A Stronger or Weaker INR against USD: Market Force or Market Distortion? A Study on Recent Trends, its Possible Reasons and Impact on Economy

Like any other commodity, a foreign exchange rate in any economy is function of demand and supply, unless regulators controls otherwise. The demand and supply may be aggregate of formal and informal markets. Many a time, informal markets are dominant and it becomes very difficult to capture the data. The recent trend shows an appreciation in the Indian Rupee against the USD. Sapovadia noted in 2007 when Rupee was appreciating against US Dollar; “Indian Rupee stood at INR 44.90 to the USD in April 2006; it dipped to INR 40.57 in third week of May 2007. Skyrocket land prices in urban and urban periphery, rising inflation & interest rate and gossip in the town about NRIs investing in land & banking sector (through formal as well as informal channels) have drawn our attention to test whether INR becoming stronger is reason of market force or unwanted market distortion?” The recent trend since April 2018 is totally reverse and US Dollar is becoming stronger. The paper captures observation made in 2007 and subsequently compares current situation in 2018. Though new dimensions become pertinent in totally a contrast situation in 2018, still several reasons of market trend and its impact on economy remains same.

Rupee Appreciation in 2007

As per one of the World Bank reports, India is the world’s top receiver of remittances in 2003, that is around US$ 17.4 billion, and we expect it is yet grown till 2007 substantially. The paper argues that remittances undoubtedly help ease poverty and improve living standards in their home countries by enabling better health care, nutrition, housing, and education. In many communities, however, the money is often put to unproductive uses such as buying land and building houses. The Non Resident Indian population across the world is estimated at over 30 million. Total remittances by the Indian Diasporas have touched a new high. According to the Reserve Bank of India (RBI) figures, overseas Indians remitted $23.3bn in 2005 – almost double the amount of net foreign institutional investor inflows and one-fourth of the merchandise export earnings of the country during the period.

We reviewed recent literature document for finding remedies for preventing ill effect, ‘Remittances: Development Impact and Future Prospects’ by Samuel Munzele Maimbo & Dilip Ratha, which discusses how such downward spirals might be brought to a halt, and better still, reversed, through a variety of carefully tailored “smart aid” initiatives that can kick-start the productive potential of local economies in areas where high levels of migration have taken place.

We also reviewed IMF working paper by Ralph Chami et al, who developed a framework on the causes and effects of remittances, links for remittances & the motivation and their effect on economic activity. They argue remittances take place under asymmetric information and economic uncertainty; there exists a significant moral hazard problem. The implication is that remittances have a negative effect on economic growth. They conclude that the moral hazard problem in remittances is severe.
We also reviewed World Bank – Development Research Group (DECRG), contributed by Caroline Freund. The report says that recorded workers’ remittances to developing countries have grown rapidly, to more than $100 billion in 2004, bringing increasing attention to these flows as a potential tool for development. He argues that these statistics are likely to significantly understate true remittances, as a large share is believed to flow through informal channels. Estimates of the importance of the informal sector vary widely, ranging from 35 percent to 250 percent of recorded flows. We estimate informal foreign exchange flow in India on the model developed by this contribution.

The research paper would like to test whether NRIs investing in realty and high-interest-fetching bank deposits in India, and large amount inflowing unchecked through informal channels distorts market and economy of India or the phenomenon of INR becoming stronger is formal and legitimate market force, and its possible effect on

Indian economy

We will analyze land prices in selected urban area, inflation and interest rates during the period. We will discuss the role of Foreign Exchange Management Act, RBI and related government machinery in checking exchange rate and informal remittance inflow. We will use the DECRG model to measure informal remittance and its impact on distortion of the foreign exchange market. We critically analyze the impact of INR becoming stronger on export, inflation and price rise in realty. The export and inflation data for the concerned period are available from concerned government authorities.

Lead Questions:

1. Is there any impact of illegal remittance on foreign exchange rate?
2. Whether due to NRI investment in realty, bank deposit and illegal remittance, INR is becoming stronger against USD?
3. What are the other factors impacting significantly on INR – USD relationship?
4. What is the impact of INR becoming stronger against USD on some macro economic parameters like export, inflation, interest rate etc.?

Contribution to the literature & Conclusion

While remittances are not public funds, and decisions about spending is left with remitters and recipients, unproductive expenditures stem mostly from a lack of other investment opportunities and unchecked remittances. Good policies and public infrastructure in major recipient countries are therefore essential to encourage the proper investment of these funds. The study would like to suggest policy measures that can check informal remittance. By selecting appropriate investment policies, unproductive investment by NRI can be visualized and checked. Monitoring not only monetary policies but also town planning investment can provide an instrument to stabilize land prices and foreign exchange rate purely on market force. Implementation of FEMA and notification issued require appropriate data capturing mechanism, close monitoring and speedy execution. The research paper would like to give comprehensive suggestions to develop healthy foreign exchange market and preventing ill effects and market distortions.

Depreciation of Rupee in 2018

After steady exchange rate of rupee against USD, 2018 witnessed worst situation of Indian Rupee. In July 2018, rupee tumbled to its lowest value against US Dollar. India is the world’s leading receiver of remittances, claiming more than 12% of the world’s remittances in 2015. Remittances to India stood at US$68.91 billion in 2015, accounting for over 4% of the country’s GDP. India is expected to retain its top spot in 2017 in attracting overseas remittances from its diaspora to family back home, according to the World Bank. Among major remittance recipients, India retains its top spot, with remittances expected to total $65 billion this year, followed by China ($61 billion), the Philippines ($33 billion), Mexico (a record $31 billion), and Nigeria (($22 billion), said a release by the multilateral agency on Tuesday.
Beginning 2018, rupee became strong against US Dollar. Leading TV News Channel, NDTV noted its observation (read following para) in January 2018.

The rupee’s rally continues into 2018. Today, the rupee rose to 63.25 against the US dollar – its highest level against the greenback in 32 months (since April 2015). The rupee had closed at 63.37 against the US dollar on Friday. Besides a broad weakness in the US dollar, firmness in domestic stock markets also lifted the rupee. BSE benchmark index Sensex rose nearly 200 points today to post yet another closing high. The rupee however slipped later to close at 63.50 against the US dollar.

1. The US dollar index, which is a measure of the value of the US dollar relative to a basket of foreign currencies, continued to languish at a three-and-a-half-month low. The US December non-farm payrolls data on Friday was weaker than expected.

2. Though investors are reckoning that the Federal Reserve would still raise interest rates multiple times this year, they expect Fed to hike rates at a gradual pace. Investors believe that US inflation will remain tame as wage growth has been slower than before the 2007-2008 financial crisis. This is keeping pressure on the US dollar.

3. The rupee had gained nearly 6 per cent against the US dollar last year.

4. For the whole of 2017, the US dollar index slid more than 9.8 per cent. This is the greenback’s worst annual performance since 2003.

5. Currency dealers said continued foreign fund inflows and weakness in the greenback against other currencies overseas supported the rupee today.

6. The rupee is also supported by the belief that economic growth in India will accelerate this year. The recent data has been encouraging.

7. Factory activity expanded at the fastest pace in five years in December, a private sector survey showed on Tuesday, buoyed by a rise in output and new orders, which allowed firms to raise prices.

8. Services industry bounced back to modest growth in December after contracting in the previous month, another private survey showed on Thursday.

9. Forex advisory firm IFA Global Some expects the rupee to strengthen to 63.00 levels in this quarter.

10. “On a closing basis 63.35 is an extremely crucial support. Break below could open doors towards 62.90,” according to IFA Global.
NDTV noted (read following para) in July 2018 when Rupee started to fall.
Rupee Not Far From All-Time Low. It Could Fall To 70 Per Dollar
The rupee on Friday edged higher to 68.15 against the US dollar, extending its recovery after falling to 18-month low 68.42 on Wednesday. Despite the brief recovery, the rupee is not far away from its all-time low of 68.87 vs US dollar, recorded in November 2016. Besides outflows from domestic capital markets, a rising dollar and a surge in global crude prices have weighed on the rupee. The rupee is down over 6 per cent against the US dollar so far this year. Forex advisory firm IFA Global says that the possibility of rupee heading towards 70 per dollar is increasing. There is a still room for further depreciation from current levels, it adds.

Here are 10 reasons why the rupee is falling against the US dollar:

1. Rising crude oil prices are putting pressure on the rupee as India imports more than 80 per cent of its crude oil requirement. Amid tight supply and geopolitical concerns, global crude oil prices breached the $80 dollar mark last week. In the past 12 months alone, crude oil prices are up 50 per cent, supported by supply cuts from major oil producing countries.

2. Though petrol and diesel prices in the country are market-determined, the government still provides a subsidy for kerosene and cooking gas. According to estimates of global financial services major Nomura, every $10 per barrel rise in the price will impact India’s fiscal balance by 0.1 per cent and current account balance by 0.4 per cent of GDP.

3. Every $10 per barrel hike in crude oil price could also increase domestic retail inflation by 0.6-0.7 percentage points, Nomura estimates.

4. Driven by faster hikes in fuel prices, consumer price inflation accelerated in April to 4.58 per cent, after easing for three straight months.

5. Some analysts have said that the RBI may adopt hawkish commentary in June, highlighting upside risks to inflation.

6. Higher inflation, concerns over fiscal deficit and hawkish stance from the RBI have driven up bond yields, hurting bond prices.

7. Global funds, according to Bloomberg estimates, have pulled $3.5 billion from Indian bonds so far this year. India needs robust dollar inflows to help bridge its widening current account deficit and support the rupee, say analysts.

8. The dollar’s broad surge against other major currencies has also hurt the rupee. The yield on the most widely watched bond rate in the world – US 10-year Treasury notes – hit the 3 per cent threshold on expectations of faster Federal Reserve rate hikes and optimism about US economic growth. Higher US rates tend to boost the dollar.

9. Meanwhile, domestic petrol and diesel rates have been hitting new highs amid weakness in the rupee.

10. This has led to pressure on the government for cutting excise duty to bring down the fuel prices. But cutting taxes could stretch government finances.
We observe that the economist fails to capture informal market factors and sentiments, which some time are more influencing than formal market and hence perfect prediction of exchange rate is gimmick. Economists analyse available data and predict based on existing theories. Only the future tells us the new theories and hence some time the analysis is post mortem exercise per se.

Keywords: INR, USD, Foreign Exchange, Market Distrortion, Inflation, Land Prices

JEL Classification: F3

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