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Fall of the rupee - as 'bad'as it gets?

Dec 2, 2011

The last few days have seen rupee falling to all time lows against the dollar. The question one may ask is: Why is rupee declining against dollar despite India doing better than U.S in terms of economic growth? While a part of this could be attributed to European debt crisis that led to relative appreciation in dollar (US$ rise against Euro), the rest of the damage was done by weak domestic fundamentals - rising inflation, interest rate hikes, a high fiscal deficit and FII outlows.

What it implies?

Apart from the direct hit on privileges like foreign education and foreign travel, the general public is going to be impacted in many round about ways.

To start with, the trend is bad for Indian companies that have an unhedged exposure to short term foreign debt liabilities, a major portion of which is denominated in dollar. This is because now these companies will have to shell out more rupees towards principal and interest payments. The fall of rupee could be double whammy for some companies that import raw materials as cost of imports (in rupee terms) will also increase.

The trend has already been witnessed in companies in energy sector. Despite some weakness in the crude prices, the oil and gas companies had to suffer due to relatively higher amount of rupee shelled out for dollar denominated crude and imported liquefied natural gas (RLNG). To remain viable, these companies will need to increase the end prices, the brunt of which will be borne by the end consumer. Take for example the increase in the cost of Compressed Natural Gas (CNG), Piped Natural Gas (PNG) and Lubricants.

Besides, a slide in rupee erodes value of Foreign Institutional Investors (FIIs) investments and can lead to FII outflow. This will reflect directly on the performance of stock markets, thus leading to losses for retail investors.

What to expect?

The reasons that have triggered the depreciation of rupee- the weakness in the global economy, especially the European debt crisis and weak domestic fundamentals suggest that it may take a little long before the decline is rupee is arrested.

Is it all negative?

The decline in rupee will be good for companies that are net exporters, tourism industry (international tourism), IT induatry, textile firms, gold investors and individuals who have invested abroad (in real estate/global funds etc.)

Damage Control measures

If Government ensures long term investment of foreign funds (FDI), it will take a lot of pressure away from rupee and spare it from speculative tendencies and FII vagaries. We believe that FDI in retail is one such step in the desired direction. However, this is just the beginning. For this to become possible, we need to make some long term policy reforms so that foreign players are enticed enough to invest in domestic sectors.

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