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Why rupee is falling

The Indian rupee on Friday depreciated to an all-time low of 50.69 against the US dollar in early trade on continued capital outflow by foreign funds and increased dollar demand from importers.

At the Interbank Foreign Exchange (Forex) market, the domestic currency was quoted at 50.69 against the dollar, down 23 paise from its previous day's close.

Dealers said concerns of capital outflows by funds and increased demand for dollar from importers caused the rupee to weaken. They added that the dollar's gains against other major currencies also weighed on the domestic currency.

So what are the other reasons for the fall of the Indian currency?
Higher crude oil prices too have weighed in on sentiment. Oil refiners are amongst the biggest dollar buyers in the Indian currency market and the demand especially is at the high towards the end of a month as they make the payments for their imports.

Even a dip in the inflation figure did not help the rupee rise slightly. Inflation declined to about a 15-month low of 3.36 per cent mainly due to fall in the prices food articles like fruit and vegetables, pulses, and some manufactured items, raising hopes of cuts in the key policy rates by the Reserve Bank of India.

Meanwhile, the outlook downgrade by rating agency Standard & Poor's too has increased the risk of further depreciation of the rupee in the near term. S&P cut its outlook on India's long-term sovereign credit rating to negative from stable on Tuesday, citing worsening government finances, which could raise firms' overseas borrowing costs and weaken the rupee.

Morgan Stanley has predicted that the rupee could test 52-53 levels in the next 4 to 6 months on balance of payments pressures.

Demand for rupees, simultaneously, has dipped because capital inflows are down. The American sub-prime crisis that shook the global financial markets has seen unprecedented bailouts and infusion of dollars into the US economy.

This infusion has been at a cost of many an emerging market, from where funds have been pulled out to plough back into America.

India has been one of the worst hit countries on this count, as foreign funds took flight, thereby making dollars scarce. The sudden and colossal demand for the US greenback has seen it strengthen, while the rupee's exchange rate has depreciated dramatically during the same period.

India's stock market regulator, the Securities and Exchange Board of India, has said that foreign investors sold more Indian shares than they bought.
Global funds are said to have sold Indian shares to the tune of over $12 billion more than they have bought during the last few months year.

As demand for dollars from importers increased and the US Treasury poured in hundreds of billions of dollars into the floundering US economy to bail out drowning financial giants, the Indian market saw an outflow of a huge amount of dollars leading to a spurt in the dollar price against the rupee.

The growing Indian trade deficit and the large fiscal deficit are also contributing to the fall of the rupee. The demand-supply balance and the fundamentals are against the rupee.

One more reason for the fall of the rupee, as propounded by some economists, is the overseas non-deliverable forward (NDF) market that is not sanctioned by the Reserve Bank of India.

An NDF is a non-deliverable forward contract where financial institutions buy forward dollars (that is, they book dollars now for delivery at a predetermined future date) in the Indian market and at the same time sell a similar amount of dollars in an overseas market -- or vice-versa -- so that on the delivery date they make a profit or loss, which is the difference between both the rates.

The recruitment process for these jobs is expected to start soon.

How can India control the value of the rupee in the international market?
The Reserve Bank of India can sell dollars in the open market to bring down the value of the US greenback, albeit slightly.

Normally, the RBI uses its Monetary Policy to defend the rupee's value. Short-term interest rates changes do impact the value of the rupee against other currencies. But, the RBI has mostly used the policy to stabilize internal conditions, like steps to control rising inflation.

However, if the Indian stock markets boom -- like they did in 2007 -- more global funds would begin to invest in India thereby strengthening the rupee as the demand for the dollar in the local markets drops.

What has the RBI done?
The Reserve Bank of India is closely monitoring the developments in the global as well as domestic financial markets and stands ready to take such pre-emptive action as may be necessary to contain excess volatility in the domestic financial markets.

In order to alleviate these transient pressures which are related largely to external developments, the RBI has decided to take the following measures:

(a) Forex Market
In the light of current developments in the foreign exchange markets, as on some previous occasions, the Reserve Bank will continue to sell foreign exchange (US dollar) through agent banks to augment supply in the domestic foreign exchange market or intervene directly to meet any demand-supply gaps. The Reserve Bank would either sell the foreign exchange directly or advise the bank concerned to buy it in the market. All the transactions by the Reserve Bank will be at the prevailing market rates and as per market practice.

(b) Interest Rates on FCNR (B) Deposits
Currently, the interest rate ceiling on FCNR (B) deposits of all maturities has been fixed at Libor/Euribor/Swap rates for the corresponding maturities minus 75 basis points for the respective foreign currencies. In view of the prevailing market conditions, it has been decided: to increase, with immediate effect, the interest rate ceiling on FCNR (B) deposits by 50 basis points, i.e., to Libor/Euribor/Swap rates minus 25 basis points; and to increase, with immediate effect, the interest rate ceiling on NR(E)RA deposits by 50 basis points, i.e., to Libor/Euribor/Swap rates plus 50 basis points.

But why do currency values fluctuate?
There are many participants in any foreign exchange market. These entities -- like banks, corporations, brokers, even individuals -- buy and sell currencies everyday.

Here too the universal economic law of demand and supply is applicable: when there are more buyers for a currency than sellers, its exchange rate rises.

Similarly, when there are more sellers of a particular currency than buyers, its exchange rate in the global markets will fall. This does not mean people no longer want money; it only means that people prefer to keep their wealth in some other form or another currency.