Why a Free Fall in the Rupee Seems Unlikely

  • December 9, 2024
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Why a Free Fall in the Rupee Seems Unlikely

Sub: Eco

Sec: External sector

India’s economic resilience provides key reasons why the rupee is unlikely to experience a free fall despite recent challenges like capital outflows and a dip in foreign exchange reserves.

Robust Balance of Payments (BoP):

  • Current Account Deficit (CAD):
    • India’s CAD for 2023-24 is $23.29 billion, significantly lower than past highs like $78 billion in 2011-12.
    • This manageable CAD is supported by strong surpluses in the invisibles account, primarily from:
  • IT and software services exports: $142.07 billion in 2023-24.
  • Remittances: A record $106.63 billion in 2023-24.
  • Goods Trade Deficit:
    • While the merchandise trade deficit remains high ($242 billion in 2023-24), the invisibles surplus offsets much of its impact.

Stable Foreign Exchange Reserves:

  • India’s forex reserves, at $658.09 billion (as of November 29, 2024), are among the world’s highest.
  • Despite a dip from the peak of $704.89 billion in September 2024 due to FPI outflows, these reserves still provide a significant buffer against external shocks.

Nature of Capital Flows:

  • Foreign Direct Investment (FDI):
    • FDI, which represents long-term investment, has declined to $26.47 billion in 2023-24, but it remains a stable source of capital inflow.
    • FDI’s stability contrasts with more volatile sources like FPIs.
  • Foreign Portfolio Investors (FPIs):
    • FPIs pulled out $11.47 billion in October 2024 and $2.54 billion in November 2024, causing temporary rupee depreciation. However, such outflows are cyclical and not indicative of structural issues.

Comparatively Favorable Position:

  • During the 2011-12 and 2012-13 crises, India faced:
    • High CADs (~$78 billion).
    • Drying up of capital flows triggered by the US Federal Reserve’s tapering policy.
    • Dwindling forex reserves, leading to rupee depreciation.
  • Current Scenario:
    • A much smaller CAD, combined with significant forex reserves, offers a buffer against sudden shocks.
    • Even if capital flows tighten, the reserves can help stabilize the rupee.

Global Dynamics and India’s Preparedness:

  • India’s exports have been boosted by post-pandemic digitization and the rise of Global Capability Centres, enhancing invisibles revenue.
  • Policies to attract stable FDI and manage external commercial borrowings (ECBs) contribute to a more robust BoP.

Balance of Payments (BoP) and Its Components

The Balance of Payments (BoP) is a systematic record of all economic transactions between a country and the rest of the world. It reflects the flow of goods, services, and capital, helping to measure a nation’s economic stability and international economic standing.

Components of BoP

  • Current Account:
    • Tracks the flow of goods, services, income, and transfers.
    • Trade in Goods: Exports minus imports of tangible products.
    • Trade in Services: Includes IT services, tourism, financial services, and transportation.
    • Income: Earnings from foreign investments minus payments to foreign investors.
    • Current Transfers: Includes remittances, gifts, and foreign aid.
  • Capital Account:
    • Focuses on capital transfers and acquisitions or disposals of non-financial, non-produced assets.
    • Capital Transfers: Includes grants for infrastructure projects or debt forgiveness.
    • Acquisition/Disposal of Assets: Involves items like patents or trademarks.
  • Financial Account:
    • Records financial transactions involving foreign investments.
    • Foreign Direct Investment (FDI): Investments in businesses or real estate abroad.
    • Portfolio Investment: Investments in equities and debt securities.
    • Reserve Assets: Changes in foreign currency reserves held by the central bank.
    • Loans and Banking Capital: Borrowings and deposits in foreign banks.

External Commercial Borrowings (ECBs)

ECBs refer to loans or funding obtained by an Indian entity from non-resident lenders in foreign currencies. These borrowings are typically used for financing specific projects, infrastructure development, or expanding business operations.

economy Why a Free Fall in the Rupee Seems Unlikely