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5 Questions on Rupee Depreciation…Answered

The past few months have seen a sharp depreciation in the value of Indian Rupee against the US Dollar (US$). From about Rs 53 per US dollar in early-May 2013, the rate now stands around Rs 60.


Data Source: Yahoo Finance

I have been facing a lot of questions from friends and readers of The Safal Niveshak Post asking for explanation of rupee’s depreciation and its impact on their investments.

While I am not an expert on the currency market, here are my answers to five key questions on rupee’s depreciation and how it impacts you as a consumer and investor in Indian stock markets.

1. When the rupee moves from 50 per US dollar to 60 per US dollar, why do we call it ‘depreciation’ and not ‘appreciation’ given that the rupee has risen against the dollar?
Let’s replace rupee with potatoes. Today, US$ 1 can buy 50 pieces of potatoes. Tomorrow, 1 US$ can buy 60 potatoes.

This means that potatoes have gotten cheaper since you can buy more pieces for the same US$ 1 Alternatively, it means that potatoes have depreciated or declined in value.

The same is true for the rupee. When US$ 1 can buy 50 rupees today, and 60 rupees tomorrow, it means that the value of the rupee has depreciated or declined. On the other hand, if the Rs per US$ rate moves from 45 today to 40 tomorrow, it means that the value of the rupee has appreciated or risen against the US dollar.

2. Everyone is saying that the depreciating rupee will make things expensive. How?
The rupee depreciation will not make just about everything expensive. It will only make those things expensive that we import from outside India.

Crude oil (that is used to make petrol, diesel, kerosene and LPG) is one such commodity that we import in huge quantities. Let’s assume you can buy 1 barrel of crude oil for US$ 100 today. But you don’t have US$ 100 with you. So you go to a bank, pay it Rs 5,000 and get US$ 100 in return (assuming US$ 1 = Rs 50 currently).

Now assume, the rupee depreciates to Rs 60 per US$ (as it has), and you again need to buy 1 barrel of crude oil. Now you need to give the bank Rs 6,000 to get US$ 100 in return to pay for oil.

While the international oil price has remained at US$ 100 per barrel, it has still gotten expensive for you to buy it because the rupee has depreciated to Rs 60 per US$, from Rs 50 earlier.

Now convert 1 barrel of oil with everything we import in India. Rupee’s deprecation would mean that these imported things will become expensive for us.

As for oil, since we consume it in so many places – for cooking, transportation, and power generation – these will also become expensive due to rupee’s depreciation against the US dollar.

Alternatively, when the rupee appreciates against the US dollar, our imports (like crude oil) become cheaper.

3. What about things that India exports?
With depreciating rupee, exports will become lucrative for Indian companies. This is simply because every US$ 1 of export income can now be converted into Rs 60, as against Rs 50 earlier.

So even when a company earns US$ 1 from exporting one unit of its product (like it was earning earlier), its income will increase in Indian rupee terms.

All in all, depreciating rupee is bad for companies that import things and good for companies that export. Alternatively, appreciating rupee is good for companies that import things and bad for companies that export.

By the way, one negative impact that companies feel when rupee depreciates is on their foreign borrowings. Suppose a company borrowed US$ 100 in 2010 and then converted it into Rs 4,500 (at Rs 45 per US$) to spend on its expansion. Now, when it has to repay that loan of US$ 100, it needs to pay the bank Rs 6,000 because the rupee has depreciated to Rs 60 per US$.

So, in an environment of depreciating rupee, companies with US$ borrowings face a negative impact on their balance sheets.

4. But what determines whether the rupee depreciates or appreciates against the US dollar or any other currency?
It’s simply demand and supply. If people demand more of a thing while its supply is low, the price of the thing will rise, right?

On the other hand, if something is in excess supply in the market as compared to demand, the price of that thing will fall.

This also holds true for currencies. When supply of rupee rises while demand falls, the value of the rupee depreciates (like it is depreciating now).

As far as the current rupee depreciation is concerned, it is large a result of appreciation of US dollar than any inherent weakness in the rupee.

A lot of money is finding its way through to the safety of the US dollar (yes, despite all the problems in the US, the dollar is still the safest paper currency in the world!).

What this means is that the demand for the US dollar is rising. Thus the dollar is rising in value, and subsequently the rupee is facing a downward pressure.

Another reason for the pressure on rupee is massive selling by foreign institutional investors. Foreigners, who had invested in Indian stocks, are pulling out money and thus demanding dollars that they can take back home. This is adding to the rupee’s fall.

The circle of vicious. When foreigners sell in Indian rupee and demand US dollars to take back home, it pulls the rupee down. And before the rupee gets pulled down even further, the foreigners would like to sell even more, which would add to the pressure on the rupee.

5. Does the rupee depreciation impact stock market investors?
Yes. As we discussed above, rupee’s depreciation negatively impacts imports. Thus, Indian companies that import a lot of raw materials will face pressure on their profits if the rupee continues to weaken against the US dollar, or even if it remains at the current weak levels.

The companies that import oil derivatives (crude or palm oil) as raw materials – like those from the paint, plastics and FMCG industries – will be especially hurt on their margins in the short to medium term.

Also, companies that have foreign borrowings on their books will see a negative impact on their profits.

On the other hand, Indian companies (like those from the IT and pharmaceutical sectors) that are major exporters, will benefit from the falling rupee.

So, overall, while rupee’s current depreciation is bad for you as a consumer or an investor in companies that import a lot, it is good if you own a software company or are an investor in one of them.

Also, if you are an Indian working abroad and earning US dollars, you can remit more rupees to your dependents in India. 🙂

Can things get dangerous?
I hate predicting, especially the future! 🙂

But if I were to venture a guess, I remember reading about the impact of currency volatility on South Asia in 1997. India was spared then, given our dealings in foreign exchange were not big enough.

As things stand now, the rupee is more closely related to the US dollar than ever.

This is especially true of the Indian stock market, which largely depends on the mood of foreign investors, especially in the short term.

Much of the growth we have seen over the past few years has been caused by artificial liquidity (cheap and easy money) flowing around the world, which is not a sustainable situation in the long run.

So, a sharp mood swing of the foreign punter, coupled with low levels of confidence of Indian investors, and we may find ourselves in a crisis of sorts.

Remember, we side-stepped the Asian financial crisis in 1997, and were not majorly impacted even in 2008.

This makes us as vulnerable as the drunkard who has no experience of falling in the manhole, and thus has a weak defense mechanism to avoid falling into one.

Sadistically, as an investor, I hope we fall…so that assets I am eyeing are available at prices I want to buy them. 🙂

But I still hope we don’t fall hard! Amen.

This article was originally published in November 2011. I have updated it to capture the recent depreciation of the Indian Rupee.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Suresh K Perumalla says:

    Hi,

    Thanks for the clarification.. A very good explanation !!!
    I am weekly reading all the articles and really helpful for a techy like me who is not good on Financial knowledge..

    Regards,
    Suresh K Perumalla

  2. Vishal Khandelwal says:

    Hi Suresh,

    Thanks a lot for your kind words, and thanks for reading the articles! I hope they are helpful to you.

    Regards,
    Vishal

  3. richfellow says:

    Very good article vishal, i appreciate ur simple and crisp writing.

    • Vishal Khandelwal says:

      Hi Richfellow,

      Thanks a lot for your feedback! I hope my articles continue to be helpful for you.

      Regards,
      Vishal

  4. bharti patel says:

    thanx sir,its really understanmdable and knowlegable

  5. nice explanation. thanks

  6. Hi Vishal
    article is really helpful, thanks
    regds
    deepak

  7. Hi,

    I am working abroad . By sending money at this time to my country , Am I doing anything wrong for our economy here ? Will it depreciates the money further ? Please clarify

    • Hi Mouli, if you are sending US dollars to India, know that your family here will receive more dollars for the same number of dollars you were sending earlier. As far as the depreciation of the rupee in absolute terms is concerned, yes it is anyways getting depreciated due to high inflation in India.

    • praveen says:

      By sending you are helping the country, the desperate need to have Dollars is supported by your action.
      this is one of the reasons why NRIs are paid higher bank deposit rates.

  8. Dear Vishal,

    Nice explanation. I would like to add the following:

    1. For an Indian Individual Resident, who is going to earn in Indian rupees and spend in Indian Rupees. The exchange rupee does not matter directly. Yes, he does pay a higher or lower charges for imported items which is partially reflected in the form of Inflation (import examples are Oil, Gold, Raw materials, Finished Electronics etc.).

    2. For an Individual Indian Resident, who earns in Indian Rupee but having some plans to spend in some other currency like Dollar in the future (example: Education for self or children in future), while carrying out his financial plan, he need to take into consideration of the depreciation or appreciation of currency that could happen. Had you planned at a exchange rate of 48 and the rupee raises to 38 (as it did some years before) you will be spending less for that foreign education. On the contrary, if one planned at exchange rate of 48 and rupee reaches 57 (like now), you need to pay more that sometimes become a tough ask.

    3. For a NRI, who earn in dollar and saves in / spends in dollar. It does not matter at all.

    4. For a NRI, who earns in dollar and saves for his retirement in rupees for a future settlement in India and to spend in Rupee. The ideal way is to to systematically transfer funds into India on regular basis without bothering much about exchange rates and invest in appreciating long term investments such as mutual funds / stocks etc. (again systematically). The appreciation in the Indian funds will take care of the end needs of the NRI thereby eliminating the risk of exchange rates. For expenses in Dollar, he might choose dollar based investments and other avenues. If he/she chooses to invest in Indian rupees for dollar expense, then he/she need to account for the exchange rate appreciation or depreciation in arriving at the target value for the goals.

    For an individual, it is very difficult (almost impossible) to time and benefit out of exchange rate. You may be successful sometimes but not always. Therefore, the end use of the funds and its currency should determine your choice of currency and investments you hold.

  9. Thanks Vishal for the detailed explanation.
    Also the current account deficit and policy paralysis has added to the woes.

    Regards,
    Jana

  10. Hi,

    Recently we are imported machines from china to india,the shipping agent charged Rupees Depreceiation to me too much,only shipping agent is charged this amount,we need to pay this charges to shipping agent only not to government,we don’t know why they are charged this amount to me,please explain about this.

  11. Currency depreciation is an indicator of lower confidence (in the depreciating currency country) of foreign entities. It is more a reflection of what all we have just simply continued to procrastinate about like FDI (as if hundreds are lined up and they will colonise India), Now that things are coming to a head suddenly wisdom is being found in raising FDI limits etc which is nothing but an excuse to do what should have been done in any case. (This is similar to blaming the unfortunate and sad Uttarakhand calamity only to Nature’s fury and building of dams without punishing those who conveniently looked the other way all these years and now these very people will be corrupt beneficiaries of the large amounts that would be needed in re-building.)
    As an investor depreciation of a currency indicates economics of a country is not what it should be. It means policies and thinking is in some other direction rather than the logical direction. That is what should worry a domestic investor.
    I too am waiting and watching and also buying small amounts.

  12. Neet Arora says:

    Dear Vishal , can you please explain the impact of FII’S pulling out money / rupee depreciation on bond yields too ?

  13. Sreedhar says:

    Very nice Article Vishal! You have explained it in a very simple language. Couple of points:

    1. Its surprising that even with QE (which means Fed was printing more $ and which means more supply) dollar never really depreciated. But in the current scenario probably there is talk of withdrawing QE and hence the increase in demand and strengthening of the dollar.

    2. How this is impacting imports and exports explains the widening CAD which is again not good in the long run.

    3. Finally, for most Indians Gold is still the best investment and safest asset! They will not care about rupee depreciation and say “dekho abhi bhi gold prices kitna jyada hai, girta hi nahi hai” In reality gold has done quite badly this year.

  14. Mahender says:

    Thanks a lot Vishal for sharing with us.
    Got a picture of how rupee dollar is related and their impact our companies / markets.

  15. Well written, crisp and very informative. Thanks a lot.

  16. really worth reading,, thanks for the information,, its really gud knowledge

  17. prashanth says:

    First of all FII should not have been allowed to invest in India, then there would have been no pulling of FII selling their stakes to pull US dollars from india.

    India should ban all FII in future, so that there would be no FII selling their stakes and creating rupee devaluation., India would be a economy on its own devoid of what USA dollar does.

  18. abhijeet says:

    Vishal, may you explain that how rising power US economy co relate with deprecating Indian currency?

  19. Nice explanations for all the questions….very thankful….and i have a doubt that why we are ready to pay more for CALIIFORNIA ALMONDS,WASHINGTON APPLES & SPANISH OLIVES is it only because of rupee depreciation against USD ?

  20. Thank You Sirji. Very nicely and easily explained. Thanks again.. 🙂

  21. Hi i need some urgent help…. how has the rupee depriciation impacted the FMCG sector, a lil more in detail.

    Thx.

  22. Sam Sengupta says:

    1. How realistic is it that the INR will appreciate against the USD in the Medium Long Term? I think it is zero
    2. What will be the impact of a total ban on import of gold and other non essential items – Economically and socially?
    3. India is loosing out very fast on the backend processing/outsourced services industry to newer players like the Philipines. Do you see any alternatives? If so what? This will impact the BOT negatively and hence inflation.
    4. There will always be a lag between the rate of inflation and wage increase. Especially for the people in the finge of poverty. What is the socio-economic impact/solution?

  23. very well explained. One question I have in my mind. If there is high demand for a product, woudn’t number of suppliers will increase and competetion between the suppliers would bring down
    the price?

  24. kalpana ravi says:

    thanks for your wonderful explanation as i was finding it a bit difficult to understand certain terms………..
    as a housewife it is difficult for many of us if the rupee value continues to depreciate….

  25. sir, does rupee depreciation has positive effect on economy??pls rply

  26. thanks nice explanation

  27. Hi Vishal sir.,
    Your article is really very helpful and has cleared many things that were obscure to me. But can you explain me one thing……
    What if (just suppose) 1 USD = 1 Rupee, then what will be its impact on Indian economy? Will it effect in the price of goods that are produced in India?.

  28. Hey,
    thats a very good explanation in very simple words, I appreciate your website, I will bookmark it.

    Thanks for the information.
    -Shilpa

  29. mayank malhotra says:

    Nice explantaion thank u

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