The Indian Rupee hit an all time low of 72.66 against the dollar in September. And while this happened, the country slipped into panic of the rupee deteriorating even more. This fear led to serious consequences. Businessmen went mad trying to buy dollars in the forex market before it plunged further, our imports became super expensive, and our investments started drying up. All of this in turn contributed to the rupee devaluation pushing our economy into an endless cycle.
The reasons for the rupee free fall are manifold (watch the video to know more) but the underlying principle is just one – the direct relation between the currency’s value and the dollar reserves with RBI. When the reserves deplete (like it is doing right now), the rupee value falls, and when the reserves are high the value improves. So if the government wants to rescue the rupee, every policy, and every action must lead to stopping the reserves from reducing or at least adding more dollars to the reserves.
But there’s little the government can actually do for that. Here’s it.
FIIs – the little blue pill for strength
One of the core reasons for a dip in the rupee value is the outflow of FIIs (Foreign Institutional Investors). An FII is just like any other investor whose interest in a country’s markets depends on the profits he makes, aka the 10-year yield.
India received a lot of FIIs after the 2008 financial crisis when investors had huge sums to invest but no safe market. At that time, the Indian market was considered to be “emerging” with high yield rates and a good USD to INR rate (43.51). Since then FIIs have been attracted towards Indian bonds. And their investments helped improve the economy with more cash inflows and in turn better the rupee value. In fact, between December 2011 to February 2012, FIIs invested $13 billion and the rupee shot up by 6% to 49.07 from 52.17. Then again from July 2012 and September 2012, FIIs pumped in over $8 billion in the Indian market and the rupee jumped by nearly 7% to 52.70 from a low of 56.31 against the dollar.
But FIIs have proved instrumental in the past, they come with added external debt. Bonds literally mean that the government is asking investors for money to invest in development projects in India. Of course the government has to pay interest on these bonds and at any moment if the investor wishes to sell off the bonds, the government should have the money to repay the investor in whole.
A high inflow from FIIs means that a higher external debt. And in future if too many investors plan to pool out their money it will again affect the rupee. This system of foreign investments and bonds is just a cycle of slumps and peaks for the rupee.
This is exactly what struck the Indian rupee. Overtime, the American market bounced back and FIIs gradually started pooling out of India and into the US bond. In 2018, India lost FIIs worth $4 billion in just 6 months, the worst since the 2008 global crisis.
But the hope’s not done yet. Even though it’s a short term solution, FIIs can make a comeback this year. India still provides a higher yield (8.1%) than the US (3%) and the RBI can use this to convince FIIs to reinvest in our bonds. The only problem is the country’s unstable market, but previous RBI governors have managed to lure investors despite the instability, on hopes of higher yields in the next few years. This is exactly what former RBI Chief, Raghuram Rajan had done in 2013 and what YV Reddy had done in 1997 after the Asian crisis.
Selling NRI Bonds – a red pill for stimulation
NRI bonds are as the name suggests meant for non-resident Indians. The system is similar to FIIs – which involves bringing in investments into government bonds. The only difference is that these bonds are sold to individual NRIs instead of big companies or institutions like in the case of FIIs.
The idea of these bonds is that NRIs earning in dollars will have higher capacity to invest in Indian bonds, and thus the government can urge them to do so. With a low rupee value, the NRIs can buy more rupees for each dollar giving them even more money to invest in India.
This will act in the same way as FIIs both positively and negatively – in improving the rupee value and adding to external debt. So this too is a short term solution.
Delaying Import Payments – green one to sleep off your problems
The government through the RBI pays the cost of all imports at the end of each month. This is a regulated system which prevents the country from falling into too much debt by paying off all the money it owes on a monthly basis. Since all trade (import and export) is done using the dollar, the country is losing more rupees (Rs 70 for each USD) every month to pay off the import bills.
For a few months the RBI used its dollar reserves to pay off the import, but now even those reserves are depleting. And buying more dollars at this point is an expensive affair.
The best thing to do would be delay payment until a time when the rupee improves. In that case we’ll be spending lesser rupees to buy dollars to pay off our import debt than we’re spending now. Of course this would be sweet talking exporters into allowing us a longer payment period – a move which former RBI chief Raghuram Rajan had adopted in 2014.
Imposing Import Tariffs – yellow one to make you less depressed
The other best way to go is to reduce our dependence on imports. This can be done by raising tariffs to discourage companies from importing goods. The other plus side of this, though not directly connected to the rupee value, will be keeping inflation in check. You see a higher import cost will reflect the cost of the product for the consumer which will only raise up inflation.
So India has already raised its import duty on multiple goods. In July it increased tariff on 30 US products by 50%, and earlier this year it proposed to raise duty on another 20 US products by up to 100%. All of this of course also comes in reply to the US’s tariff hike this year (Trump’s move to strengthen his economy. Watch the video in this article).
But while all this is fine, is it really practical to expect an import reduction soon enough to rescue the rupee from falling even more? Because India so heavily depends on oil imports for its development that 25% of the total import bills go towards crude oil. So reducing imports is out of the questions. And with oil prices touching $68 per barrel, the country’s expense on oil is expected to shoot up to $100 billion by the end of 2020.
RBI’s Market Intervention – white one to soothe the pain
This can be done by selling dollars in the currency market. As discussed earlier, we need dollars to import and where else would the private importers get their dollars from? The government has dollar reserves, but private importers have to buy dollars separately to import. And this demand for dollars in the market can further devalue the rupee. This is why the RBI has resorted to market intervention on several previous occasions.
On June 28, it tried to stop the mad rush for dollar by selling it to private importers in exchange for rupees. The RBI has not yet disclosed how much foreign exchange reserves were spent on that day, but market observers estimate that the RBI might have spent close to $2 billion in the forex markets to stem the fall in rupee value.
And as of August end, the RBI had foreign exchange reserves of $400 billion. This figure is important because the government can’t afford to buy more dollars if it wants to maintain the rupee value. So in a market intervention, it needs to spend the limited reserved wisely.