Depreciation of Indian Rupee and FDI in Retail Sector

For several months, India has suffered the double misfortune of a slowing economy and high inflation. Now, it has another problem: a rapidly depreciating currency.

The value of the Rupee has fallen nearly 14 per cent, to 52.21 against the dollar, since the end of August as investors have stepped back from the Indian economy and many traders have stepped up bets against the currency. Less than three months ago, the rupee was trading at 45.79 to the dollar. 

Foreign investment in India, which has a big need for foreign capital because it imports more than it exports, has been falling sharply since June, when the country took in $6.5 billion. In September, it took in just $616 million. 

During that time, many analysts and investors have grown more concerned about the growth prospects of the Indian economy. Some analysts now predict the country might grow 7.2 per cent in the current fiscal year, down from 8.5 per cent last year. 

Partly in response to the concerns about growth, Prime Minister Manmohan Singh's Cabinet voted on Thursday to allow foreign retailers to invest in stores in the country in spite of significant political opposition. Analysts said the long-delayed proposal should help lure more foreign investment into the country, though not right away, especially given the stringent conditions that policymakers imposed on foreign investors. 

The rupee was up just 0.3 per cent against the dollar Friday after the decision to open the retail market. 

While many currencies have recently depreciated against the dollar, the rupee has fallen more than most. It is the worst-performing Asian currency this year, and some analysts are predicting that it could fall further. Strategists at HSBC said in a note issued Thursday that the rupee could fall to 58 against the dollar.

Analysts say the depreciation of the rupee could exacerbate inflation, which has been at or above 10 per cent for more than a year, by sharply increasing the cost of oil and other commodities that India imports and has to pay for in dollars. That would also worsen the government's large fiscal deficit, because the country heavily subsidizes imported fuel and fertilizers.

For Indian exporters, including software outsourcing companies like TCS and Infosys, a weaker rupee could help increase sales because it would make their products and services cheaper. But analysts say those gains would be muted because Western customers are not spending much. Moreover, higher exports would not fully offset the rising cost of imports because India has an annual trade deficit of more than $80 billion. 

"We are just waiting to see if it will come down from the current level so that there will be no reason to increase prices right now," he said. "I am just praying to God that the dollar can go down below Rs 50." 

Analysts say investors have bet heavily against the rupee in recent weeks after officials at the central bank, the Reserve Bank of India, suggested they would not intervene to limit the currency's slide. 

The central bank, however, has since stepped in to try to check the sharp depreciation by selling dollars and buying rupees, analysts say. The bank has also said it would sell dollars to state-owned oil companies so that they would not have to buy them on the open market, which would further drive down the value of the rupee.

In the longer term, the government's decision to allow foreign retailers in the country should help, if companies like Wal-Mart, Tesco and Ikea inject money into the Indian economy to set up new stores, warehouses and other facilities. 

But the flow will be measured and drawn out, analysts said. India's commerce minister, Anand Sharma, told reporters in New Delhi on Friday that foreign retailers that sell multiple brands of clothing could set up stores only in cities with more than 1 million people; there are 53 such cities in the country. 

Sharma also said those retailers would have to invest a minimum of $100 million, put 50 per cent of their investment in back-end infrastructure and buy 30 per cent of the goods they sold from small companies. Also, each of India's 28 states would have to individually allow foreign-owned retail stores in their territory. 

"The step which we have taken is an investment in the present and the future of this country," Sharma said. 

Retailers have welcomed the move. 

Ikea, the Swedish furniture and home furnishings retailer that had previously said it wanted to set up stores here, said in an email that it would "expect to present more information shortly about our intention to establish retail operations." The company would be able to own 100 per cent of its Indian operation, because it sells only one brand of products, under India's new rules. 

Rajan Bharti Mittal, a vice chairman of the Bharti Group, Wal-Mart's Indian partner, said in an interview that the conditions imposed by the government on retailers that sell more than one brand were acceptable. He said Bharti and Wal-Mart would soon start discussing how best to take advantage of the new rules. The companies have a 50-50 joint venture that operates 15 wholesale stores across India. Bharti also wholly owns a 170-store retail chain. 

Mittal said allowing foreign investors into the retail business should provide a boost to the rupee and the stock market here. "Markets work on sentiment, so obviously when the sentiment is tough, it reflects" that, he said. "Once the foreign direct investment starts flowing in and the foreign institutional investors start investing, it will start affecting the rupee."

Many in India, however, argue that opening the retail market to foreign investors would result in job losses at the country's millions of small shops. In New Delhi, the Parliament adjourned a little after midday Friday after opposition politicians protested the decision to allow foreign retailers into the country by refusing to allow deliberations on any other matter.