Top 5 reasons for Indian rupee’s freefall

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The Indian rupee has been in the news recently for all the wrong reasons. Over the past few weeks, the rupee’s value has fallen considerably. As of today, a US dollar will fetch you 54.4250 Indian rupees. Singapore-based investment firm CLSA is predicting the Indian rupee will go as low as Rs58 versus the US dollar.

Despite economists predicting India to become the world’s largest economy by 2050, the rupee’s weakness is seen as a sign of India’s more profound underlying economic problems and casts doubts on these forecasts.

Here are some of the reasons behind the Indian rupee’s downfall:

1. India’s Large Current Account Deficit

Current Account Deficit (CAD): Current Account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid). The balance of trade is typically the most important part of the current account.

Experts attribute the sharp widening of CAD due to high crude prices and rising gold & silver imports. Oil imports constitute about 20% of India’s import bill.

India’s gold imports have reached 11.5% of total imports in 2012 compared to 9% in 2011. Apart from the huge intrinsic demand for the yellow metal, expectations of rising gold prices and gold being used as a hedge against inflation are the reasons cited for increase in gold imports.

2. Eurozone’s escalating sovereign debt crisis

During the 2008 global meltdown, we were talking of banks and companies collapsing. Today, it is about economies. The worst-affected eurozone countries including Greece, Ireland and Portugal account for just 6% of the economic bloc’s GDP. There is also Spain and Italy from where some bad economic news keeps coming out. The French, British and Dutch economies are suffering from zero growth rate while the German GDP growth is negligible. This shows how weak the eurozone countries are and the fear of contagion spreading that can bring down the single-currency bloc with a catastrophic effect.

Such a scenario is already weakening the euro and making US dollar the most secure currency. With experts predicting that the euro will go further down against the US dollar, Indian rupee is also expected to reach record lower levels.

3. Dollar outflows from Indian stock markets

Stronger US dollar has lead to less capital inflows as Foreign Institutional Investors (FII) tend to be more conservative. Reuters reported that foreign investors have sold a net of nearly 10 billion rupees ($187.88 million) of domestic equities on 9 May.

Political uncertainty in Greece combined with constant worries about taxation for investments from overseas forced foreign investors to take drastic measures and sell whatever they can to stave off losses.

Many analysts believe India is vulnerable to volatile capital inflows and is struggling to plug its balance of payments due to the external account and fiscal side.

4. India’s deteriorating macro-economic conditions

Among its emerging Asians peers, India’s Fiscal & Current Account Deficit (CAD) is the highest.

India’s combined fiscal deficit, including that of state governments, has risen sharply. India’s UPA coalition government has also been accused of going slow on policy reforms. This has lead to further decrease in foreign investments into the country, especially Foreign Direct Investment (FDI), which is considered safer and better than fly-by-night Foreign Institutional Investors (FII).

Many economists are suggesting to open up FDI in retail and insurance sector to encourage more capital flows. In December 2011, India did a U-turn on FDI in retail after announcing it was opening up FDI investments in retail.

5. India’s new taxation rules and reopening of old cases

The Indian government, in its Union Budget 2012-13 in March, proposed a clarification in tax rules to bring all cross-border mergers and acquisition deals involving Indian assets or businesses under the tax net, with effect from 1962 when the rules were written.

This announcement sent shockwaves across international investors in India with several international trade groups representing over 250,000 firms voicing their concerns over the proposal to Prime Minister Manmohan Singh in a letter, saying the move may lead global companies to rethink investing in India.

The change in rules would have brought back the UK-based telecommunication giant Vodafone under the tax net over its $11-billion purchase of Hutchison group’s Indian operations in 2007.

India’s Finance Minister Pranab Mukerjee later allayed fears of international investors by clarifying that no case which is more than six years old can be reopened and that India will hold fair and open discussions with those having objection against the proposed law.

What is your opinion on the future of the Indian rupee? Are you an Indian expat planning to send money to India now? Let us know your comments!

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