Fluctuations in India’s Rupee Rate and Its Economic Impact

Rupee appreciation makes imports cheaper and exports more expensive. According to intelligence reports by the Associated Chambers of Commerce and Industry of India, sectors like petroleum and petroleum products, drugs and pharmaceuticals and engineering goods – which have import inputs of as much as 77 percent, 19 percent and 21 percent, respectively – will gain if the rupee appreciates. They would have to pay less for the imported raw materials which would increase their profit margins.

Likewise, a depreciating rupee makes exports cheaper and imports expensive. So, it is good news for industries such as IT, textiles, hotels and tourism which generate income mainly from exporting their products or services. Rupee depreciation makes Indian goods and services cheaper for overseas buyers, thus leading to increases in demand and higher revenue generation. The foreign tourists would find it cost effective to come to India, therefore increasing the business of hotel, tours and travel companies.

India’s IT sector is dependent on foreign clients, especially the United States, for more than 70 percent of its revenue. When an IT company gets a project from a client, it pre-decides on the length of the contract and the cost of the project. The contracts with U.S. clients are usually quoted in U.S. dollar terms. So, the fluctuation in the exchange rate can bring about a considerable difference in the performance of a company.

Some companies undertake a range of measures like hedging exchange risks using forwards and futures contracts. This helps in mitigating some of the losses due to exchange rate fluctuations, but none-the-less the impact is substantial.

The exchange rate is a significant tool that can be used to examine many key industries; with fluctuations potentially having a serious impact on the economy, industries, companies, and foreign investors. Rupee appreciation is generally helpful for industries which rely closely on imported inputs while depreciation of the rupee is welcome news for industries which are exporting a majority of their products.

Determination of Exchange Rate and its Fluctuations Like other prices, exchange rate also changes with the changes in the state of market. Just as other prices depend on supply and demand, exchange rate also depends on the configuration of forces of supply and demand. However, two important facets have to be noted: (i) Unlike goods and services, foreign exchange has no direct cost of production. It has only opportunity cost. Import bills have to be paid through export earnings. So cost of production of exportable surpluses may be taken to constitute the direct production cost of exports and indirect cost of imports. Opportunity cost is accounted by with drawl of exportable surplus from domestic consumption. Fluctuations are a natural characteristic of foreign exchange rate market, provided that the exchange rate is not an administered price. If exchange rate is an administered price, it is determined administratively by the central bank of the country. Administered foreign exchange rate is generally endowed with stability as both demand for and supply of foreign currency is under the control of central bank. Exchange rate, on the whole, fluctuates like other prices, which generally varies with change in demand and/or supply. Imports, foreign aid, investment in other countries and remittance of profits abroad are the major sources of demand for foreign exchange. Export earnings, foreign investment in the domestic market, foreign aid from other countries and receipt of remitted profits from other countries, remittance of NRI earnings are the major sources of supply of foreign exchange. A change in any of these brings about a change in supply and demand for foreign currency. But imports and exports are the major sources of demand and supply of foreign exchange. Demand for foreign exchange increases with imports, investment in other countries, profits remitted to other countries and foreign travels etc.

The mechanism of determination of exchange rate may be distinguished broadly into two categories: administered and market based. Besides, in second category, outflows of exchange may be under full convertibility on revenue and/or capital account. Under administered price regime, fluctuations in exchange rate are not associated with the official rate; black market rate does show fluctuations. In market oriented exchange rate regimes, central bank may be induced to intervene if the rate moves in a non-acceptable band. The intervention occurs through the sale and purchase of foreign currencies by the central bank in the market. Subject to this limitation, market based exchange rate fluctuates on day to day basis. These changes comprise both benefits and losses to individuals, organizations, and economy. International travelers, for example, will gain if the value of their domestic currency falls, while an appreciation will inflict loss. Export and Import houses and service providers for international business, such as shipping, insurance and banking companies also loose or gain in the market due to rate fluctuations. The companies, making huge investment in international business, may lose or gain relatively more. Quantum of in and outflows of foreign investment will naturally be directly affected by rate fluctuations which, in turn, will affect stock market. Fortune of the corporate houses in general and export and import houses in particular is affected directly. If the Indian rupee appreciates, it will have diametrically opposite effects. Gross terms of trade and exchange earnings will rise per unit of exports. However, overall export earnings may be adversely affected as Indian exports may lose an edge in international market due to rise in prices. It may ultimately become counterproductive. All such changes, taken together, affect the economy, business and growth. The study focuses specially on the effect of exchange rate fluctuations on export earnings, imports and output of different sectors of the economy.

Under the recent economic reforms in India, not only have we liberalized the Industrial sector but have also opened up the economy, made our currency convertible and allowed exchange rate to adjust freely. It is important to understand the full implications of opening up the economy and allowing our currency to ‘float’.

It is worthwhile to note that under a fixed exchange rate system when citizens of a country spend some of their income on imports it reduces the value of multiplier because imports, like savings and taxes, serve as a leakage from the circular flow of income. On the other hand, exports, like investment and Government expenditure, raise the aggregate demand for domestically pro¬duced goods and services and thereby cause an expansion in output through a multiplier process.