’s Rupee Rise. Time Magazine. Retrieved on March 18, 2008 from http://www.time.com/time/world/article/0,8599,1643855,00.html?xid=feed-cnn-topics 2 Ramachandran, M. & Sambandhan, D. (2007, April 14). Resisting Rupee Appreciation? Economic and Political Weekly. Retrieved on March 18, 2008 from http://www.epw.org.in/epw/uploads/articles/10490.pdf 3 India’s Strong Rupee. (2007, July 27) The Economist. Retrieved on March 19, 2008 from http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=6899464&story_id=9396854 Rs48.40:US$1, marking an average annual depreciation of close to 5 percent over the nine year period.3 In between FYs 2003/04 and 2005/06, the rupee reversed course and appreciated by an average of 3 percent per year.3 The Indian currency had reached its height in May 2002, Rs49:US$1, and continuous month-on-month appreciation took shape in September 2006 enduring to the present. During 2007 the rupee strengthened by close to 15 percent against the dollar.4 This was the biggest increase since 1974.5 India has also witnessed over a 10 percent rupee rise on an inflation-adjusted, trade-weighted basis since August 2006.5 As of March 31, 2008, the exchange rate stands at Rs40.14:US$1. The rupee has performed badly since the beginning of the year- the second worst in all of Asia.5 Yet, in the face of huge capital inflows into the country, to be discussed further on, the RBI has fared fairly well in containing inflation. The losers in this equation however are select Indian export sectors whose jobs and livelihoods are at risk due to expected losses resulting from a strong rupee.6 Cheaper imports on the other hand, especially those required inputs for manufacturing goods to export, have eased export sector pains. Yet, to grasp the reasons behind the rupee’s rise and what it means both commercially and economically for India and the U.S., addressing the various factors involved with currency movements is an appropriate first start. II. Fluctuation Factors ______________________________________________________________________________ Forecasting currency movements is laborious work. Firms spend countless hours and resources analyzing and measuring what are thought to be the critical factors needed to accurately address 4 The Uncomfortable Rise of the Rupee. (2007, December 13) The Economist. Retrieved on March 19, 2008 from http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=6899464&story_id=10286077 5 Varma, Anil. (2008, March 20). Rupee Set to Rebound as India Weathers U.S. Showdown, BOA Says. www.bloomberg.com Retrieved on March 22, 2008 from http://www.bloomberg.com/apps/news?pid=20601091&sid=axWlqwE6OOQk&refer=india 6 Chandra, Shobhana & Thomas, Cherian. (2007, September 26) India May Shield Exporters from Rupee, Minister Says (Update 4). www.bloomberg.com Retrieved on March 22, 2008 from http://www.bloomberg.com/apps/news?pid=20601080&sid=alS4DteWrtco&refer=asia the reasons behind fluctuation. Although no clear-cut recipe exists to undertake this task, there are some common factors that have a direct correlation to the movement of money. Political and psychological factors as well as the overall strength of the economy cause the most fluctuation. Essentially, if an economy is growing quickly it will tend to attract foreign currency which will in turn strengthen its own currency. Some countries such as India over the years have adopted export-only growth strategies which result in much more foreign currency coming in than home currency flowing outward. This will also strengthen the home currency. Political factors such as a change in government or the possibility of war cause speculation resulting in currency fluctuation. Psychologically, a war or a government deemed to be anti-market signals trouble. Similar to the stock-market, speculation can lead to massive inflows and outflows of capital and this can strengthen or weaken a currency overnight. Exchange rates typically move in a direction to compensate for an economy’s relative inflation rates. Frequently, if a currency is overvalued, measured by whether it is stronger than is warranted by the economy’s relative inflation rates, a depreciation of that currency will occur to correct the position of the currency.7 Generally, high inflation will reduce a country’s competitiveness and weaken the country’s ability to export and sell its services or goods abroad. Once this occurs, demand or expected demand for the country’s currency will in turn weaken, thus making demand for foreign currency more attractive. Aside from exports though, one of the advantages India maintains from a strong rupee is that it has helped to subdue inflation by reducing the costs of imports and keeping domestic prices in check.8 Movements in large sums of capital in and out of a country are considered one of the most influential reasons for changes in the exchange rate. A large net inflow of a foreign currency will generally strengthen the home currency. This intuitively makes sense because depending on the amount of inflow, the foreign currency would then end up being in excess of what is considered 7 Kramer, Charles, Oura, Hiroko, Richter-Hume, Andrea, Topalova, Petia, Poirson, Helene, Kohli, Renu, Prasad, Ananthakrishnan, & Jobst, Andreas. (2008, February) India: Selected Issues. International Monetary Fund. Retrieved on March 18, 2008 from http://www.imf.org/external/pubs/ft/scr/2008/cr0852.pdf 8 India Rupee at Fresh Dollar High. (2007, October 10) BBC News. Retrieved on March 18, 2008 from http://news.bbc.co.uk/2/hi/business/7037807.stm normal market demand. When India first began to liberalize its economy billions of U.S. dollars came streaming into the country, thus strengthening the currency. In 1996 and 1997 foreign investors extracted billions of dollars which in turn weakened the rupee.7 A government’s monetary and fiscal policies directly affect supply and demand for a currency which as a result impacts trade. For example, a policy designed to increase the supply of money will raise prices and also make imports more attractive from a trading perspective. To attract money into an economy governments have an array of tools at their disposal. Central banks can offer high rates on treasury bills for example, and many banks will buy foreign currency when there’s an excess in supply, or sell it when the demand for the currency exceeds the supply.9 Fiscal surpluses on the other hand tend to result in a decreased demand for imports, but increased opportunities for exporters. In this scenario, domestically a country’s importers will not be able to capture a favorable return due to the weak exchange rate, but the same country’s exporters will have greater opportunities to sell due to the favorable exchange they are providing foreign partners. Historically, tariffs and quotas were designed to protect a country’s foreign exchange by reducing demand from potential domestic consumers. Tariffs and quotas also serve to protect selected domestic industries for economic or political reasons as well. The ease at which information can be accessed in today’s world has shed light on the real effects tariffs and quotas impose. Obviously, if you work or will gain from a sector protected by tariffs and quotas, you would like to see your government hold these in place. If you are looking to buy an item that would cost you $1 in a neighboring country, but $5 in your country, you might not be as forgiving. Tariffs and quotas protect the exchange by reducing demand, but they also close markets which can in the long-term pose its own significant problems on the currency in question.