Investment Shastra

Falling Rupee: How does it hurt you?

The Indian rupee has depreciated by about 12% since July and touched the psychological mark of Rs 50 recently. A few reasons for this are:

  • The euro economic crisis, led by default concerns of Greece and the downgrading of two French banks has led to a loss of confidence in the Euro resulting in its devaluation against the dollar. This has also led to the dollar appreciating against other currencies including the rupee.
  • The global economic crisis has caused the investors in the developed markets to be wary of investments in emerging economies like India. And as a result FII’s have started selling their investments in Indian Markets and are converting their rupee investments back into dollar. This outflow of foreign capital has resulted in depreciating of Indian rupee against US dollar. (Net FII outflows in the months of Aug and Sept have been close to Rs. 14,000 cr.)
  • Also, due to the recent increase in the price of gold over a very short period of time there are fears of a bubble building in gold and hence investors do not perceive gold as a safe investment alternative. Due to these events investors have started viewing dollar as a safe currency.

How does a depreciating rupee impact the common man?

For consumers:

Products that are directly imported, such as crude oil, fertilisers, pharmaceutical products, ores and metals, or use imported components such as Personal Computers and laptops, become more expensive following rupee depreciation.

A major chunk of the components in computers, viz., processor, hard disk drive and motherboard, is imported. Products such as mouse, keyboard and monitor would also witness a discernible impact on their prices on account of rupee depreciation. As the input costs increase, inflation may rise in the economy.

Depreciating rupee thus has an adverse impact on the inflation in the Indian economy, which is currently a major cause of concern for the RBI and the Industry alike.

For companies:

a) Borrowing costs can go up:

Companies who have taken foreign currency loans will be adversely impacted. The borrowing cost on Indian Rupee has gone up in the recent months due to rising interest rates in India; however, the same is low in US. Hence, Indian companies have resorted to borrowing in US dollars to reduce the effective cost of borrowing. Indian companies have raised $ 21bn loans through external commercial borrowings form Jan – July ’11 as against $ 18bn for the entire year 2010. Significant levels of foreign currency-denominated, especially dollar-denominated loans will result in forex losses for companies with dollar loans, because of increased interest payout and principal obligations occasioned by the declining rupee.

For instance, if a borrower borrows $100 when the exchange rate was Rs 45 to a $, his original borrowing stands at Rs 4,500. After rupee depreciation to Rs 50 to a $, the same loan amounts to Rs 5,000. The increased Capital Outflow is 5000 – 4500 = Rs 500 or $ 11.11 (500/45). If the interest rate is 10 per cent, the additional interest turns out to be Rs 50 (5000-4500 = 500, 500*10% = 50) i.e. 1.11 per dollar borrowed (50/45). The rupee depreciation results in an incremental outflow of $12.22 (11.11+1.11) for this borrower.

b) Margins will be affected:

A depreciating rupee makes imports of component, capital goods and raw materials more expensive. As inputs and other equipment that are imported get costlier, margins get reduced to that extent. Companies with a high import component and those with foreign currency borrowings may be marked down in the stock market as the rupee depreciates.

On the other hand, companies that are export-driven may benefit in the form of better prices for the products and services sold. Let us consider the example of the IT sector.

The IT sector is among the major job creators in the Indian economy and a depreciating rupee spells good news for the sector. For Information Technology companies, services are billed mainly in dollars or in other foreign currencies. Any depreciation of the rupee pegs up their realisations and bodes well for their margins.

The worst affected will be the oil and gas companies and capital goods companies which are net importers. For these companies raw material is in $ terms and sales are in Rupee terms. So, depreciating rupee will have a very adverse impact as this will cause an increase in the cost of raw materials without any corresponding increase in the price of finished products.

For companies who have their revenues in foreign currency terms, especially the US dollar will be neutral to the extent that their increased borrowing cost will be covered by their increased revenues. If the increase in the revenues for these companies is higher than the increase in the borrowing cost, such companies can benefit from the rupee depreciation.

The falling rupee could also prompt FIIs to reduce their investments in the Indian stock markets as their investment returns reduce.

To summarise, a falling rupee hurts you in the following way:

  1. Prices of products –  especially oil – could go up hurting your wallet
  2. Investments in companies with foreign borrowings or which are exposed to currency fluctuations due to their business models can suffer.

Read more about Falling Rupee on:

http://businesstoday.intoday.in/story/rupee-fall-against-dollar/1/18929.html

http://articles.economictimes.indiatimes.com/2011-09-15/news/30160438_1_rupee-equity-markets-mecklai-financial-services

http://economics.about.com/od/moffattprize/a/trade_balance.htm

http://in.reuters.com/article/2011/09/29/idINIndia-59608120110929

Disclaimer: This publication has been prepared solely for information purpose and does not constitute a solicitation to any person to buy or sell a security. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations or needs of an individual client or a corporate/s or any entity/ies. The person should use his/her own judgment while taking investment decisions.

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