Rupee appreciation

For the last week, there was a lot of discussion on rupee appreciation, a sudden drift of the media from Yuan appreciation. This is because, if you see the trend of rupee from July 2008, till now, there was a wide swing against the greenback – from below 42 levels then, it moved up to 51/$ exactly a year ago, and now coming down to 44.2 /$, a drastic swing ever in a shorter period of time.  What is triggering the appreciation of rupee and its effects in an unusual Q& A style. (This is bcos, one of our readers has asked me these questions and I have added a few more to her list)

Is the rupee appreciation because of dollar depreciation?

 No, not completely. Might be a slight effect because of dollar losing its value. But rupee is not only appreciating against dollar, but against all major currencies – Euro, Pound etc.

 

Is there any relation between stock market performance and currency?

 There is a greater relation to stock market and currency. Stock market in India moves up when there is a large amount of FII inflows. FII inflows obviously brings in lot of dollar and demand for rupee goes up , thus making the rupee appreciate. If you see the currency value in Feb – Mar 2009, it was around 52/$, and the stock market was at its lower levels. After March, the trend reversed, Indian market started attracting more foreign money and every month, the net FII inflow was greater and rupee started appreciating.

 

What is the reason behind this huge inflow of money ?

 This is the effect of carry trade. Remember we discussed this… FII’s now borrow money from US, at a near zero interest rate and invest the money in Indian markets, which gives a wonderful spread . This is the main reason for FII’s to pump in money to India, to make quick return of investment and also to set of their losses which they made in their homeland J

 

Will there be any effects of Yuan appreciation on Rupee?

 First of all, there is no question of Yuan appreciating significantly. As the Chinese economists say, they will accommodate.. Ok, if at all china appreciates Yuan, this will have a positive impact on Indian exports, since Chinese firms will lose price competency and India might get more exports, which will result in pulling down or slight depreciation of Rupee.

 

Does RBI have any role in stopping the currency appreciation?

 Yes, RBI can decide the ups and downs of Rupee.

 

What methods can it adopt to stop currency appreciating further?

As an act to stop rupee appreciating further, RBI can start buying dollars and add it to its reserves, but it will lead to lot of other operations which it should perform as a whiplash effect.

This is how it can happen:

 RBI will add more dollar to its Forex reserves, which will result in stemming the rupee appreciation and monetary flow in the market, which will move inflation to higher levels, and again to control this RBI should issue more government bonds/ MSS to absorb the excess money from the market. Amusing right…

And the question is it will pose excessive burden on the government to service those debts. And this is why RBI has not yet intervened the currency market by mopping reserves as it usually does…

How will it impact the economy?

 The impact of Rupee appreciation in the economy will be quiet balanced. On one hand it will ease the imports, and cost of imported goods to come down as most of the payments are dollar denominated. But this will have a big impact on export oriented sectors like textiles, software etc, where in their revenue comes down when accounted in INR.

What levels will the rupee reach further? Will it go down below 40?

 Voila… If I could answer this question right, I have a fair chance of replacing CFO of TCS who usually loses about hundreds of crores in Forex positions, every quarter

There is a wide spread news that, govt will direct RBI to intervene when the rupee goes below 42 levels…chances are fairly less for the rupee to go below 40.

China, Yuan and Dollar – Part 6 : Current issues and implications

 

Let’s look into some speculations.. What if US levy extra tax on Chinese products in an attempt to pressurise them to appreciate the currency?

1)      The Chinese products will cost more

2)      Americans need to cut down consumption a little less, since no savings to accommodate for the increased cost of goods

3)      Inflation in US will go high.

4)      China, as a retaliation might sell the US treasury bonds which they are holding.( about a trillion and more )…

1. This will be a double edged blade for china as well as US.
2. Because this will cause dollar to go down in value as demand goes down by huge Chinese sale of Treasury bonds..
3. This will make the holdings worth less for china
4. China’s exports will lose a market share from its biggest market US
5. Chinese economy will get hurt- since exports down- lesser money to spend on internal infra- etc.
6. But for US , this will pose a better opportunity and a worse situation. One, its dollar value goes down , and economy might cripple, but on the other side, it will be easy for them to pay back their huge debts.

One advantage I could foresee is I can buy the Nikon D5000, at a much cheaper price, imported from US

  So, as far as we could think, US will stop all these nonsense with just a “Stern Warning” note from Obama and the congress , condemning China for its currency manipulation ,and China will as usual laugh at it and say “ Protectionism by US govt”… because China is a dragon which has spun around the globe and become a necessary evil, and which is the one who has the might to replace US , in 30 years of time…and we all will forget this for a while, because there is always a Greece or mighty UK , to have many financial problems , to speak and write about…

China, Yuan and Dollar – Part 5 : All about appreciation

Let’s see what’s currency appreciation…. It is nothing but, your currency (lets take Rupee), is in demand. So the value of the currency goes up. It means,

 Say for example on January 1, you were paying 50 Rs to buy a dollar. Now, on March 21, we say, rupee has appreciated. So, that means, we now pay less for every dollar. I.e. we will pay only 45 Rs.  So what is the impact of this on import and exports and economy? 

Now there is a guy who imports goods and the other one who exports goods. 

For the importer, now the goods will be cheaper. How? If he is importing goods worth 100 $ every month. IN January he would have spent 5000 Rs, to pay for the import. But now in March, he will pay only Rs 4500, for the same import. Has the price of the article gone down in US… no, but the currency has appreciated and he gets the benefits. So he can eventually sell his imported products at a cheaper rate, than earlier, or can invest the money saved in some other options, or even he can import more. 

Now take the case of exporter. He was getting 100 $ for every software he sells abroad, and then he converts the money into rupee and then pays his employees and etc. for him, he would have got 5000 Rs in January , but now for the same work, he will get only 4500 Rs. He will not be encouraged by this situation. Because his profitability goes down, and he cannot increase the price for his products also, because, there are other companies or nations who can still do it at the same rate.

 But what is good for an economy? If the country is importing more, and the currency appreciates, it is good for them, and if it is an export oriented country, then, currency appreciation is not good for them. So what will a government do? They cannot control the movement of dollar, but can control their own currency. That is what china does full time and India also does that, but very candidly… Any country will prosper with more exports. That is how they get money… (Remember Current accounts)

 For Import scenario what happens- if currency appreciates, more imports will happen, and the internal industries will lose market, because, now you can import the same goods much cheaper than what is produced in the local market. So your industries will be closed and no productivity in your home.

So to avoid this situation, all countries will provide incentives to their exporters thereby currency.

 But the pitfall in this arrangement is, if you don’t allow your currency to appreciate, you will not import any goods from other countries you trade with. This is one of the main reasons which irritate US about china.

So now we will look into china’s story. China is not allowing Yuan to appreciate for many years (or as US calls, keeps its currency depreciated.), while all other currencies getting appreciated. So if India is exporting the same goods like china, Chinese products will be cheaper and India’s exports will get a hit. This is the big picture effect. China is  shutting the export options of other countries. ( China literally produces everything  and they are cheaper than anywhere in the world.. the last option they might think of producing cheap would be Children i think J).

  This is a problem for US , more than anyone because, they being the spoilt rut of all economies, their household savings rate is worse than any other developed/ing country. This creates a problem for them, because, their current account deficits will keep on increasing, as there is no savings in the country and a big gap in exports and imports. Soon, their currency will be devalued, and their chance of losing it to Euro is high.

IN the next post, lets look in to the implications

China, Yuan and Dollar – Part 4: The Chinese case of Yuan

So, where does china fits in, what seems to be an issue of individual countries and their money management?

It’s just as simple as this, u are running a wholesale shop in a market. Some one brings (exports) tomatoes daily… there are other tomato suppliers for you but he supplies it cheap and in huge mass. So most of the shop owners buy tomato from him. But, he is not buying anything from you. Even though you want to settle his balance with some potatoes and dal from your shop, he says, just give me money, and you have been doing this. One fine day you realize that, all your goods are stagnant/ no demand for your products and money leaves from your pocket daily. You wanted to see, what the tomato vendor is doing in the backyard after getting payments from you…

1) He is not giving money to his wife and other labours who work in the family to spend the money.
2) He spends all his money in buying new fields and investing in producing cheap tomatoes
3) He indirectly lends you money to run your shop, through bonds which you issue.
4) He gets more customers by selling tomatoes at low price and eliminates small farmers from market.

One fine day, u and ur relatives, wake up and tell him, boss, better u spend the money on other things, otherwise we will levy tax on your tomatoes and you will suffer, because ur neighbour is ready to give tomatoes and will listen to us..
He retaliates back that,
1) If I don’t give tomato, Ur shops will need to buy at a higher price and as such u idiots don’t have the habit of saving money, will find very difficult to buy products from others which will be costlier than mine.
2) I will stop lending you money and will sell all the loan bonds given to you in the market at a cheaper rate, and your money value will go down since I sell in huge quantity and less demand will be there , and because you are the leader of all shops, everyone will collapse.

This is what exactly the situation happening between China and US. But is this a matter of concern only for US and not for other countries? Why are they silent on these issues? To understand in a broader manner, we need to understand
• What role currency plays in economy,
• What appreciation or depreciation means for one country and relative countries,
• How currencies are related to each other etc, in detail.

China, Yuan and Dollar – Part 3- Balance of payments

Balance of Payment:

 As the word suggest, the payment should be balanced. This is a typical accounting book. Both the sides of the book should be balanced.  The two sides of BoP are Current account and Capital account.

A Balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country’s exports and imports of goods, services, and financial capital, as well as financial transfers.

 We have seen what a current account is…

To explain Capital accounts, in simple terms, it’s the investments made into /out of the country.

 A country is like an individual. Here,

• Exports- salary
• Imports- spending/expenses

When exports are more imports are less, we have current account surplus. Similar to more salary and less expenses. The reverse is deficit.

 So now a country (individual) runs into deficit. How can he manage?

• Reduce the expense
• Increase income/salary
• Borrow money from friends…

 When a country does this, the options are

• Reduce spending ( which is impossible for developing economy like us)
• Increase exports (make it competitive, cheap, good products) – here is where the hero, china is accused of… using its currency to make its exporters win everywhere…( and there is joke in US and other western countries- there might be a day, when u can see your child labelled -made in china)
• Borrow money- Make other countries to invest… FDI……..

  So, when ever u hear noise in the political scenes about bringing more foreign investment in India, this is the main reason… To bring more investment and bring down the imbalance.

 So, to speak in terms of intellectuals, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counter balanced in other ways – such as by funds earned from its foreign investments, by running down reserves or by receiving loans from other countries.

 In the next post, let’s come into the main issue, what china did and what US wants….

China, Yuan and Dollar – Part 2 : Current account- deficits and surplus

Current account:

As the name says, something is accounted for the current period of study. Usually a financial year. What do we do in accounting? Calculate inflows and outflows. Current account is exactly the same. It’s just the accounting for a country’s inflows and outflows. 

Current account = balance of trade + Income (a.k.a Factor Income) + Transfer Payments.

 Balance of trade – difference between the export and import of a country. It does not include the financial transfers or investments.

 Income- Income earned on investments made by a country abroad like interest earned or dividends received. This will be accounted as (+) value, and paid to foreigners by a country will be accounted as (-) sign. (You should note that this will take only income out of investments. Original investments/capital investments will be accounted in a different head Capital accounts) The Income, also includes the infamous Remittances made by our Non residents… (Thanks to millions of SW geeks and labors from across the globe. – We might even say a malayali chai shop or someone working in a construction site, in Arab countries, indirectly influences the Moody’s rating for India  J

 Transfer of Payments- cash transfers from abroad like foreign aid, charity aid etc… Money spent on society directly than on economy.

 So in short,

A current account deficit occurs when Imports are more than Exports (when a country’s total imports of goods, services and transfers is greater than the country’s total export of goods, services and transfers.) 

A current account surplus occurs when Exports are more than Imports. (When a country’s total exports of goods, services and transfers is greater than the country’s total import of goods, services and transfers.) 

 We (India) are in a deficit situation every year… Might be we would have been in surplus before the East India Company or the Moguls ventured in . Currently our fiscal deficit stands at 5.8 billion USD.. .. needless to say, the Chinese are in huge surplus of 284 billion USD, and they say it has come down from 368 billion USD.. and guys, we have more or less the same work force compared to china….( hmm… its all the government /ruler who makes the difference…)

 In the next post , lets see about what is balance of payments…

China, Yuan and Dollar – Part 1

Lots of noise and lots of columns on currency manipulation in recent days.To explain the whole of Chinese currency which is making the headlines and the heads of the states worried, we need to start from the basics of what is the role of a currency, balance of payment, balance of trade, current account (might be deficit or surplus), capital account, how exports/imports get affected when a currency moves up or down etc.

 And as add on’s first lets refresh on three most used and abused words of politico-economics. Trade Deficit, Current account deficit and Budget deficit.

 Remember, all these tree deficits are related to one another.

 Trade Deficit:

Its trade… Inflows versus outflows… Countries measure this by more outflow of the local currency than the inflow. I.e. more imports (u pay more and money goes out) and fewer exports (no one buy’s goods from u)… Do I need to say whether India is on deficit or surplus?

 Budget deficit:

 It’s the same again… what govt earns  as income from tax revenues and other sources, is not sufficient to meet the expenses it makes for public…( why we all blame a govt who wishes to spend more on us :-) )

And here comes the source of all,

current account deficit:

In simple terms, its the difference between the net exports and imports.

Current account = balance of trade + Income (a.k.a Factor Income) + Transfer Payments.

so, in next post, let’s see in detail on what is balance of payment, Income, Transfer payments and more on current account – deficits and surplus, and much more.