:: Issue Analyses For how long will the Indian rupee continue to depreciate? Choi Ho-sang Research Fellow, The Korea Center for International Finance he Indian economy has recently been at risk of coming to a deadlock due to the falling value of the rupee. The value of the rupee against the dollar has declined since August of 2011, T hitting a record low of 53 rupees to the dollar in December. The rate continued to fall from February of this year and reached 56.1 at the end of May. This figure is 21.2% lower than at the end of July of 2011. During the same period, among BRICs countries, the Indian currency depreciated the second most, after the Brazilian real (23.2%). It is feared that the sharp decline in the rupee is not merely currency devaluation, but could lead to a shortage of foreign currency. Some people even suggest the possibility of the next financial crisis. The degrading value of the rupee has emerged as the biggest risk for the Indian economy. ○● The rupee continues to fall despite government intervention In order to prevent the rupee from falling sharply, the Reserve Bank of 111 Autumn 2012�POSRI Chindia Quarterly India (RBI) has implemented a series of measures to attract capital and prevent currency speculation; for example, direct market intervention by purchasing foreign currency, a rise in investment ceilings on government and corporate bonds for foreign investors, and an increase in forex deposit interest rates for Non-resident Indians (NRI). While carefully monitoring foreign exchange rates and capital inflows with regard to raising interest terms of external commercial borrowings (ECB), the RBI is making efforts to prepare countermeasures. Some companies find themselves in a difficult situation with financing because depreciated currency value and diminished capital inflows have pushed up the costs of international financing. Despite the government’s intervention in the foreign exchange market, India seems to have a hard time preventing the value of the rupee from falling. At the end of March of 2012, India’s foreign currency reserves were USD 268.7 billion, a decrease of USD 25.7 billion from USD 294.4 billion at the end of July of 2011. If India’s foreign currency reserves continue to decline, the Indian authorities’ ability to intervene in the foreign exchange market will diminish. ○● Weak fundamentals─the main cause of anxiety in the foreign exchange market The rupee’s decline is caused by weak economic fundamentals, including a chronic current account deficit, high dependence on external debts, and enormous government debts. When comparing India’s current account, external debts, and government debts for 2010 with those of other emerging Asian countries, India’s vulnerability is easy to spot. India is an emerging country with high growth potential; however, its prolonged current account deficit has led to meager domestic savings. To address this issue, India needs to have stable foreign capital inflows. Unfortunately, foreign capital inflows to India are usually indirect 112 POSRI Chindia Quarterly�Autumn 2012 :: Issue Analyses investment, such as equity investment, rather than direct investment. This explains why India’s financial system has become more vulnerable to the volatility of the international financial market than any other emerging Asian economy. As of 2010, India’s current account to GDP ratio was negative 2.6%. This is in stark contrast to other Asian countries, which keep their current accounts in The Indian economy is highly likely the black through trade to suffer from internal and external surpluses (excess exports). troubles for some time due to the With insufficient capability for expansion of the European financial crisis, inflation pressures, industrial production, India and the unstable rupee. has a trade structure wherein high economic growth rates translate into rising imports and expanding trade deficits (excess imports). For this reason, India cannot significantly cut trade deficits only though service income (the development of software and the operation of call centers for western companies) or remittance from NRI’s. India’s net external assets and debts to GDP ratio is negative 9.7%. As suggested by its external debts, India is mainly dependent on equity investment and loans, having a low percentage of direct investment. When the international financial market is stable, massive inflows of foreign capital can be made through equity investment and loans to the market, but this structure is, in turn, highly influenced by the volatility of the financial market. India’s policy, which makes it difficult to raise direct investment, has become an issue. India’s government debt to GDP ratio is 64.1%. This is one of the highest ratios among emerging Asian countries, raising concerns about India’s financial soundness. Due to its current account deficit, India has low 113 Autumn 2012�POSRI Chindia Quarterly The Indian rupee trend 40 (Rupee/Dollar) 42 44 46 48 50 52 54 12.14 (53.7) 56 5.31 (56.11) 58 2011 2012 78910111212345 Source: Bloomberg domestic savings and high government debts. Under such a structure, funds in the market cannot be smoothly circulated through the private sector. As the European sovereign debt crisis is deepening, countries with weak fundamentals, such as India, are likely to experience rapid retraction of foreign investment and the pressure of long-lasting currency depreciation. Also, there is a possibility of domestic funds fleeing overseas. It will take much time until overseas funds that have fled from India due to the slowing growth of the economy after the first quarter of 2011 flow into India again. ○● Structural problems keep the rupee weak The value of the rupee is likely to either remain unchanged or to fall further due to internal and external risks. The International Monetary Fund (IMF) projects that India’s economic growth for 2012 will be 6.9%. India’s GDP growth in the fourth quarter of 2011-12 (Jan.-Mar. 2012) was 5.3%, the lowest growth rate since the first quarter of 2003. According to a survey of 28 investment banks conducted by Bloomberg, the Indian rupee to U.S. dollar currency exchange rate will continue to rise and fall, averaging 114 POSRI Chindia Quarterly�Autumn 2012 :: Issue Analyses The BRIC currency devaluation 5 (Unit: %) 0 -5 -10 -15 -20 -25 Brazil India Russia China Korea Note: The BRIC currency depreciation against the dollar as of the end of May, 2012, compared with the figures as of the end of July, 2012 Source: Recalculated from Bloomberg around INR 50, until the first quarter of 2013. If the rupee maintains its weak trend in the long term, Indian exporters will be restricted from securing foreign currency necessary for purchasing intermediate goods. Due to deteriorating external economic conditions, Indian companies could have trouble borrowing money from overseas. Korean companies doing business in India are expected to see their U.S. dollar-denominated operating profits fall. Automobile and home appliance makers, which are highly dependent on imports of raw materials and parts, will inevitably face deteriorating profitability. Therefore, the auto parts sector and other sectors that have already established their production bases in India, are expected to increase their local purchasing within India. ○● Increasing risk of economic downturn amidst internal and external troubles The Indian economy is highly likely to suffer from internal and external troubles for some time due to the expansion of the European financial crisis, inflation pressures, and the unstable rupee. Serious inflation pressures are standing in the way of expanding domestic demand. In September of 2011, 115 Autumn 2012�POSRI Chindia Quarterly 2010 Current account, external debts, and sovereign debts of major emerging Asian economie (Unit: USD 1 bln, %) External debts Current Net external Sovereign External assets and account Direct Equity debts assets net debts (to GDP) Total invest invest Loans (to GDP) ment ment (to GDP) India -2.6 381 504 164 117 122 -9.7 64.1 China 5.2 4,126 2,335 1,476 222 239 30.5 33.8 Korea 2.8 688 825 127 491 139 -13.5 33.4 Indonesia 0.8 98 316 108 96 105 -40.6 27.4 Malaysia 11.5 251 216 79 85 n.a. 18.2 54.2 Note: External assets and debts, and net external assets and debts to GDP of India, Indonesia and Malaysia are based on figures as of the end of 2009. Source: IMF DB India’s wholesale price index decreased by 10% year-on-year, and remained low until rebounding by 7.2% in April of 2012. The rising price of raw materials and manufactured goods is the biggest factor of inflation pressures. Moreover, the prolonged rupee depreciation has pushed up import prices, hindering inflation stabilization. Prolonged inflation is having a negative impact on consumption, and the rise in interest rates and raw material prices is leading to sluggish investment and production activities. The Indian government is unable to cut interest rates for economic recovery for fear of further inflation. The implementation of fiscal policies is limited, because government debts are huge. India’s policies to expand domestic demand have limitations in that India needs stable capital inflows to reduce its chronic current account deficit. On the other hand, some people believe that a wholly negative outlook for the Indian economy is inappropriate. As India is not an export-driven economy like China and Southeast Asia, the European crisis will trigger the 116 POSRI Chindia Quarterly�Autumn 2012 :: Issue Analyses depreciation of the rupee and the reduction of capital inflows to some extent; however, the ripple effect on the real economy will be limited. Unfortunately, though, India seems to have insufficient means to curb rupee depreciation, which is its most urgent issue.