Yesterday, the Sensex crashed a whopping 928 points. This month, the rupee fell to INR 82.7 per dollar. In a world of volatility, a weakening rupee is not all bad news for a business. In this explanatory article, Compliance Calendar traces recent causes of a weak rupee and sectors which are favourably disposed to gain from it.
Weakening Rupee : A strong indicator of inflation
Inflation, to put simply, is an increase in prices. A weaker rupee means that more money goes out for every payment involving foreign currency. The major items that get affected are crude oil payments (which are made in dollars), interest payments on loans taken from foreign banks, imports and salaries to workers abroad. This depreciation of money is a strong indicator of inflation in the economy.
As the value of the rupee falls, every sector in the economy gets affected. Governments and businesses find loans more expensive, price of fuel increases and consumers find fruits, vegetables, and food more pricey. This triggers a general price rise in the domestic market, impacting personal and corporate finance while adding to inflation.
The Adani saga, losing the tag of fifth-largest economy and the rupee weakening
India, in September 2022 had overtaken the United Kingdom to become the world’s fifth largest economy, with a growth rate of 7%. IMF calls us a “bright spot in the world economy”, and India alone is set to contribute 15% of the global growth in 2023. Yet, in February, 2023 -UK overtook India again.
Experts believe that the Adani-Hindenburg report led to a market capitalisation crash (eroding an estimated $100 billion value from the group), adding to an already weak rupee and loss of international investor sentiment.
In this backdrop, one might wonder, why is the rupee falling? This is because of a combination of multiple factors.
• The Russia - Ukraine war adding volatility to oil prices
• In 2022, the US Federal Reserve (think of it as USA’s RBI) raised the interest rates, thereby increasing returns for investors. This led to a flood of investors flocking investments in the USA, by exiting the Indian stock and debt markets.
• Foreign Institutional Investors sold stocks worth over INR 1.2 lac crores in 2022. This was also one of the reasons why our stock market has been very volatile in 2022.
• 2021 will go down in history as the year of Initial Public Offerings (a term which refers to raising new money from the market for the first time), when equity and debt fundraising reached an all time high. However, the year 2022 witnessed a slowing outlook towards initial investments in IPOs.
• Higher imports : When imports exceed exports, we land up in a situation called trade deficit. This means, we owe more money to other countries than we receive from them. Thus, we require more dollars to settle the payment. This increase in demand for dollars weakens the rupee, and makes payments even more expensive.
Profiting from the weakening rupee - The positive impact on business and economy
The rupee is depreciating. But there’s good news for many businesses. Any business with a revenue stream coming from the US which is negotiated in dollars gets a huge boost every time the rupee weakens.
India has become a leading exporter of services in segments like IT, software technology, chemicals, pharmaceuticals, gems and jewellery etc. So, every time the value of the rupee falls, the value of the dollar increases. Thus, bills and receivables denominated in dollars get a thrust.
• Companies like Infosys, TCS and Wipro - get more than half their earnings from service exports. Thus, any fall in rupee brings greater income to the export based IT service sector.
• Chemicals, plastics, dyes, synthetic rubber, agrochemicals, pesticides etc, of which India is a leading exporter also record a gain from weakening of the rupee.
• India, now regarded as “pharmacy of the world” profits when dollar prices increase vis a vis rupee, on its generic medicines, vaccines and other health related exports.
• Regardless of the sector, any company that is a net foreign exchange earner records a positive cash flow due to a falling rupee.
• The weakening rupee also has societal benefits - it makes our exports competitive, as foreign firms find a weaker (or cheaper) rupee more lucrative. This increases exports and helps narrow the trade deficit. A more expensive loan/shopping experience abroad also means that domestic investors are discouraged from overspending on foreign goods, and are steered towards Indian alternatives.
Which businesses are the worst affected?
When the rupee starts depreciating, any industry which is highly dependent on imports is likely to face huge losses. The imported raw material, machinery and logistics payments in international trade become expensive.
Take for instance, India’s automobile industry which has consistently faced losses in the last few years. During Covid, when semiconductors (an essential component in car manufacturing) shortage coincided with a weakening rupee, the automobile sector’s growth rate fell to 1.5% (from a CAGR of 12%), daily losses reached around INR 2600 crores and lacs of employees lost their jobs.
Similarly, electronics and hardware, engineering goods, coal and other heavy industries relying on foreign goods as part of the industrial process are adversely affected.
Guarding against inflation : Should you invest in Inflation Indexed Bonds?
In India, the RBI issues an instrument called Inflation Indexed Bonds. These are government securities and debt instruments that do what their name suggests - adjust their returns for inflation. They guard the interest received, by providing a formula (linked to the Wholesale Price Index) that accounts for inflation. This helps middle class and small investors in preserving their investment. A retail investor can participate in bidding of these bonds through primary dealers and banks. A gilt account with the bank or demat account is a prerequisite for such participation. While these bonds are a great way to keep your interest income shielded from inflation, the earning potential of such bonds is often low. The formula adopted for inflation calculation is also not a perfect metric, and hence may not truly adjust for real inflation in all sectors.
Financial planning for your business against the risks of inflation and currency fluctuations is a crucial decision for every entrepreneur. Connect with our experts at Compliance Calendar to get the best of advice for safeguarding your profits from market fluctuations.