Rupee Devaluation, its Causes and Impact on Indian Economy

Devaluation means reduction in the value of currency with respect to goods, services or other monetary units with which that currency can be changed. For example suppose the exchange rate between rupee and dollar is Rs 50 = 1$. If this exchange rate is fixed Rs 55 = 1$then it is called the devaluation of rupee. This is a monetary policy tool used by countries that have a fixed exchange rate or semi fixed exchange rate. A country may devaluate its currency is to combat trade balances. It means the exports are less expensive and more competitive in the global market and the imports are more expensive so that the people use the domestic products. Devaluation is a term which is different from depreciation because the value of rupee is decreased by change in the demand and supply of currency. But devaluation is done by government to improve the balance of payment.

• Devaluation is done for correcting the balance of payment. • For increasing the exports, devaluation is done. • For decreasing imports, devaluation is done.

HISTORY OF RUPEE

India got freedom from British rule on August 15, 1947. At that time the Indian rupee was linked to the British pound and its value was at par with the American dollar. As shown in table, in year 1947 the value of rupee is equal the dollar. But slowly, due to many reasons the value of rupee is decreased. Historical Indian Rupee Rate

1947 1.00 1948 4.79 1965 4.79 1966 7.57

Since 1950s India suffered in negative balance of payment. The main reasons of devaluation are huge trade deficit, India – Pakistan war and draught in 1965. So for improving the trade deficit, India devaluate its currency at first time in 1966. And this devaluation is done by Lal Bahadur Shastri in June 1966.

Since 1985 – 1990, India found itself in a serious economic trouble. In 1991 India faced large government budget deficit. For decreasing the budget deficit, government devalued its currency by 18 to 19%. The main reasons of devaluation are huge gross fiscal deficit, inflation and rise in oil prices etc.

• High fiscal deficit – High fiscal deficit is regarded as the main reason of devaluation of currency. Fiscal deficit is the difference between government income and expenditure. In case of high fiscal deficit government may use foreign reserve to finance the deficit. Due to this, the reserves are reduced. And this problem encourages the government to devalue its currency.

1960 21.05 12.37 8.68 1965-1970 25.75 16.46 9.29 1970-1975 23.14 14.17 8.97 1975-1980 22.62 14.07 8.55 1980-1985 30.23 20.34 9.89 1985 32.13 20.57 11.56 1986 35.06 23.21 11.85

1987 33.49 20.34 13.15 1988 32.58 17.96 14.62 Source: Foundations of India‘s Political Economy, pp. 192

• Current account deficit – It is the difference between the import and export in a country. This gap between income and expenditure keeps a downward pressure on the value of rupee. In the year 1990, the current account deficit is US $9.7 billion. The wider CAD • Inflation 1980 – Inflation means continuously rise in prices. From 1966 to 1980, the value of rupee is constant. But after this, the value of money is decreased. And it decreases the purchasing power of money. Due to this there is a decline in demand of the goods and this is cause of devaluation of currency.

Year Inflation

1988 9.4% 1989 6.2% 1990 9.0% 1991 13.9%

1992 11.8% 1993 6.4% 1994 10.2% 1995 10.2% Source:http://oldfraser.lexi.net/publiccations/books/ecom_free/countries/ india.html

• Indo – Pak war 1965 – At the time of war US and other countries friendly with Pakistan and withdrew foreign aid to India. Because of this reason, the value of rupee is devalued by 57% in 1966. • Drought of 1965/1966 - In 1965 – 1966, India faces many problems due to natural calamity draught and the prices of goods are increased because of this. So it is necessary for the government to devalue the currency. • Trade deficit – Since 1950s India face the problem of huge trade deficit. So India devalued its currency in 1966. But again the balance of trade deficit is increased in 1990 was US $ 9.44 billion. Because of this deficit India again devalue its currency in 1991.

1950 947 1025 78 1951 1106 1379 273 1952 873 1002 129

1953 813 855 42 1954 918 998 80 1955 922 1024 102 1956 977 1423 446 1957 1001 1633 632 1958 903 1424 521 1959 1008 1515 507 1960 997 1768 771 1961 1033 1718 685 1962 1069 1783 714

1966 1153 2078 925 1967 1193 2008 815 1968 1354 1909 555 1969 1409 1567 158 1970 1524 1624 100 Source: Data of export and import are from India and International monetary management.

• Gulf war – India also face a problem because of gulf war. It leads to increase in the prices of oil. So the imports of India are higher. For controlling this situation, devaluation is done by government. • Defence spending – Defence spending in 1965/1966 was 24.06% of total expenditure which is very high. So this is another factor which affects the value of currency. • Political and economic instability – Another main reason of devaluation of rupee is political and economic instability. Before 1966 devaluation, in three years three persons (Nehru, Shastri, and Indira) were the PM of India. Different PM have different strategies. So this situation encourages the government to devalue its currency in 1966 and 1991. • Increasing imports – In 1965 – 1966, Indian exports had increased up to 20% while the imports had increased up to 131.3%. So for increasing exports and decreasing imports, Indian government devalue its currency.

Year Exports Imports

• Exports cheaper – A devaluation of the currency will make exports more competitive and cheaper to foreigners. • Imports expensive – Because of devaluation of rupee, the petrol, food and raw material will become more expensive. This will reduce demand for imports. • Improvement in current account – Current account deficit is the difference of exports and imports. Because of devaluation the • Impact on common man – There would be a higher burden on the common man because of devaluation of currency. For example – the prices of fuel, imported goods and fees of abroad universities etc. Are increased and trips becomes costlier. • Impact on infrastructure – The devaluation of rupee has negative impact on the infrastructure sector. It increases the cost of projects by increasing the cost of raw materials like steel, cement and price of construction equipment‘s. • Impact on agriculture – Devaluation of rupee has positive impact on agriculture. India is world‘s largest producer of wheat. So fall in the value of rupee increase the profit of Indian wheat exporters and similarly the export of sugar, rice, cotton and edible oil etc. are increased. • Impact on real estate – Devaluation of currency increases the cost of projects by increasing the prices of raw material, transportation, import of construction equipment, wages and salary of labour etc. • Impact on foreign investors – Foreign investors bear a loss when the value of currency is devalued. • Impact on Economic growth – The devaluation of rupee can only increase the short term economic growth. But it has negative impact on the long term economic growth. Because of devaluation, there is a loss of confidence in International and domestic investors. Long term economic growth is affected by reduction in investment. • Impact on Inflation – Due to devaluation, the prices of goods are increased because of imports are more expensive and exports are cheaper. So more money is pay for the same products for which less money is paid before devaluation. So this situation increased inflation. • Impact on Foreign Direct Investment – After the devaluation of currency the inflow of foreign direct investment is increased. As we seen in table after the devaluation of rupee in 1991 the inflow of FDI is increased from 409 crores to 64,193 crores.

1991-92 409 1992-93 1094 1993-94 2018 1994-95 4312 1995-96 6916 1996-97 9654 1997-98 13,548 1998-99 1,2343 1999-00 10,311 2000-01 10,733 2001-02 18,654 2002-03 12,871 2003-04 10,064 2004-05 14,653 2005-06 24,584

2006-07 56,390 2007-08 98,642 2008-09 142,829 2009-10 123,120 2010-11 97,320 2011-12 165,146 2012-13 121,907 2013-14 147,518 2014-15 64,193 Source: Various issues of SIA Publication

This research paper helps to find out the causes and effect of devaluation of Rupee. Almost all the countries of the world have devalued their currencies at any time with a motive of achieving certain economic objectives. So India also devalued its currency in many times like 1966 and 1991 for achieving many objectives. The main objectives are: - Economic stabilization, correcting the unfavorable balance of trade, to raise the national income and per capita also. However devaluation also affects the many parties in positive and negative manner also. So the Govt. and RBI take the step of devaluation of Rupee.

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