What is Devaluation of Currency?
Devaluation indicates the meaning of official lowering of the value of currencies within a framework of fixed exchange rate system in a particular country. Devaluation is the result of official government action for fulfilling certain motives. There could be many motives of the devaluation. It plays the significant role in ensuring the stimulation of exports of commodities. In addition, it exerts restriction on import demand with respect to goods and services. It helps in ensuring the creation of a commendatory balance of payments. Almost all the countries around the globe have devalued their currencies at one time or the other with the purpose of achieving certain economic objectives.
In the pre-independence days, the Indian rupee had been regarded as one of the strong currencies. In old days, all international currencies were pegged to the value of gold and silver, followed by the British pound and the American dollar in the post-world war period. After India came out of the shackles and yoke of Anglo-Saxon colonialism (1947), it became the member of International Monetary Fund. At that time, the rupee was tied to the pound sterling and 1 rupee was equivalent to 1 pound at that time. Around 1947, the Indian rupee was valued as $1 = Rs 1.3. This means one rupee and thirty paisa could buy a dollar back at that time. Because of perennial devaluations and fluctuations in exchange rates, it will take around 67 INR today to buy a dollar. Even after the devaluation of the pound after 2 years of independence, i.e., 1949, India had been able to maintain par with pound which, signifies improvement with respect to economic growth.
However, this trend has not been maintained for a long time. In the year 1966, devaluation of rupee by 36.5% again halted the growth of Indian GDP thereby resulting in bringing about the disaster in monetary policy. In 1966, India faced challenges in the form of high inflation and large Government budget deficits. This led the government towards devaluation of Indian Rupee . At that time, 1 dollar became equivalent to 4.76 INR. Later on, this gap increased and it resulted in making 1 dollar equivalent to 7.50 INR. Despite United Kingdom’s initiative in devaluating pound sterling in the year 1967, India did not make such efforts for ensuring the devaluation of INR.
In 1971’s month of August, which is marked as difficult time due to the worldwide financial crisis, INR was pegged to gold/dollar. The dollar was devalued at that time due to the financial crisis. At the end of the same year, INR was again pegged to sterling pound. Due to the adoption of import substitution between the time periods of 1971 to 1979, overvaluation of INR had been ensured as a result of which, Indian economy had been affected to a great extent. India had been able to maintain fixed exchange rate with the pound in the initial period of the 70s although the United Kingdom floated pound. In the year 1975, India had been able to link rupee with the basket of currencies of major trading partners. This trend had been maintained till 1991 when re-occurrence of devaluation had been witnessed. However, it cannot be denied that the basket was periodically altered.
After The Arrival of Globalisation
After the fall of Soviet Union, Liberalisation process had been initiated in India as a result of which, the market economy flourished in India. However, Indian Government was not able to show efficiency in managing continuous devaluation of INR as a result of which, this trend of devaluation was again witnessed. In 1991, India still had a fixed exchange system, where the rupee was pegged to the value of a basket of currencies of major trading partners. India started having the balance of payments problems since 1985. However, by the end of 1990, India found itself in serious economic trouble. The government was close to default and its foreign exchange reserves had been dried up to an alarming point. India could barely finance three weeks’ worth of imports. In the year 1991, the rupee was again devalued by 18% to 19%, which was definitely not the good sign in economic growth. In the subsequent year, LERMS had been introduced in India, which facilitated the bulk sale of foreign exchange receipts at market determined rates of goods and service exporters as well as recipients of remittances from abroad. It signified the progress of Indian economy towards the way of liberalisation. In the year 1993, 1 dollar became equivalent to 31.37 INR and it was recognised as the unified exchange rate. In the year 1993-1994, INR was made freely convertible for trading. However, its application had not been approved with respect to investment purposes. At the end of 1999, the Indian Rupee was devalued considerably. The value of INR has been depreciated as much as 16% in the year 2017.
Reasons for Devaluation
There are some reasons, which are held responsible for the devaluation of Indian rupee. They can be summarised below:
- Widening current account deficit
This results in creating more actual as well as speculative demand for the dollar along with other convertible currencies.
- Policy in action
Despite RBIs promise of tightening liquidity and injective 1 billion dollar in market for boosting economy, perception with respect to lack of clarity on the policy front is increasing the strength of speculative demand.
- Low forex reserves
India’s foreign exchange reserves can be regarded as enough for covering imports of only seven months. The forex reserves have declined in the recent months. Due to low reserves, the RBI can’t intervene aggressively in the currency markets.
- Growth slowdown
India’s gross domestic product (GDP) growth fell to a decade low of 5 per cent in 2012-13. The situation is unlikely to improve much this year. Foreign investors are pulling money out of the Indian markets due to slow growth. It has been resulting in affecting the entire economy.
- Dependence on foreign money
India’s current account deficit was financed by foreign money for the last many years. Withdrawal of money by overseas investors is leading to the weakness in the rupee as a result of which, Indian economy has been affected.
- Recovery in the US
The slow but steady recovery in the US is making the greenback stronger against other currencies.
- Stimulus withdrawal
Indications that the US may withdraw or ease the fiscal stimulus package could potentially put the brakes on funds for developing economies.
- Capital controls
The decision by the Reserve Bank and the government to impose temporary restrictions on capital flows has not gone down well with the markets, as it will not only discourage Indian companies from investing abroad but also foreign firms from pumping money into India.
- Trends in other markets
The rupee is also following the trend seen in the currencies of other emerging economies such as Brazil, Indonesia, Russia and South Africa.
- Speculative trading
Speculative trading in the currency markets is putting further pressure on the Indian rupee.
To prevent the rupee depreciation, Indian policy makers need to consider some of the measures to cover up the losses.
- Exporters Should Buy Rupees
The Reserve bank of India could ask all the exporters to convert some part of their foreign earnings into rupee so that it can bring temporary relief to the declined rupee rate.
- Moral Influence
To protect the rupee, the government may possibly rework on the strategy that they used when overseas rates seemed attractive. The RBI could also persuade Indian banks and financial institutions to raise their funds in dollars and lend them locally.
Delay Import Payments
The Indian government can delay the import payments to prevent the rupee decline. Normally, import payments are done at the month end but to cover up the losses, RBI could take this step to cushion the decline, which has not taken lately.
What’s the RBI doing?
At present, the RBI permits hedging of currency risks on the basis of past performance (exports or import) for average three years. The company or unit could also take a hedge based on actual performance in the last financial year. Now, for importers using the past performance facility, the facility stands reduced to 25 per cent of the limit. Importers, who have used the facility in excess of the revised or reduced limit, are barred from making further bookings. The RBI said forward contracts booked under the facility would be on a fully deliverable basis. The exchange gains emerging from the cancelling of contracts should not be passed on to the customers. All cash and spot transactions by banks for clients will be done for actual remittances/delivery only. They cannot be cancelled or cash-settled. In an effort to control the effect of currency derivative deals by FIIs, the RBI banned rebooking of cancelled contracts by overseas portfolio investors. They can, however, roll over contracts on or before maturity. At present, FIIs are allowed to hedge currency risk on the market value of the entire investment in equity and/or debt in India. The RBI also said the intra-day open position/daylight limit of dealers should not exceed the existing approved limits. At present, a company’s board is permitted to fix suitable limits for various treasury functions with net overnight open exchange positions and aggregate gap limits.