Dec. 5 – After depreciating to a record low of 52.73 against the U.S. dollar on November 22, the Indian rupee (INR) rose in value to 51.206 per dollar on Friday to complete the currency’s first weekly advance since October.

The Indian rupee is under great stress as overseas investors are paring their exposure to Asia’s third-largest economy amid international uncertainty and mounting worries over the domestic economy.

On November 21 alone, overseas funds sold more than US$500 million worth of Indian-listed shares over the five trading sessions, reducing net inflows for 2011 to under US$300 million – a tiny sum compared with the record investments of more than US$29 billion experienced in 2010. The rupee has lost more than 10 percent of its value this year, making it one of the worst performing currencies in Asia.

The rupee’s modest 2.1 percent advance against the dollar last week occurred as six monetary authorities, led by the U.S. Federal Reserve, agreed to lower the interest rate on dollar-liquidity swap lines.

The premium banks pay to borrow dollars overnight from central banks will fall by half a percentage point to 50 basis points, the Fed said. It coordinated the move with the European Central Bank and monetary authorities in Canada, Switzerland, Japan and the U.K.

“Sentiment has improved slightly after the central banks’ actions,” Vikas Babu, a Mumbai-based currency trader at state-owned Andhra Bank, told Bloomberg News. “This is unlikely to last long as only the symptoms of the crisis are being tackled, and I expect dollar-buying to resume soon.”

The exchange rate of the Indian rupee is dependent upon the market conditions. Though, in order to sustain effective exchange rates, the Reserve Bank of India (RBI) actively trades in the US$/INR currency market. The RBI also intervenes in the currency markets to maintain low volatility in exchange rates and remove excess liquidity from the economy. The rupee is pegged by the Bhutanese ngultrum at par and with the Nepali rupee at INR1 to NPR1.6.

India has a managed floating exchange rate system. This means that the Indian government intervenes only if the exchange rate gets out of hand by increasing or reducing the money supply as the circumstances demand.

Impact on economy
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.

Dezan Shira & Associates is a boutique professional services firm providing foreign direct investment business advisory, tax, accounting, payroll and due diligence services for multinational clients in India. For more information, please contact india@dezshira.com, visit www.dezshira.com, or download the firm’s brochure here.