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 45 per US dollar in July 2011, the rate now stands at above Rs 52.

Data Source: Oanda.com
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.

By the way, if you have any other question regarding the rupee, email it to me, and I will try to answer it.

Let’s get started.

1. When the rupee moves from 45 per US dollar to 52 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 45 pieces of potatoes. Tomorrow, 1 US$ can buy 52 pieces. Doesn’t 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 45 rupees today, and 52 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?
Well, 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 5,200 and get US$ 100 in return (since US$ 1 = Rs 52 currently).

Now assume, the rupee depreciates to Rs 55 per US$, and you again need to buy 1 barrel of crude oil. Now you need to give the bank Rs 5,500 to get US$ 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 55 per US$, from Rs 52 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 52, as against Rs 45 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 5,200 because the rupee has depreciated to Rs 52 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.

Given the deepening crisis in Europe, 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.

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.

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.