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CASE STUDY 4.

1
When One of the BRIC(K)s Falls: Trials
and Tribulations of the Indian Rupee
This case study accompanies Chapter 4 of International Corporate
Finance.
The chapter on the Fall of the Rupee you may omit. It is somewhat too
sensational.
Miss Prism, in Oscar Wilde's The Importance of Being Earnest, 1895
Narendra Aneja is the chief investment strategist at the Flying Dragon
Fundan India country fund domiciled in Bostonthat has close to $1
billion under management in Indian stocks. The first semester of 2012
had been an utter disaster, with the Bombay Stock Exchange down
more than 18 percent, further compounded by a steep depreciation of
the rupee. Narendra was reviewing the latest balance of payments
statistics and short-term projections (see the case exhibits) in
preparation for the board quarterly meeting, when he would have to
map out the rupee's likely course. Somehow he would have to make
amends for failing to anticipate the reversal in the rupee's fortunes,
which only a year ago had seemed so much more auspicious.

ECONOMIC GROWTH AND FISCAL DEFICITS


In spite of its economy expanding at the rate of 6 percent in the first
two quarters of 2012, India's currency was now down 20 percent on the
year, while its budget deficit at 5.9 percent of GDP (March 2011 to
March 2012) grossly overshot its target of 4.6 percent. Structural
economic reforms are hindered by the government's lack of a reliable
parliamentary majority, and it is likely to focus on the more pressing
concerns of high inflation, slower economic growth, and a falling rupee.
For almost a year, India's central bankthe Reserve Bank of India
(RBI)has spent billions of dollars to support the beleaguered rupee
but still seems powerless in bucking the downward trend. Some
analysts see the exchange rate weakening further toward 60 rupees per
U.S. dollar by year-end, versus its closing rate of 54.48 rupees.
CASE EXHIBIT 4.1 India's Current Account

CURRENT ACCOUNT
Because of subdued global demand and sustained import growth, the
deficit on the current account will widen from 2.2 percent of GDP in
2011 to 3.7 percent in 2012. This would primarily result from a
widening trade deficit, expected to reach US$182 billion in 2012.
Services exports such as information technology and business process
outsourcing continue to attract Western firms to India. The rupee has
been declining partly because of a flight of capital from emerging
markets, but also because of concerns over India's deteriorating
financial health. Unsurprisingly, the country's current-account deficit
recently hit its highest level ever, as the federal government's heavy
spending widened its budget deficit. India's government failed to raise
fuel prices to reduce demand for costly imported oil, while government
spending on massive fuel subsidies kept inflation high. (See Case
Exhibit 4.1.)

CAPITAL ACCOUNT
Historically, capital inflows have been financing India's structural
current-account deficit; however, the deepening of the euro-zone crisis
is triggering a new increase in investors' risk aversion. The central bank
also has made it easier for foreigners to invest in rupee-denominated
assets. And more drastically, it recently ordered Indian exporters to
convert foreign-currency earnings into rupees. By mid-December, the
rupee hit a then-record intraday low of 54.29 to the dollar, and the
bank took actions aimed at increasing capital inflows and curbing
speculative activity. For example, it restricted banks' ability to cancel
and rebook forward contracts, thereby taking bets on the currency's
movement. The RBI also tried to lure Indians living abroad to move
more money back onshore, by allowing banks to offer higher interest
rates on deposits held by nonresident Indians. Unfortunately,
controversial new proposals to retroactively tax foreign investors have
scared capital away. Between April and June 2012, for instance, foreign
institutional investors pulled out $350 million from Indian stocks
versus net inflows of $1.15 billion in the same period a year earlier.
(See Case Exhibit 4.2.)

CASE EXHIBIT 4.2 India's Capital Account

RESERVE BANK OF INDIA'S INTERVENTION POLICY


It appears that the central bank's principal objective is to tamp down
day-to-day volatility rather than draw a line in the sand. India's central
bank has foreign reserves of $286 billion or equal to six months of
imports, compared to China's $3.3 trillion. Shortly after the rupee's
descent started in August 2011, the central bank began to intervene by
selling dollars to steady the decline. It spent $22 billion in foreign
reserves between September and April, according to data from the
bank. (See Case Exhibit 4.3.)
CASE EXHIBIT 4.3 India's Foreign Exchange Reserve

CASE EXHIBIT 4.4 Summary Macroeconomic Statistics for India (20072013)


QUESTIONS FOR DISCUSSION
Refer to Case Exhibit 4.4 to answer questions 1 through 5.
1. Analyze India's current account performance over the period
2007 to 2012.
2. What is the relationship between India's fiscal policies and its
current account?
3. Does it explain the recent steep rupee's depreciation?
4. How would you characterize RBI's forex policy?
5. What is the outlook for the rupee over the next 6 to 18 months?

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