High inflation, eurozone debt issues have been attributed to the rupee fall

The fall in rupee value against major currencies, especially the U.S. dollar, has surprised the markets. Till August 2011 (calendar year) the rupee was quoting in the 44-45 range to the dollar. Thus, the fall in rupee value to above 52 was sharp and sudden. It closed at 52.25 last Friday. It opened at 52.2350 and traded at a high of 52.4550 and a low of 52.0750. The markets suspect central bank intervention by pumping dollars (some say it was around $3 billion) into the market after the rupee hit an all time low of 52.73 intra-day on Tuesday. The Reserve Bank of India (RBI) also said that it would intervene whenever necessary. But many government officials felt that there was no need for it now. Finance Minister Pranab Mukherjee said “RBI intervention will not help. The increased uncertainty in the eurozone on account of the sovereign debt crisis has led to shifting of capital from Europe to the U.S. which has hardened the U.S. dollar against most currencies.” The RBI Governor also said that volatility in the rupee would continue till the eurozone problem was solved.

The rupee depreciated by more than 16 per cent from July till today. Widening trade deficit, high inflation and eurozone debt issues have been attributed to the fall in rupee value against the dollar. Interestingly, there are various financial instruments which may end up in losses like foreign currency convertible bonds on the basis of mark-to-market (MTM) losses on account of exchange rate fluctuations. Further, the losses on account of derivatives products by hedging export revenues against a fixed rupee-dollar rate could be on a higher side.

Derivative contracts

A recent case explains the huge losses suffered by exporters and importers in the 2008 crisis. The RBI recently investigated the violation of the Foreign Exchange Management Act (FEMA) by several banks, the victims of these violations are importers and exporters as well as companies which sold forex derivative contracts resulting in the massive losses of Rs.25-lakh crore as per the rupee-dollar exchange rate of 46-47. These contracts were purchased at the time when the rupee was quoting at 37-38 a dollar. What will be the future? Experts feel that the persistence of global risks and weak domestic prospects will continue to keep the bias tilted towards a weaker rupee in the near- to medium-term. With the new record lows being reached, “We now revise our rupee view further up to trade between 49.50 and 53.50 over the next 5-6 months against our earlier estimate of 49-51 range....... Global sentiments would continue to have an upper hand in directing the rupee movement going forward,” says Upasna Bhardwaj, Economist, ING Vysya Bank. As the rupee touched an all time low last Tuesday, the RBI has stepped in and announced a few measures to stem the slide. The central bank asked the corporates to bring in the proceeds of external commercial borrowings (ECBs) raised abroad for rupee expenditure in India.. “It. should be brought immediately for credit to rupee accounts with AD Category I banks,” the RBI said in a notification last Wednesday. The RBI has announced a special window to sell U.S. dollar to government-owned oil importers. So these companies would avoid entering the market to purchase the dollar, which was estimated at around $350 million a day. While oil payments to Iran in August 2011 and risk aversion acted as initial catalysts, the deterioration on the domestic macro front accompanied by lower inflows have resulted in a sustained fall in rupee value.Domestic fundamentals have taken a turn for the worse. These include the domestic policy gridlock, elevated levels of inflation despite 525 basis points of effective tightening, likelihood of a near more than one per cent fiscal slippage, and growth expectations coming off significantly.

This has resulted in equity flows slowing to $1.2 billion so far this fiscal against $24.4 billion last year and October's record high $20 billion trade deficit.

Apart from a higher import bill, rupee depreciation is likely to complicate macro management. Inflation is likely to remain elevated as input costs across all components could see an increase. This would also be a drag on the fiscal situation as every Re. 1depreciation oil under-recoveries will increase by Rs.8,000 crore.

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