Rupee’s decline

Rupee’s decline

Subject :Economy

Section: Monetary Policy

Context: RBI probing Refinitiv’s forex outage

Details:

• The Indian rupee plunging to a life-time low of ₹83.33 against the US dollar may partly be on account of massive volatility caused by an outage in Refinitiv, an electronic trading platform authorised to offer forex products.
• Refinitiv is a subsidiary of LSEG or London Stock Exchange Group. It is among the five non-bank entities authorised by the RBI to operate electronic trading platforms for spot foreign exchange market.

Rupee Decline:

• The Indian rupee experienced a significant drop to a lifetime low of ₹83.33 against the US dollar.

Market Disruptions:

• The brief outage on Refinitiv is reported to have caused disruptions in the currency market.
• Market participants were reportedly unable to log in to the platform during the outage, leading to a drying up of orders and volume on the trading terminal.

Volatility and Investigation:

• The incident resulted in increased uncertainty in the money market, contributing to excess volatility in the movement of the rupee.
• The central bank, RBI, is said to be investigating the matter, seeking information on the circumstances of the disruption and whether standard operating procedures for business continuity were followed.

Rupee Movement:

• The rupee opened at 83.28 against the US dollar on the day of the incident and touched a high of 83.49 during intraday trading.
• Possible intervention from the central bank influenced the closing rate, with the rupee ending at Rs 83.33 against the US dollar.

Regulatory Response:

• The RBI has reportedly sought an explanation from Refinitiv regarding the disruption.
• The regulator is seeking information on the circumstances of the outage, adherence to standard operating procedures, and the root cause analysis to determine whether the disruption resulted from a system failure or human error.
• In summary, the Refinitiv outage is identified as a factor contributing to increased volatility in the rupee’s exchange rate, leading to regulatory scrutiny and investigation by the RBI.

Currency Appreciation:

1. Definition:
   • Currency appreciation refers to an increase in the value of a country’s currency relative to other currencies in the foreign exchange market.
2. Causes:
   • Higher Demand: If there is an increased demand for a country’s currency, its value tends to rise.
   • Economic Strength: A strong and growing economy, coupled with positive economic indicators, can lead to currency appreciation.
   • Interest Rates: Higher interest rates in a country can attract foreign capital, leading to an appreciation of its currency.
   • Trade Surplus: If a country consistently exports more than it imports, it creates higher demand for its currency, contributing to appreciation.
3. Effects:
   • Import Prices: Appreciation makes imports cheaper for domestic consumers.
   • Inflation: It may contribute to lower inflation due to cheaper imports.
   • Exports: It can negatively impact exports as they become more expensive for foreign buyers.
4. Central Bank Intervention:
   • Central banks may intervene to manage the currency’s value through buying/selling in the foreign exchange market.

Currency Depreciation:

1. Definition:
   • Currency depreciation occurs when a country’s currency loses value compared to other currencies.
2. Causes:
   • Lower Demand: Reduced demand for a currency can lead to depreciation.
   • Economic Weakness: Economic downturns, high unemployment, or weak economic indicators can contribute to depreciation.
   • Low Interest Rates: Lower interest rates may discourage foreign investment, leading to currency depreciation.
   • Trade Deficit: Persistent trade deficits can result in a depreciation as more of the currency is needed to pay for imports.
3. Effects:
   • Export Competitiveness: Depreciation can boost exports by making them more affordable for foreign buyers.
   • Import Prices: Imports become more expensive, potentially contributing to higher domestic inflation.
   • Debt: Countries with significant foreign debt may face increased repayment costs.
4. Managed Depreciation:
   • In some cases, countries intentionally allow or manage depreciation to support exports and economic growth.
5. Floating Exchange Rates vs. Fixed Exchange Rates:
   • Floating Rates: Most major currencies have floating exchange rates that fluctuate based on market forces.
   • Fixed Rates: Some countries peg their currency to another (or a basket of) currency, aiming to maintain a stable exchange rate.

Capital Account Convertibility:

1. Definition:
   • Capital account convertibility (CAC) refers to the freedom to convert local financial assets into foreign financial assets and vice versa. It involves the ability to conduct transactions related to capital flows without restrictions.
2. Components:
   • Foreign Direct Investment (FDI): Unrestricted flow of investment in physical assets in another country.
   • Foreign Portfolio Investment (FPI): Unrestricted flow of investment in financial assets like stocks and bonds.
   • Borrowing and Lending: Freedom for residents to borrow and lend money internationally.
3. Implications:
   • CAC allows for greater flexibility in managing capital flows.
   • It attracts foreign investment and enhances the integration of a country into the global financial system.
4. Risks:
   • While CAC offers benefits, it also exposes a country to risks such as sudden capital outflows, which can impact exchange rates and financial stability.

Current Account Convertibility:

1. Definition:
   • Current account convertibility (CAC) involves the freedom to convert local currency for international trade in goods and services. It ensures that transactions related to the trade of goods, services, income, and transfers can be conducted without restrictions.
2. Components:
   • Trade Transactions: Unrestricted movement of funds for importing and exporting goods and services.
   • Income Transactions: Unrestricted flow of income earned from investments and labor.
   • Transfer Transactions: Unrestricted movement of gifts, remittances, and other transfers.
3. Implications:
   • CAC facilitates international trade and ensures smooth transactions related to income and transfers.
   • It promotes economic openness and fosters international economic relations.
4. Risks:
   • Excessive current account deficits may lead to external debt accumulation and vulnerability to external shocks.

Difference:

1. Nature of Transactions:
   • Capital Account deals with capital flows, including investments and borrowing.
   • Current Account deals with transactions related to the current account, such as trade and income.
2. Flexibility:
   • Capital Account provides flexibility in managing capital movements.
   • Current Account provides flexibility in conducting transactions related to the current account.
3. Risks:
   • Risks associated with Capital Account include financial instability due to rapid capital movements.
   • Risks associated with Current Account include the accumulation of external debt and potential imbalances.

Both convertibilities are crucial aspects of a country’s economic policies. Striking a balance between liberalizing capital flows and ensuring stability in the current account is essential for sustainable economic growth and stability. Central banks and policymakers often implement convertibility measures gradually, taking into account the country’s economic conditions and vulnerabilities.

Current Account Balance:

1. Definition:
   • The current account is a part of a country’s balance of payments that records its transactions with the rest of the world in goods, services, primary income, and secondary income.
2. Components:
   • Goods and Services: Includes exports and imports of tangible goods and services.
   • Primary Income: Represents income earned and paid on investments (e.g., interest, dividends).
   • Secondary Income: Involves transfers of money, such as foreign aid or remittances.
3. Surplus and Deficit:
   • A current account surplus occurs when a country exports more goods and services and receives more income than it imports and pays out. It indicates a net inflow of funds.
   • A current account deficit occurs when a country imports more goods and services and pays more income than it exports and receives. It indicates a net outflow of funds.
4. Implications:
   • A surplus contributes to an accumulation of foreign assets, while a deficit leads to increased foreign liabilities.
   • Persistent deficits may require financing through capital account transactions.

Capital Account Balance:

1. Definition:
   • The capital account is another component of the balance of payments that records financial transactions. It includes capital transfers and the acquisition or disposal of non-produced, non-financial assets.
2. Components:
   • Foreign Direct Investment (FDI): Investments in physical assets, such as factories or real estate, in another country.
   • Foreign Portfolio Investment (FPI): Investments in financial assets like stocks and bonds in another country.
   • Changes in Reserves: Movements in a country’s official reserves, including gold and foreign exchange reserves.
3. Surplus and Deficit:
   • A capital account surplus occurs when a country receives more financial resources from other countries than it invests abroad.
   • A capital account deficit occurs when a country invests more abroad than it receives from other countries.
4. Implications:
   • A surplus in the capital account means the country is a net lender to the rest of the world.
   • A deficit implies the country is a net borrower.