Chapter 28 The Cause and Consequences of Falling Rupee – Indian Economy


The Cause and Consequences of Falling Rupee

What is Depreciation of Currency?

Under the present circumstances, the exchange value or exchange rate, i.e., the rate at which a country’s currency exchanges for currencies of other countries depends on its supply in relation to its demand in that market.

According to economists, the value of money, like the value of everything else is determined by the Theory of Value namely the value is determined by the demand for and supply of money. The demand for a country’s currency is derived from the demand for that country’s exports, while the supply of its currency is dependent on its demand for imports. Thus if the demand for a currency in the foreign exchange market is larger in relation to the supply it will bring about an appreciation of that currency in terms of other currencies but if the supply of it is large in relation to demand for it, the currency will depreciate. The effect of the depreciation of a currency makes imports costlier. For an economy such as ours which spends huge sums of foreign exchange for in the import of oil-based products and some luxury goods to cater to the rich and affluent, the depreciation of the rupee will adversely affect growth. Unfortunately, we are not in a position to export more goods and services such as the Chinese do, as in our consumerist society nothing substantial is left for exports. The direct impact of this situation is a fall in the value of the rupee.

The depreciation of the rupee against the US dollar—which over the period of time has assumed the position of an international currency—became a hot topic of discussion during the second half of the financial year 2013. The fall in the value of the rupee over a period is shown below.

Table 28.1 Exchange Rate of Indian Rupee between 1990–91 and 2012–13

The Indian Rupee had a historic fall on August 22, 2013 at Rs 65.56 preceded by a week-long pressure on its value. The extent of its depreciation over successive days has been unprecedented creating a political turmoil. It has knocked doom the rupee almost 25 per cent in two months. The decline in rupee was accompanied by a fall in the stock prices, which though recovered within a short period. While the value of the rupee was Rs 65.56 in August 23, it fell further to Rs 68.75 in terms of US dollar, the steepest fall in 20 years. Yet another psychological mark of Rs 70 appeared to be ominously imminent. The value of the rupee being citizen’s pride in the country’s capacity to withstand pressure both from within and without, the volatility and the free fall of the rupee shook the prate and confidence of an average Indian as nothing else has done before.

However, it should be mentioned here that the volatility of the Indian currency is not an exceptional phenomenon. Several other currencies of developing countries have gone through such adversity. ‘The Indonesian rupee hit a four-year low on corporate dollar demand. The Malaysian ringgit fell to its lowest in three years. Thailand and the Philippines have also seen their domestic currencies fall sharply in tandem with their stock prices. But India was the worst affected, probably due to its higher dependence on foreign flows.’1

What Triggered the Rupee Downslide?

There are several factors that have brought about the havoc of the steep downslide of the rupee– economic and monetary, domestic and international, short term and secular, and psychological with the country’s poor performance of the economy for the preceding couple of years. The lack of initiative on the part of the UPA government to steer the economy to bring about vibrancy and stability, a highly vocal opposition that articulated with high decibel, the failure of the government to arrest the downslide, increasing the burden of imports that could not be offset by exports are some of the domestic causes for the rupee fall. With regard to external causes, one major factor was the one that originated from the United States.

The Federal Reserve, the Central Bank of the United States, has been pumping out $85 billion cash per month under its policy of quantitative control easing to help its economy recover from the recessionary phase it was going through. Once the American economy showed the phase of recovery, the Fed plans to reduce this cash bonanza in stages to zero. Another trigger has been the possibility of military intervention in Syria by the United States. This action has further aggravated concerns over the stability of currencies. Emerging markets such as India has been enjoying for long a slice of this bonus, which once stopped caused havoc to the Indian rupee. It will also have another harmful impact in as much as, the previously enjoyed bounty will reverse to the United States. The reverse flow may be in hundreds of billion dollars. This has knocked the rupee almost 25 per cent of its value over the past two months.

A steep fall in the value of a currency increases the price of all goods imported or exported. This will erode people’s purchasing power to the tune of 2.5 to 3 per cent. This is highly recessionary as evidenced in the recent data reflecting falling production of services as well as manufacturers.

The fall in the rupee has caused the movement of short-term capital flows to the US and other developed markets. ‘The pull out by foreign institutional investors selling Indian stocks and repatriating proceeds in dollars has hit the financial markets hard through lower stock prices and lower rupee.’2

Another significant cause has been India’s macroeconomic problems, especially her fiscal deficit and current account deficit.

Besides, there was the usual month-end demand for dollars from the real economy such as the need to make payments for oil imports.

A striking feature of the downslide in the rupee is that Indian corporates borrowed, as if there was no tomorrow—from not only Indian banks but also from overseas capital markets; between 2003–04 and 2010–11 the Indian corporate sector’s net bank credit increased from 31 per cent GDP to over 37 per cent Since 2006–07 its share has been consistently higher than net bank credit to the government’.3

One of the important aggravating factors in this context has been the governments hurried passing of the Food Security Bill whose, cost is likely to increase by the day, both for the central and state governments. It is estimated to cost the Exchequer as much as Rs 1,40,000 crores and more. Other factors that also contributed to the rupee downslide have been huge subsidies on petrol, foodgrains and PDS, petroleum under-recoveries, lack of proper follow-up in PSU disinvestment, spectrum sale and the doubtful nature of revenue projections.

The Prime Minister and Finance Minister have, while not belittling the causes and consequences of the rupee fall, assured the country that it would be short term phenomenon and that the Reserve Bank and Finance Ministry are seized of the issues and would do everything possible to reverse the trend. They argued that speculation and irrational panic have caused overshooting while economic fundamentals, which were strong would soon force the dollar value back to Rs 60.

However past experience does not justify the confidence and problem relating to the current problem associated with the rupee. Similar things were said in 1997 when such crisis occurred in Asian currencies. This was because when a currency crashes the process changes economic fundamentals. With domestic prices falling, it creates a recessionary trend. With rising prices, over time prices shoot up neutralizing the positive effects on exports. Companies that have borrowed abroad heavily go bankrupt. Banks that have provided loans to such businesses and others hit by recession are unable to recover their loans. This induces further capital flight. International rating agencies down grade such economies as they have done now in our case. ‘With a wobbling stock market free-falling rupee and bleak employment outlook, people have started doubting the India growth story.’ ‘One thing certain about the Indian macro economy right now is that it is hard to be optimistic.’ Robert Head of economic research for Southeast Asia and India, credit Suisse, The Week, September 2013.

What is the Impact of the Falling Rupee on the Real Economy?

Though the Government have been saying that India’s economic fundamentals remain strong and vibrant, a discerning observer could see a perceptible change for the worse. The increased level of current account deficit over all external for debt by 13 per cent $390 billion was seen as a perceptible change. As a result, the external debt—GDP ratio has risen to 21.2 per cent from 19.7 per cent of the previous year. The growth rate of the core sector comprising eight infrastructure industries decelerated to 3.1 per cent in July 2013 when compared to a healthier 4.5 per cent for the same month in July 2012. The cumulative growth rate during the April-July period marked a slow down to 1.9 per cent, a sharp deceleration from the 6.3 per cent registered during the same four-month period in 2012. A slowing economy will help to reduce the current account deficit, but hit the fiscal deficit. Wholesale prices had been falling but are accelerating again, causing a dent in the purchasing power. All industries face slowing revenues and rising costs, eroding profits. Tax revenue may grow by hardly half the budgeted estimate of 19 per cent. Disinvestment can happen only at throw away prices. The threat of a credit down grade has become very real.4

Presently, with the joint efforts of the Finance Ministry and the Reserve Bank, the rupee has regained some lost ground, but the global monetary situation and the internal problems facing the rupee, it is difficult to predict that normally can be restored soon.

What is the way out of this malaise?

According to some analysts, the following are some of the ways to get out of this self inflicted situation and restore confidence in the rupee.

  1. 1. The Government should speedily reduce the huge and unsustainable oil subsidies which may reach Rs 1,50,000 crores in the Financial Year 2013–14. India’s annual oil import bill is $ 160 billion and we need to ensure that demand for oil is elastic Diesel prices should be raised and oil companies should be allowed to raise diesel price so as to keep pace with market determined rates, until such time the current under recovery of Rs 11 per litre is removed. So should it be with cooking gas’ There should be a clear road map to eliminate all fuel subsidies with direct cash transfers to farmers and the poor.5
  2. Food subsidies which account for $ 23 billion today should be replaced with cash transfers with a view to eliminating the leakages and loopholes in the distribution system. To help poor Indians who suffer from malnutrition rather than from absolute poverty as hardly one per cent of Indians go through that kind of hardship–they should be given direct cash transfers. This will reduce subsidies and improve nutrition.
  3. Governments and people at large should create an environment where corruption is eliminated. Transparency International (TI) ranks India 94th in the world with a score of 36/90. We should also set up an independent body to investigate and prosecute corruption cases,6 based on the Hong Kong model where The Independent Commission Against Corruption set up in 1974 significantly reduced. Corruption and enabled the island nation to rank 14th in the world with a score of 77 in TI rankings.
  4. Government has to address urgently supply side constraints. India, as a vast country has inadequate infrastructure in terms of electricity transport and communications and ports. If the Government only redistributes essential commodities through enhanced subsidies without addressing in adequate infrastructure it will only lead to an economic situation called stagflation slow economic growth amidst inflation. To avert such a situation, the Government has to give speedy clearness to infrastructure projects. The recently passed Land Acquisition Bill will help Government acquire land for such projects, but for the industry the cost of acquisition will be high as much as 300 per cent. This problem has to be solved so that it does not act as a deterrent to economic growth.

Another problem is one of poverty amidst plenty. Despite the country’s huge coal and iron ore reserves, we are currently importing these minerals due to political considerations, thus worsening our balance of payment problems. We need to reopen closed mines with better environmental controls so as to meet our mineral requirements from internal resources without adverse environmental impact. India ranks 132nd in the World Bank’s Ease of doing business’ rankings. The government needs to speedily implement pending governance and investment reforms to move India into the high trajectory of growth.

Lastly, we should not resort to the imposition of capital controls as we did during pre-1991 days that caused have with the orderly growth of our economy. India requires $ 250 billion during the next 12 months to fund its trade deficit and meet its short term loan repayment obligations. The recent announcement of capital controls has contributed to the fall in the value of rupee.

Reacting to the public furore over the falling value of the rupee, the Finance Minister said that it is market-determined and there was no question of going back to the pre-1991 days of fixed exchange rate. Referring to the latest situation he asserted that there is a definite improvement in the value of the rupee as a result of measures initiated by the government and the RBI. Referring to inflation, the Finance Minister argued that the minimum support price (MSP), Spike in crude oil price in the international market, import of edible oil and pulses and gold created unfavourable balance of payments position which impacted the value of the rupee. Therefore the Government would initiate measures to curb import of gold and other inessential commodities, while at the same time boost exports.

Moreover, Government need to curtail spending to boost investment. This can be done by (i)  re-establishing the macro-economic balance through a reduction in government expenditure and subsidies, and compression of revenue and fiscal deficits, (ii) reviving corporate investment and growth, and (iii) initiating administration and legislative reforms. These reforms need to be backed by measures to bring about transparency in the system and streamline process. They must be complemented by measures to restore confidence in government and its now defined credibility.7

Since the 1991 economic reforms the country has witnessed millions and millions of people being lifted out of the quack mire of poverty. With a determined government policy to boost savings and investment and resolute measures to stay the fall of the rupee, there is no reason why the economy cannot regain the momentum of growth with monetary stability. A return to 9 per cent economic growth is certainly achievable and will ensure that poverty is wiped out from India within a generation.8

Discussion Questions

28.1. What is meant by depreciation of currency?

28.2. Enumerate the factors that contributed to the fall of the Indian rupee.

28.3. Do you agree with the view that the fall the rupee signified mismanagement of economy?

28.4. What are the measures initiated by the UPA government to restore rupee’s value? With what effects?


1 Narasimhan, C.R.L., ‘A Runaway Rupee Train.’ The Hindu, Chennai, 2 September.

2 Swaminathan S. Anklesaria Aiyar (2013), ‘Why the Rupee can keep Falling,’ Sunday Times of India, Chennai, 1 September.

3 Sridhar, V. (2013), ‘The malaise that drove down the rupee’, The Hindu, Chennai, 17 September.

4 Swaminathan S. Anklesaria Aiyar (2013), ‘Why the Rupee can keep falling,’ Sunday Times of India, Chennai, 1 September.

5 Johan, S. (2013), ‘A Five Point Recovers Plan’. The Times of India, Chennai, 2 September.

6 Ibid.

7 Vermani, A. (2013), ‘Cut spending Boost Investment,’ The Times of India, Chennai, 30 August.

8 Johar, S. (2013), ‘A Five Point Recovery Plan’, The Times of India, Chennai, 2 September.