The effect of rupee depreciation on businesses

Posted On Friday, Jun 28, 2013

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Impact of Rupee Depreciation

Its all over the news - the Indian Rupee has touched an all-time low against the US Dollar. The Indian rupee on Thursday, 20th June 2013, weakened to touch the 60-mark against the US Dollar, its all-time low. Since January 2013, it has declined 7.4 percent against the dollar since the start of May, 2013.

What does this rapid, unchecked depreciation of rupee mean? Well, rupee depreciation means that rupee has become less valuable with respect to the US Dollar. Which in turn means that Americans can afford to buy more from India spending the same amount of dollars, which means our exports are that much more ‘lucrative’ to the US.



What causes the rupee to depreciate?

Reasons which cause the rupee to fall in comparison to dollar are:


Demand Supply Rule:

The value of rupee follows the simple demand and supply rule of economics. If the demand for the dollar in India is more than its supply, dollar appreciates and rupee depreciates. Similarly, when the supply of dollars in India increases its demand, the value of dollar decreases in terms of rupees. Demand for dollars may be created by importers requiring more dollars to pay for their imports or by FII’s withdrawing their investments and taking the dollars outside India, thus creating a shortage of dollar supply, which in turn can also increase the demand for dollar. On the other hand, supply can be created by exporters bringing in more dollars from their revenues or FIIs bringing more dollars in India to spur their investments.


Dollar gaining strength against the other currencies:

The central banks of Eurozone and Japan are printing excessive money due to which their currency is devalued. On the other hand, US Fed has shown signs to end their stimulus. Hence, making the US dollar stronger against the other currencies including the Indian rupee, at least in the short term. One doesn’t really know when Helicopter Ben will shut the door and stop the printing of money, though one doubts whether the door will be shut anytime soon.


Oil prices:

Oil price is one of the most important factors that puts stress on the Indian Rupee. India is in the unhappy situation where it has to import a bulk of its oil requirements to satisfy local demand, which is rising year-on-year. In International markets, prices of oil are quoted in dollars. Therefore, as the domestic demand for oil increases or the price of oil increases in the international market, the demand for dollars also increases to pay our suppliers from whom we import oil. This, increase in demand for dollar weakens the rupee further.


Volatile domestic equity market:

Our equity market has been volatile for some time now. So, the FII’s are in a dilemma whether to invest in India or not. Even though they have brought in record inflows to the country in this year chances are they may be thinking of taking their money out of the equity market which might again results in less inflow of dollars in India. Therefore, decrease in supply and increase in demand of dollars results in the weakening of the rupee against the dollar.
Now, let’s understand the mechanism of the impact of this currency depreciation. How, for some people it helps to make huge earnings and for some it incurs huge losses. Following are the points which tries to explain the advantages and disadvantages of a falling currency:


Benefits of Rupee Depreciation


Advantage to Exporters:

Weakening of rupee gives up a huge advantage to the exporters. You might be thinking how this can happen. Let’s take up an example to understand this point. Suppose, an exporter exported goods to US and his receivable payment is 100 USD. Let’s take the value of 1 USD = Rs. 55 at the time of trade. So, his net receivable will be Rs. 5500. Suddenly, at the time of payment if the rupee declines sharply in terms of dollar and let’s take 1USD at that time becomes Rs. 57. So, at the time of payment the exporter will get Rupees 5700 of the same trade due to the currency fluctuation. Therefore, his net profit due to depreciation of rupee becomes Rs. 200. This is how the exporters are benefited when rupee declines in terms of dollar.

Boom to tourism industry:

Travel and tourism is a sector which will benefit from the depreciation of the rupee. Let’s take up an example again to understand how this industry will benefit. Suppose, if a trip to India costs Rs. 1,00,000 to a foreigner and the dollar is quoting 1USD = Rs.50 at that time. So, the trip would cost the foreigner 2000 USD. If the rupee declines in front of dollar and suppose it quotes at 1USD = Rs. 60. Then the same trip would cost the foreigner approx. 1666 USD. This will entice foreigners to visit India and help increase revenues through the travel and tourism industry.


Disadvantages of Rupee Depreciation


Imports become extremely expensive: A depreciating rupee would mean that the importers would have to pay more for their imports as every dollar will constitute more rupees. So, this means that price of the goods or commodity which is being imported to India increases substantially.
Reduction in Purchasing Power Parity: One of the outcomes of a depreciating rupee will be the rise in inflation in the economy. When the inflation rises, prices of goods and commodities shoots up. Therefore, the purchasing power of the rupee falls down.
Seeing the global economic outlook and quantitative easing by the central bankers around the world, it is very much possible that Indian rupee may decline further against the USD. The Indian government is stuck in a dicey situation as they have to decide whether they should intervene in the monetary policies and counter the fall in rupee or do nothing and let the rupee find its own level as a falling rupee helps to improve the current account deficit but decreases the purchasing power.


Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article constitute only the opinions and do not constitute any guidelines and recommendation on any course of action to be followed by the reader. The views are meant for general reading purpose only and are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the readers. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and opinions given fair and reasonable. Recipients of this information should rely on information/data arising out of their own investigations. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.

Above article is authored by Quantum.

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