Fluctuating Indian Rupee: Cause and Consiquences

Fluctuating Indian Rupee

Introduction

The past month has been disastrous for the rupee value against dollar currency. The same time last month (22-Aug-2011), rupee value against dollar was 44.5 – 45.0 range; today it is hovering to the range of 49.0 – 50.0. It is expected to rise further which would result in weakening the rupee value against the dollar currency. This kind of increase would have the drastic impact on the macro economy of the country like heavy raise in the import cost where countries like India heavily depends on the importing on Oil and other crucial raw materials needs for the industries.

This article explores the reason behind the rupee value depreciation, how RBI trying to defend the rupee value and how it is going to affect the industries. If you have any thoughts, please post it in the comments section. 

How currency value is determined?

We are not going deep dive into economic terms to understand the currency value fluctuation. There are many factors to decide the currencies values but that could be very difficult for the common man to understand the theory. Here I will put it in the simple words why the currency value is often fluctuated. A currency will tend to become more valuable when its demand is higher than supply. A currency will tend to become less valuable when its demand is less than supply. It is the basic theory. We need to understand in the global economy terms, when the currency will have more demand and when it will have less demand.

Remember that exchange rates are expressed as a comparison of two currencies. It is always relative and can be measured between two countries. To know more about currency market click here

Interest rates, Inflation and exchange rates are highly related. Reserve bank changes the interest rates to control the Inflation and exchange rates. We can take our real time example of stock market investment to understand the above principle. As we know that, our stock market is dominated by the overseas investors (outside India), because of our growing economy and industrial development. When our economy is doing well and market is performing better than other countries, overseas investors would invest heavily on our market. How they would put it in our market?. They will sell or convert to our currency and invest in India. It is clear that when more investors coming to India, the demand for the currency will be very high. Our rupee value will be increased against dollar. In the same way, when they are pulling out of market, demand for the rupee will be decreased and value is depreciated.

Here I am talking only about the dollar, because it is the global currency and most of the countries trading using the dollar as trade reserve currency. The above example is given to explain it in simple words, the demand for a currency would come in the different way. When we are importing from other countries, we should have the currency of that country to pay for the trade. The value for the currency is fluctuated on real time.

If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly on financial markets, mainly by banks, around the world.

 A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a currency. For example, between 1994 and 2005, the Chinese yuan renminbi (CNY, ¥) was pegged to the United States dollar at ¥8.2768 to $1.

Why RBI intervene on Currency valuation?

In the last week we have seen RBI has acted to stop the erosion of rupee value against the dollar currency. What it did was  sold the dollar currency in the market to increase the value of rupee. But, it is very difficult for the Reserve Bank of a country to adjust the value of the currency, the long term solution would be fix the problem in economy and bring the inflation into control. You would wonder why RBI has to intervene on currency value decrease or increase. Note that, RBI would not allow currency to be higher after certain level because of the exports would get affected like IT companies would suffer if the rupee gets appreciated against the dollar. To know more about this click here

India is heavily depending on the import of raw materials and Oil for its industrial development. In the decreasing rupee scenario, the outgo of money will be much higher. This would affect the expenses for the companies who imports raw materials for their factory and all the Oil Marketing Companies (OMC) will incur heavy payment to import the Oil. Now you would have understood why the Petrol prices have been increase in the last fortnight. If you look into the news papers, the reason said by our finance minister was the depreciation of rupee value against dollar.

Major Factors Influencing the Currency Value

In the above section, I have explained in the simple words to make a common man understand the currency fluctuations. This section writes down few economic conditions when the currency value will be under pressure. The following are the three major factors influencing the changes in the currency values. There are many other factors too, but we are not talking about all the factors in this section.

·         Inflation

o    As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies.

·         Interest Rates

o    A higher interest rates offer good returns compare to other countries. It will result in the foreign capital come into the country. Lower interest rates decrease the currency value. Note that interest rates have the close relation with interest rates. The currency value would not be affected only based on the interest; it is impacted based on the other conditions like inflation or economic situation.

·         Current Account Deficits

o    Basically current account of a country presents the status on the trade of a country between other trading partners. If there is any deficit in the current account that means country is doing more trading outside the country then its actual earning inside the country. This situation is not good for a country because the country needs to buy more foreign currency to fulfill its need inside the country. A country needs to manage its deficit within control, otherwise it will lead to a economic problem. More demand for the foreign currency would reduce the value of that country’s currency.

Impact of INR vs USD

In the last two weeks Indian rupee has depreciated about 7% against the USA dollar value. It is expected that it would continue the slide as many macro economic factors not in favor of Indian economy. The following are the factors which would slide down the rupee value.

·         Foreign Funds Outflow

o    It is the major concern of Indian economy now. Because of the global uncertainty and various economy crisis like Europe sovereign debt problem, US economic slowdown, etc leads to search for the safe heaven among the investors. They are quickly pulling out the money from Indian market and investing in any other safe investments like Gold or US bonds.

·         Government Deficit is High

o    The government finances are in a bad shape and the combined central and state government deficit has stubbornly stayed around 10 per cent of GDP. It is high deficit and investors lost faith in the local economy.

·         Political Uncertainty and Corruption

o    This is one of the major factor for any country to stabilize the economy. In India, last one year we are seeing the series of corruptions and there is no good news from the ruling party (Congress) about the economic reforms and lot of agitation among the citizens including the veteran Gandhian Anna Hazare’s campaign of Fight for second freedom which took attention from global media. India needs political change to gain confidence among the investors.

Summary

I hope this article would have given an idea about the rupee depreciation and the reason why the currency is changed. But, there are hundreds of parameters to decide a currency value and politics also there to manipulate the own currency which China has done for a long time. The above are the very basic idea on currency value and how it is affected. If you have any thoughts, please post it in the comments section.

End of Kodak: A lesson to learn..

End of Eastman Kodak

Eastman Kodak Co. the unprofitable 131-year old camera maker, is weighing options including a bankruptcy filing because of concerns raised by possible buyers of its patent portfolio. It’s amazing to me that Eastman Kodak (EK) has lasted as long as it has. In the 1980s, Kodak was heading unstoppably for its end decades ago — but it took longer than anticipated. Kodak plunged 91 cents, or 54 percent, to 78 cents a share on September 30, in New York Stock Exchange composite trading, the biggest drop since at least 1974. Trading was halted four times by circuit breaker introduced following the May 6, 2010, crash to prevent losses in one security from spreading throughout the stock market.

When Kodak was founded in 1888, quality was its “fighting argument.” It gladly gave away cameras in exchange for getting people hooked on paying to have their photos developed  — yielding Kodak a nice annuity in the form of 80% of the market for the chemicals and paper used to develop and print those photos.

Inside Kodak, this was known as the “silver halide” strategy — named after the chemical compounds in its film. Kodak had a fantastic success formula that keyed off of international distribution, mass production to lower unit costs, R&D investment to introduce better products, and extensive advertising to make sure consumers knew about Kodak’s superior quality.

Unfortunately, competition came along and introduced ugly splotches all over this beautiful picture. Here are three examples:

·         Instant photography

 In 1948, a Massachusetts-based inventor, Edwin Land, offered consumers an instant camera that developed photos in 60 seconds – just in time for Thanksgiving. Instant photography threatened Kodak’s profits from chemicals and film. Kodak responded by introducing its own instant photography products. Polaroid sued — alleging that between 1976 and 1986 Kodak stole its technology – asking for $12 billion in damages. In 1990, Polaroid won a mere $909 million and ultimately filed for bankruptcy in October 2001.

Cut rate film from Japan

·          In the 1980s, Japan’s Fuji started to sell rolls of film at a price way below the one that Kodak had been accustomed to charging. Fuji’s willingness to cut prices was quite popular with the rapidly growing mass merchandisers like Wal-Mart (WMT) that preferred to deal with suppliers who were willing to sell high volumes at ever-lower prices. And Fuji helped make consumers aware of its value by sponsoring big events — such as the 1984 Los Angeles Olympics. By 1999, Fuji’s market share gains were so great that Kodak took a $1.2 billion charge along with 19,900 layoffs. Such layoffs persisted, for example in January 2009, Kodak took a $350 million charge to nuke 3,500 people on a 24% revenue plunge.

·         Digital photography

Digital photography offered consumers a better value but one that wiped out a decent way for Kodak to make money. After all, digital film — flash memory — was a low margin proposition even if you had the huge fabs needed to produce it. And even though Kodak was number two in digital cameras by 1999, it lost $60 on each one it sold. In one of many bids to replicate its Silver Halide business model in digital photography, Kodak offered a Photo CD film-based digital imaging product – but since it was priced at $500 per player and $20 per disc it did not attract many customers.

In January 1988, Kodak  acquired Sterling Drug for $5.1 billion.

Kodak thought this was a wise investment for two reasons: drugs had high margins and Kodak made chemicals. Unfortunately, those two facts were not sufficient to make this deal pay off for Kodak shareholders.

To do that, Kodak would have needed capabilities that it lacked — such as the ability to come up with new, valuable, patented drugs or to make generic drugs at a rock-bottom cost. It only took six years for Kodak to realize that Sterling Drug was not a good fit for Kodak and sell it off in pieces.

One hope for returning to a decent business model might have been producing high quality personal printers for those digital images. Selling inkjet cartridges and papers might have yielded a nice profit stream for Kodak. But regrettably for Kodak, many other competitors — most notably Hewlett Packard (HPQ), had gotten there first.

Since peaking in February 1999 at about $80 a share, Kodak shares have suffered a steady tumble that wiped out 99% of their value — to 78 cents a share as of Sept. 30.  At the end of June, Kodak’s liabilities exceeded its assets by $1.4 billion. It then owed $1.4 billion and had $957 million in cash, down $847 million from the end of 2010.

Its latest CEO (since 2005), former HP printer exec, Tony Perez, has been unable to revive Kodak. Last week, it pulled $160 million from its credit line and hired restructuring advisor, Jones Day on Friday even as Kodak denied that it was on the verge of filing for bankruptcy.

It’s taken decades for Kodak’s final picture to develop — but the corporate skull and crossbones it depicts is the result of too much success leading to a slow and painful inability to adapt to a changing competitive landscape. The end of Kodak marks the end of an era and gives a lesson to the world that no matter how big you are one has to fall if it fails to keep itself in line with the changing environment. To prosper one have to be innovative and flexible and corporate needs to formulate their strategies with much more accuracy leaving minimal chances of failure.