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What does the current financial crisis mean for you

The fall: The rupee's dive gainst the US dollar, the slipping Sensex and a widening current account deficit are compounding the woes of an already weak economy. Gaurav Choudhury looks at what the implications are for you.

india Updated: Aug 21, 2013 03:04 IST
Gaurav Choudhury
Gaurav Choudhury
Hindustan Times
currency market,sliding rupee,US dollar

How does the currency market operate?
Like any other commodity, the exchange rate or price of a currency is determined by the laws of demand and supply. A stronger demand for a currency will push up its price and vice versa.

What is exchange rate?
The exchange rate gives the price at which currencies of different countries are bought and sold. An exchange rate of Rs 50 to a dollar simply means that the value of one US dollar is equivalent to Rs 50

What does appreciation and depreciation of currency mean?
If a currency is depreciating it implies that its value has fallen in relation to another currency. In the present context, the value of rupee has fallen or depreciated from about Rs 50 to a dollar to about Rs 54 in a little over two months.

Why does the exchange rate fluctuate every day?
Banks, corporations, brokers, individuals and governments buy and sell currencies every day. That explains the daily fluctuations in currency prices according to changing demand and supply situation.

Why is the rupee falling?
The US economy is showing signs of recovery, so, global investors are withdrawing money from emerging economies. The central bank of US, the Federal Reserve, is likely to withdraw its easy monetary policy that will take out money countries such as India. In addition, high demand for gold and high crude oil import is increasing demand for dollars.

How will the unwinding of monetary stimulus in the US affect India?
The third round of quantiative easing or QE3 by the US central bank, the Fed, will impact India in a number of ways. QE3 involves a purchase of bonds by the Fed to pump in loads of cheap money ($85 billion or about Rs 5.3 lakh crore each month) into the financial system to help the American economy claw out of its worst decade since the Great Depression.

With the US — which represents about a quarter of the world's economy — showing early signs of turnaround, there are signals that the Fed may start rolling back this stimulus package, effectively taking out funds from emerging countries such as India.

In India, analysts believe that a reduction of QE purchases would be very negative in the short-term, but should bode well over the medium term. Net capital inflows totaled $88 billion (Rs 4.84 lakh crore) in 2012, largely aided by global quantitative easing.

With the current account deficit likely to be almost $100 billion in 2013, a reversal of capital inflows would likely pull down the rupee making the financing of current account deficit (CAD) difficult. All in all, this could delay a growth recovery in India.

Why are stock markets falling?
The Reserve Bank of India's decision last week to impose capital controls on amount of dollars Indian companies and individuals can spend abroad spooked the markets. Foreign funds began withdrawing from equity markets triggering a collapse.

Why are bond yields rising?
Bond prices and yields move in opposite direction. Yield gives the return one gets on a bond. The yield on India's 10-year benchmark government bond climbed as high as 9.26%, its highest since August 1, 2008.

What has the Reserve Bank of India done in the bond market to prop up the rupee?
The Reserve Bank of India sold Rs 22,000 crore of short-term cash management bills (CMBs) every Monday, beginning this week, to drain liquidity from the banking system

What are cash management bills?
CMBs are short-term paper with a tenure of as low as seven days. The central bank will be selling Rs 11,000 crore each in two CMBs maturing in 35 and 34 days on Monday and Tuesday, respectively. The bills will mature on September 17. The RBI had auctioned similar CMBs of 28 and 56 days on July 25.

Why has September 17 been selected as the date of maturity?
The date has been fixed to ensure matching cash requirements as liquidity gets strained in the banking system by September 15, the last deadline for paying the second quarter advance taxes.

Who buys CMBs?
Designated primary dealers (PDs) are underwriters of bond auctions. If there are no takers for the bonds in the market, PDs have to buy the unsold stock, known as devolvement. Banks are usually the main investors in these bills as these qualify as investment in government securities by banks for statutory liquidity ration (SLR) — the proportion of money that banks have to invest in gold and government bonds.

Why is Reserve Bank of India trying to suck out liquidity?
By draining liquidity, the RBI wants to curb banks' lendable resources being used for taking speculative positions on the rupee.

Should I be worried?
You better be, if you have plans to study and travel abroad. A weaker rupee implies you end up paying more to buy dollars to pay for your fees. If you were planning to an overseas vacation, you better set aside more money A weaker rupee implies you end up paying more to buy dollars to pay for your air tickets, hotel tariffs, shopping and other expenses.

First Published: Aug 20, 2013 22:10 IST