COMMENTARY

the benchmark rates have crossed the

Recent Downfall of 2% mark for the first time since 2008.
It noted,
the Indian Rupee the labor market has continued to strengthen,
and that economic activity has been rising
at a strong rate. Job gains have been strong,
Parthapratim Pal, Partha Ray on average, in recent months, and the un-
employment rate has stayed low. Household
spending and business fixed investment

Assessing the trends in India’s
balance of payments, it is argued
that a combination of substantial
trade deficit and a significant
current account deficit financed
predominantly by fickle portfolio
investments could have made the
rupee vulnerable to the moods
of the global capital market.
India’s huge dependence on oil
imports along with high gold and
electronic imports could also have
played their roles in making the
exchange rate volatile.
T
he exchange rate of the Indian
rupee has always been an emotive
issue in India and has often tended
to have generated more heat than light.
The current episode of the downfall of
the rupee is no exception. After all, the
movement of the Indian rupee/United
States (US) dollar exchange rate from
less than `65 in early April 2018 to
almost `73 by the end of September 2018
has turned out to be substantial. Owing to
the underlying issues, opinions in this
context have a tendency to differ sub-
stantially. Is it entirely due to the global
instability created by US President Donald
Trump’s sabre-rattling of the trade war
with China? Is it a result of the begin-
ning of tightening monetary policy cycle
in the US? Is it a reflection of the conta-
gion of the crisis in Turkey? Or, is it an
outcome of the inherent weaknesses of
the Indian economy with high imports
of gold and huge dependence on oil?
Dollar Strengthening
There is a view that the depreciation of
the rupee has been the result of a general
appreciation of the dollar across all cur-
rencies. This appreciation of dollar is a
fallout of the tightening of monetary
policy by the Federal Reserve (Fed) in
have grown strongly. (US Fed 2018)
This monetary tightening by Fed is a
key factor which is leading to a general
appreciation of the dollar across all major
currencies. Other policies like loose fis-
cal policy and increasingly protectionist
trade measures are also helping the rise
of the dollar (Ahmed and Thorne 2018).
But, the downfall of the rupee is not
limited to the dollar. In fact, the rupee
has indeed depreciated with respect to
all four major currencies since April 2018
(Figures 1A and 1B). However, it is
important to highlight that the recent
slide of the rupee has been sharper than
most other currencies from the emerg-
ing market with the exception of the
Argentinian peso or the Turkish lira. In
fact, this year, the rupee has depreciated
Figure 1: Nominal Exchange Rate of INR with
Respect to Major Currencies
(A) Daily Nominal Value of Rupee vis-à-vis Some Major
Currencies of the World
60
70
US dollar Japanese yen
80
Euro
90
Pound sterling
100
13 July 2018
6 Apr 2018
20 Apr 2018
4 May 2018

1 June 2018
15 June 2018

27 July 2018
10 Aug 2018
24 Aug 2018
7 Sept 2018
21 Sept 2018
18 May 2018

29 June 2018

recent times. During the financial crisis

of 2006–08, most developed countries,
including the US adopted an expansion- (B) Relative Movement of Rupee vis-à-vis Some Major
ary and accommodative monetary policy Currencies of the World (base = 4 April 2018 =100)
which led to a nominal depreciation of 95
Pound sterling
the dollar. But, over the last year, the
100
US economy has been showing signs of
healthy growth. The job figures are 105
pointing towards historically low un- US dollar Japanese yen
110
employment figures and the gross do- Euro
mestic product (GDP) is poised to grow 115
6 Apr 2018
17 Apr 2018
26 Apr 2018
9 May 2018

17 July 2018
18 May 2018
29 May 2018
7 June 2018

27 June 2018
6 July 2018

26 July 2018
6 Aug 2018
16 Aug 2018
29 Aug 2018
7 Sept 2018
19 ept 2018
18 June 2018

Parthapratim Pal (parthapal@iimcal.ac.in) close to 3% in 2019 (IMF 2018). Conse-

and Partha Ray (pray@iimcal.ac.in) are with quently, the US Fed has started pushing
the Indian Institute of Management Calcutta, up the reference interest rates and with Vertical axes values are in reverse order.
Kolkata.
the recent increase on 26 September, Source: Reserve Bank of India (RBI).

12 OCTOBER 13, 2018 vol lIiI no 41 EPW Economic & Political Weekly
 COMMENTARY

Figure 2: Nominal Effective Exchange Rate and Real Effective Exchange Rate of India dollar is sharp, and there are mounting
(Six country trade weight-based index, base = April–March 2016–17 = 100) pressures both from the current and the
106
capital accounts, which are posing serious
104 challenges for policymakers.

102 NEER Widening Current Account Deficit

But, is the downfall of the rupee a mystery?
100
After all, traditionally India has been a
98 current account deficit economy and the
current account deficit has increased
96
REER sharply over the last few quarters. While
the average quarterly current account
94
deficit for the four quarters of 2015–16
Apr 2015

June 2015

Aug 2015

Oct 2015

Dec 2015

Apr 2016

June 2016

Aug 2016

Oct 2016

Dec 2016

Apr 2017

June 2017

Aug 2017

Oct 2017

Dec 2017

Apr 2018

June 2018

Aug 2018
Feb 2016

Feb 2017

Feb 2018
was around $5.54 billion, the average
current account deficit for the last three
Upward/downward movement of the graph shows appreciation/depreciation of INR vis-à-vis the currency basket. quarters (2017–18: Q3, 2017–18: Q4 and
Source: RBI.
2018–19: Q1) had reached $14.2 billion
by 12% against the dollar which makes it February 2016 to April 2017, it appears (Table 1). This rapid rise of current
the worst performer among the Asian that both the NEER and the REER were account deficit in the last three quarters
countries (Patnaik 2008). showing an appreciating trend. (iii) From can be largely attributed to the rapidly
April 2017 to December 2017, the trend growing deficit in merchandise trade.
Nominal and Real Rates of the first period was repeated, that is, While the balance of trade in services has
But, what is influencing the value of the the NEER declined but the REER remained remained strongly positive, it has been
rupee? Is there any disjoint between the stable. (iv) Since December 2017, there showing a stagnating trend since Q1 of
real and nominal exchange rates of the has been a steady decline of both the 2015–16. Net private transfers (mostly
rupee? The monthly six-country trade REER and the NEER. remittances) have remained resilient over
weight-based nominal and real effective What is also notable from the graph the same period. Stability of remittanc-
exchange rates (NEER and REER) of India is that despite the sharp decline of es perhaps indicates that despite a wid-
since April 2015 (Figure 2) were exam- the REER, its value in August 2018 is ening current account deficit, there was
ined and admittedly, the REER and the still higher than what it was during no widespread build-up of expectations
NEER have not always moved together February–June 2016. It is possible that in of depreciation of the rupee. Generally,
since April 2015. Several phases can real terms, the present slide of rupee may an expectation of depreciation among
be discerned. be partly due to a correction of a phase the expatriates can lead to a temporary
(i) For the period from April 2015 to of nominal and real appreciation it expe- drop or even reversal in remittances
January 2016, the NEER depreciated but rienced in 2016. However, the current flow. This has happened before in India.
the REER remained largely stable. (ii) From depreciation of rupee with respect to Despite a growing current account defi-
cit, such a trend is not evident from the
Table 1: Select Items of India’s Current Account in Balance of Payments ($ billion)
2015–16 2016–17 2017–18 2018–19
data this time.
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 How does India’s current account deficit
Merchandise -34.2 -37.2 -34 -24.8 -23.8 -25.6 -33.3 -29.7 -41.9 -32.5 -44 -41.6 -45.7 look vis-à-vis other comparator econo-
Invisibles 28 28.6 26.9 24.4 23.4 22.1 25.3 27.1 27 25.5 30.3 28.6 29.9 mies? It is well known that most of
o/w: Services 17.8 17.8 18 16.1 15.7 16.3 17.8 18.5 18.3 18.4 20.7 20.2 18.7 India’s East Asian neighbours, led by
o/e Software services 17.5 18.1 18.6 17.3 17.6 17.6 18.0 17.5 17.5 18.0 18.2 18.6 18.4 China, tended to follow an export-led
o/w Private transfers 16.3 16.4 15.3 15.1 14.2 14 14 14.4 14.6 15.8 16.2 16.4 17.2 growth and industrialisation strategy,
Current account -6.1 -8.6 -7.1 -0.3 -0.4 -3.5 -8.0 -2.6 -15.0 -7.0-13.7 -13.1 -15.8
and consequently, countries like China,
Source: RBI.
Malaysia and Thailand have current ac-
Table 2: Current Account Balance of Select Countries (% of GDP) count surplus (Table 2). Russia, of course,
2010 2011 2012 2013 2014 2015 2016 2017 2018 (P) has current account surplus because of
China 3.9 1.8 2.5 1.5 2.2 2.7 1.8 1.4 1.2 oil. Among other BRIC (Brazil, Russia,
Malaysia 10.1 10.9 5.2 3.5 4.4 3.0 2.4 3.0 2.4 India, and China) countries both Brazil
Thailand 3.4 2.5 -0.4 -1.2 3.7 8.0 11.7 10.8 9.3
and India have current account deficit.
Russia 4.1 4.7 3.2 1.5 2.8 5.0 2.0 2.6 4.5
Two key points need to be noted here.
Brazil -3.4 -2.9 -3.0 -3.0 -4.2 -3.3 -1.3 -0.5 -1.6
First, notwithstanding recent deteriora-
Turkey -5.8 -8.9 -5.5 -6.7 -4.7 -3.7 -3.8 -5.5 -5.4
tion in India’s current account deficit, the
India -2.8 -4.3 -4.8 -1.7 -1.3 -1.1 -0.7 -2.0 -2.3
P: IMF projections.
situation is not as bad as the one during
Source: World Economic Outlook Database, IMF, April 2018. the period of taper tantrums. Second,
Economic & Political Weekly EPW OCTOBER 13, 2018 vol lIiI no 41 13
COMMENTARY
Figure 3: Imports of Petroleum, Electronic Goods and Gold (million $) pressure on international oil prices. The
45,000 -
40,000 -
Organization of the Petroleum Export-
35,000 - ing Countries (OPEC) has indicated that
30,000 -
25,000 - it is not going to increase production to
20,000 - compensate for the loss of supply from
15,000 -
10,000 - Venezuela and Iran. The Oil Market
5,000 -
0-
Report for September 2018 by the Inter-
national Energy Agency (IEA) indicates
July 2016

July 2017

July 2018
Jan 2016

Mar 2016
Apr 2016
May 2016
June 2016

Aug 2016
Sept 2016
Oct 2016
Nov 2016
Dec 2016
Feb 2016

Jan 2017

Mar 2017
Apr 2017
May 2017
June 2017

Aug 2017
Sept 2017
Oct 2017
Nov 2017
Dec 2017

Apr 2018
Feb 2017

Jan 2018

Mar 2018

May 2018
June 2018
Feb 2018
that the demand for oil is going to be
resilient in the near future. Given these
Petroleum Gold Electronics Total imports
developments in the global oil market,
Source: Ministry of Commerce.
it is expected that oil prices will stay
Figure 4: Oil and India’s Trade Deficit at a fairly high level in the short to
(A) Oil, Non-oil in Merchandise Trade Deficit of India (B) India’s Oil Trade Deficit (million $) and Price of Indian
(million $) Basket ($/barrel) medium term.
0 0 120 How would the current account deficit
Oil trade deficit
100 continue to be in the near future? Over-
-2,000 -2,000
Oil all, the current account deficit is expected
million $

80
-4,000 to remain high. There are reports that

$/barrel
-4,000
60 India’s current account deficit, which is
-6,000 -6,000
40 around 1.9% of GDP in 2017–18, is expected
-8,000 -8,000 20
to rise to around 2.8% in 2018–19 (Sikarwar
Non-oil Price of Indian basket 2018). To reduce the trade deficit, the
-10,000 -10,000 0
government has increased tariff rates for
July 2015
Apr 2014
Sept 2014

Dec 2015
May 2016
Oct 2016
Mar 2017
Aug 2017

June 2018
Feb 2015

Jan 2018
Apr 2014

Oct 2014

Apr 2015

Oct 2015

Apr2016

Oct 2016

Apr 2017

Oct 2017

Apr 2018

several products, including some elec-

tronic items. These are non-essential items
The composition of Indian Crude Basket represents average of Oman and Dubai for sour grades and Brent (Dated) for sweet
grades in the ratio of crude processed during previous financial year.
according to the government. However,
Source: Database on Indian Economy, RBI. Data on oil prices from Petroleum Planning and Analysis Cell, Ministry of as tariff rates for free trade agreements
Petroleum and Natural Gas.
(FTAs) have not been changed, it is unlikely
India’s situation is clearly not compara- As oil prices went up, India’s oil trade that this increase in most-favoured-nation
ble to Turkey. deficit also moved in tandem (Figure 4A). (MFN) tariff rate will bring down the
Interestingly, there is a strong (negative) volume of imports. But, it may lead to a
Is Oil the Villain? correlation between the international shift in the source of import from the
This worsening merchandise trade bal- oil prices and India’s oil trade balance non-FTA countries towards the countries
ance is driven by massive increase in the (Figure 4B). Rising oil price poses a big risk with which India has FTAs. Rupee depreci-
oil import bill, followed by imports of for the Indian economy. As the Economic ation, however, can be a more universal
electronics, gems and jewellery (includ- Survey 2017–18 pointed out, deterrent for imports as it affects imports
ing gold) (Figure 3). It is important to It is estimated that a $10 per barrel increase
from all sources. It also benefits exports
note here that in all these three catego- in the price of oil reduces growth by 0.2–0.3 by making domestic goods cheaper in
ries, there are some imports which are percentage points, increases WPI inflation by terms of international currency. However,
not meant for the domestic market. about 1.7 percentage points and worsens the by raising domestic prices of imports,
current account deficit by about 9–10 billion
Some amount of imported crude oil and rupee depreciation can also lead to infla-
dollars. (GoI 2017)
gold (and precious stones) is used even- tionary pressures. It increases prices of
tually for exports. On the other hand, in This increase in oil prices is likely all imported goods, including oil and
the case of electronics imports, a percent- to persist because some of the world’s other intermediate goods, and thereby,
age of intermediate goods are used as major oil suppliers are facing sanctions can adversely affect the competitive-
components in domestically manufac- from the US. These two countries, namely ness of the country. The net effect will
tured final products. Venezuela and Iran, are major suppliers depend on import intensity and the price
A further decomposition of the mer- of oil in the world. Oil exports from elasticity of demand for India’s exports.
chandise trade data for the period April Iran will come under US sanctions from
2014 to August 2018 shows that India’s oil 4 November 2018 and oil supply from Outflow of Short-term Capital
trade deficit improved from April 2014 to Venezuela is also dwindling at a rapid Since the liberalisation of capital flows
about February 2016 on account of favour- rate. Iran is one of the largest suppliers in 1991, India has always faced a current
able international oil prices. During Jan- of oil in the world and it is the third account deficit but inflows of capital have
uary and February of 2016, oil prices were largest source of oil import for India. If allowed the country to have a stable
at a record low level, touching $28.08/ oil supply from Iran comes to an end, balance of payments (BoP). However, it
barrel and $30.53/barrel respectively.1 then there is likely to be even more appears that this time a rising current
14 OCTOBER 13, 2018 vol lIiI no 41 EPW Economic & Political Weekly
 COMMENTARY

Figure 5: Monthly FII Flows in Equity and Non-equity (Debt and Hybrid) (` crore) may also be responsible for the with-
60,000 drawal of FIIs from the Indian market.
40,000 Equity
20,000 RBI’s Intervention
0
While the Reserve Bank of India (RBI)
-20,000
does not target any particular level of
-40,000
Debt and Hybrid exchange rate, it is well known that the RBI
-60,000
tends to intervene in the forex market
July 2016

July 2017

July 2018
Apr 2017

Mar 2018
Apr 2018
May 2018
Jan 2016

Mar 2016
Apr 2016
May 2016
June 2016

Aug 2016
Sept 2016
Oct 2016
Nov 2016
Dec 2016
Feb 2016

Jan 2017

Mar 2017

May 2017
June 2017

Aug 2017
Sept 2017
Oct 2017
Nov 2017
Dec 2017

June 2018

Aug 2018
Sept 2018
Feb 2017

Jan 2018
Feb 2018
in order to reduce the volatility.2 While
intervention data on a monthly basis are
Source: Securities and Exchange Board of India.
available at a lag, the latest available
Figure 6: India’s Forex Reserves and RBI’s Intervention data pertain to June 2018. Until June,
(A) Sales and Purchases of Dollar by the RBI: Outstanding Net (B) India’s Forex Reserves ($ billion) the pace of the net intervention appeared
Forward Sales (-) / Purchase (+) at End of Month ($ million) 430
35,000
to be modest (Figure 6A). There are un-
420
30,000
410 confirmed reports that in recent times
25,000
20,000
400 the RBI could have turned less aggres-
15,000 390 sive in defending the rupee. This could
10,000 380
5,000 370 have been prompted by an objective to
0 360 allow the rupee to be closer to its REER.
350
July 2017
Apr 2017

Nov 2017
Dec 2017
Jan 2017

Mar 2017

May 2017
June 2017

Aug 2017
Sept 2017
Oct 2017
Feb 2017

Jan 2018

Mar 2018
Apr 2018
May 2018
June 2018
Feb 2018

India’s forex reserves, however, are on a

July 2017

July 2018
Jan 2017

Mar 2017
Apr 2017
May 2017
June 2017

Aug 2017
Sept 2017
Oct 2017
Nov 2017
Dec 2017

Aug 2018
Sept 2018
Feb 2017

Jan 2018

Source: RBI.
account deficit is also being accompanied
by capital outflows. The bigger problem
is that most of the factors driving these
imbalances (like the oil prices, global
tensions and the US monetary policy)
are not under India’s control. And given
such a perfect storm, it is only natural
for the rupee to depreciate.
Perhaps, in consonance with the in-
creasing monetary policy rate cycle in
the US, the foreign portfolio investment
(FPI) flows have become markedly more
volatile in the last few quarters. If we
look at the period from September 2017
to September 2018, the net foreign insti-
tutional investor (FII) flows have been
negative in seven months and the FIIs
have taken out more than `35,700 crore
from India (Figure 5). In September 2018,
more than `21,000 crore have been with-
drawn by the FIIs on a net basis.
In general, emerging markets are fac-
ing outflows of capital due to increased
tension about trade wars, external im-
balances and commodity prices. Increas-
ing monetary tightening by the Fed, the
rising rate of interest in developed
countries, and the revival of growth in
such economies are other possible rea-
sons as to why capital is flowing out
from emerging markets. As a result of
gradual tightening of the Fed policies,
“risk-free” return from the US government
Economic & Political Weekly EPW
Mar 2018
Apr 2018
May 2018
June 2018
Feb 2018
downward trend since late April 2018
and stood at a little above $400 billion
as of end September 2018 (Figure 6B).
securities is increasing. This is prompt-
ing many global investors to look for The Way Ahead
a “safe haven” in the US, given the rising Where does the analysis lead us to? Three
uncertainties of the global economy. In comments are in order. First, there is no
case of India, expectations about rupee mystery in the recent downfall of the
depreciation, and rising instability of its rupee as it was predominantly triggered
financial and banking sectors are prob- by global factors. Second, India’s huge
ably playing a role. Average corporate dependence on oil imports and signifi-
performance in the last few quarters cant propensity for gold and electronic
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OCTOBER 13, 2018 vol lIiI no 41 15
COMMENTARY

imports have turned out to be its Achil-
les heel. Third, while the situation de-
mands serious attention, it is not as bad
as in 2013 (Lakshmi 2013).
The RBI on 5 October 2018 decided not
to react to exchange rate depreciation
and kept the policy rate unchanged. This
is in line with RBI’s philosophy of flexible
inflation targeting and not to target any
specific level of exchange rate. Viral
Acharya, the RBI Deputy Governor in
charge of the monetary policy reportedly
said, “managed float is what roughly RBI’s
policy is and what the RBI’s foreign ex-
change operations pursue” (Rebello 2018).
Although this does not seem to be a
doomsday situation, India for long has
been caught up with the tensions of the
impossible trinity, whereby a country
can have at the most two of the follow-
ing three objectives, namely a fixed ex-
change rate, monetary policy independ-
ence and flexibility of capital accounts.
The tension, in the case of India, is all
the more pronounced in view of the fol-
lowing features of India’s BoP: a substan-
tial merchandise trade deficit that is not
being adequately compensated by soft-
ware, and private remittances and the re-
sultant current account deficit that is
getting predominantly financed by fickle
portfolio capital flows (being dictated by
gravitational forces of risk-adjusted re-
turns in the global capital market), and
moderate but steady foreign direct invest-
ment. Any change in the global invest-
ment climate can seriously jeopardise
this delicate balance. While these are
more structural issues, and may call for a
relook at India’s growth strategy as well
as its approach to capital account liberali-
sation, it should suffice to state that the
rupee will continue to be under pressure
whenever the mood of global capital
market changes, for it happened in 2013
and it can happen in 2018 as well!
Notes
1 The prices are for the “Indian basket” of crude
oil which is a derived basket comprising sour
grade (Oman and Dubai average) and sweet
grade (Brent Dated) of crude oil.
2 It is instructive to refer to the former Governor
Jalan (2003) who said, “RBI does not have a
fixed ‘target’ for the exchange rate which it
tries to defend or pursue over time; RBI is pre-
pared to intervene in the market to dampen
excessive volatility as and when necessary;
RBI’s purchases or sales of foreign currency are
undertaken through a number of banks and
are generally discrete and smooth; and market
operations and exchange rate movement should,
in principle, be transaction-oriented rather
than purely speculative in nature.”
References
Ahmed, Saqib Iqbal and James Thorne (2018): “Trump
and the US Dollar: Actions Speak Louder Than
Words,” Reuters, 21 July, https://www.reuters.
com/article/us-usa-trump-dollar-analysis/trump-
and-the-u-s-dollar-actions-speak-louder-than-
words-idUSKBN1KA2KK.
GoI (2017): Economic Survey 2017–18, Vol 1, Depart-
ment of Economic Affairs, Ministry of Finance,
Government of India, p 18, paragraph 1.52.
IMF (2018): “United States: 2018 Article IV Consulta-
tion Staff Report,” International Monetary Fund,
Washington, DC: https://www.federalreserve.
gov/monetarypolicy/fomcpresconf20180926.
htm.
Jalan, Bimal (2003): “Exchange Rate Management:
An Emerging Consensus?,” speech by the
Governor, Reserve Bank of India at the 14th
National Assembly of the Forex Association of
India on 14 August, https://www.rbi.org.in/
scripts/BS_SpeechesView.aspx?Id=133].
Lakshmi, Rama (2013): “India in Uproar Over Rupee’s
Fall,” Washington Post, 20 August, https://www.
washingtonpost.com/world/india-in-uproar-over-
rupees-fall/2013/08/20/975cad98-08c9-11e3-
89fe-abb4a5067014_story.html?noredirect=on&
utm_term=.1f348b9a0dd1t.
Patnaik, Ila (2018): “The Rupee Is Falling and India
Should Let It,” 10 September, https://www.
bloomberg.com/view/articles/2018-09-10/the-
rupee-is-one-of-asia-s-worst-performing-cur-
rencies-this-year.
Rebello, Joel (2018): “Let Rupee Find Its Comfort
Level: Viral Acharya,” Economic Times, 6 Octo-
ber, https://economictimes.indiatimes.com/
markets/let-rupee-find-its-comfort-level-viral-
acharya/articleshow/66093679.cms.
Sikarwar, Deepshikha (2018): “Minimum Import Price
among Options to Curb Non-essential Goods,”
Economic Times, 17 September, https://eco-
nomictimes.indiatimes.com/news/economy/
policy/minimum-import-price-among-options-to-
curb-non-essential-goods/articleshow/65835916.
cms.
US Fed (2018): Press Release, Federal Reserve,
26 September, https://www.federalreserve.gov/
monetarypolicy/fomcpresconf20180926.htm.

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