Local currency depreciation – Do we have a panacea?

When Indian currency is witnessing the worst ever depreciation, it remains interesting to explore what measures could help finance ministry to contain the same. As depicted in the diagram, Indian Rupee has depreciated by almost 13-14% against dollar and that has further jeopardised the actions of Indian Finance Ministry which was juggling hard already to improve India’s GDP, which managed to remain in the range of 5% to 6% in the FY2012-13.
 
Among various effects that India has witnessed due to such sliding local currency depreciation, it poses intriguing challenges to see how India would react to oil imports and what measure would it take curb the sliding local currency phenomena.
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Before discussing various measures which Indian Finance Ministry would take and have taken, let us shift the lens over the fact as to what exactly has led to depreciation of local currency.
Quoting the very fundamental law of economics, if the demand for the dollar in India is more than its supply, the local currency is deemed to depreciate against dollar. Dollar demand is primarily realised by two means. Firstly, dollar demand is created by importers requiring more dollars to pay for their imports and secondly this scenario may surface when Foreign Institutional Investors (FIIs) withdraw their investments i.e. take away dollars outside India. Both these phenomena lead to shortage of Dollars in country resulting in demands for dollars. The contrary scenario is realised in case of increasing exports and FIIs investments.  Moreover there exists another grave school of thought that it is not Indian rupee that is depreciating but it is dollar that is getting stronger. The main reason behind strengthening of dollar is the fear of Federal Reserve tapering its Quantitative Easing has hit all the assets class. Also US economy is poised to gain firmness with the rising expectations that Federal Reserve will withdraw its stimulus package soon which is in turn underpinning the US dollar index.
 
While discussing Indian rupee depreciation, we can hardly afford to miss to analyse the behaviour of crude prices as India is a net importer of crude dealing in mammoth quantities. India has had the dual blow because the same time when its local currency was depreciating, the crude prices were also witnessing highly volatile trends, in both Brent and WTI categories. WTI realised price augmentation of the order of 12% whereas Brent realised as high as 9% increase in price. Amid various measures that were being taken by Indian Finance ministry, the crude price has exerted tremendous stress on the Indian Rupee. Ever increasing requirement of oil and the fact the oil prices are quoted in dollar, have only left Indian Finance ministry to tighten the oil imports and try to reduce demand for dollars in local market. As prominent from the table (Source – Petroleum Planning and Analysis Cell), India has decreased substantial oil imports from the month of May’13 to June’13 i.e 18-20% leading to saving in dollars of the order of 1700 crore. This is indeed the first step towards controlling the dollar demands.
 
Another substantial move from Indian finance ministry is being realised with the suggestion of calculating the under recoveries on the basis of export price parity formula rather than import price parity. Currently, in import price parity, 2.5% customs duty was adding to the under recoveries of the state run oil marketing companies without contributing any revenue to the exchequer. By changing the pricing methodology, the finance ministry could realise the cut in cash outflow as big as Rs. 18, 000 crore in the current fiscal year. Though this move has faced critical opposition from the OMCs, it aims to reduce the subsidy bill and add relief to staggering Current Account Deficit (CAD).
 
Hence Crude oil prices, in the scenario when oil dominates the import basket commodities of India, would play crucial role in coming future to help India curb the depreciating local currency.
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Local currency depreciation – Do we have a panacea?

by Tushar Shah time to read: 3 min
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