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Indian Rupee: What's the buzz?

Jun 7, 2006

The Indian Rupee has been largely volatile since May 2004 until now, trading in a wide range between 43.2 and 46.3. A host of factors viz., rising crude prices, widening trade deficit and international currency trends, have governed the movement of the Indian currency during this period. In this article, we shall take a look at what drives the Indian currency and the impact of the same on sectors.Factors affecting the Rupee

Global currency trends: It must be noted that appreciation or depreciation of the Rupee, as the case may be, is more influenced by the strength or weakness of the US Dollar. Which means that factors affecting the dollar against a host of other international currencies need to be closely monitored. Global currency trends are largely affected by the string of economic reports released by the US and Euro regions, statements made by the central banks in these regions, inflationary concerns and the GDP growth of these economies. It must be noted that the appreciation of the Rupee to 43.50 levels in the latter half of 2004, was largely attributed to the weakness of the dollar against major currencies such as the Euro and the Yen and the positive sentiment on the back of the Yuan revaluation.

Capital flows and the Indian stock market: The movement of capital into Indian papers (debt and equity) also plays a dominant role in determining the exchange rate. It must be noted that, in the past couple of years, despite the trade deficit, Rupee has been appreciating largely due to money being poured into Indian equities by FIIs. Recently, the Fed rate hike and the outflow of money by the Foreign Institutional Investors (FIIs) have not only impacted the Indian stock markets but also the Indian currency unit.

Oil imports: Considering that India imports around 70% of the oil that it consumes, the impact of the same on the Indian currency assumes significant importance. Crude prices have been soaring to new heights and is consequently inflating India's oil import bill. Typically the Rupee is under considerable pressure at the end of every month as oil importers look to meet their payment obligations. This is because oil firms step up the demand for dollars, thus exerting downward pressure on the Rupee.

RBI intervention: It must be noted that in comparison to currencies like the Dollar and the Euro, which are determined by market movements, the Indian Rupee is 'partially managed' by the RBI. The 'Balance of Payments' crisis in the early 1990s, wherein the Rupee was 'devalued' is a case in point. The RBI has also, off and on, intervened in the Indian currency market, when the Rupee has exhibited signs of extreme volatility. For example, towards the end of 2004, when the Euro and the Asian currencies such as the Japanese Yen appreciated sharply against the US Dollar, it was the Reserve Bank of India (RBI) intervention that kept the Rupee from appreciating at a steep pace.

Political factors: Political instability, besides affecting the economy, affects the financial markets as well. A case in point to be noted is the elections in May 2004, when the Congress came into power. While the impact of the same on the stockmarkets is a well-documented fact, the Rupee was also largely affected by the same and as a result depreciated to 46 per US Dollar levels.

Impact on sectors...


While it is an almost impossible task in predicting the movement of the Rupee, considering the variables that impact the same, the impact of currency movement on the Indian economy and industry cannot be undermined. For example, the depreciation of the Rupee could further magnify the value of oil imports, as oil firms will now have to buy dollars at a much expensive rate. This in turn is likely to negatively impact the already widening trade deficit. That said, sectors focusing largely on exports such as software, pharma and textiles would benefit immensely from a depreciating Rupee. For example, a 1% change in the US Dollar rate affects the operating margins of the software sector by around 30 basis points. At the end of the day, while it is not easy to completely eliminate forex risks, it all boils down to what prudent risk management measures companies are adopting to hedge against the same.

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