Rupee And Bond Market Recovery
Source: Indian Express
GS III: Indian Economy and issues relating to planning, mobilization of resources, growth, development, and employment, Investment Models
Overview
- News in Brief
- Factors Responsible For The Rupee Recovery
- Challenges
- Way Forward
Why in the News?
The editorial in Indian Express explains the recent recovery of the Indian rupee and bond market due to lower global commodity prices, increased foreign investment, and improved global conditions.
News in Brief
- The Indian rupee appreciated against the US dollar after a period of depreciation, showing improvement in the foreign exchange market.
- The decline in 10-year Government Security (G-Sec) yields indicates higher investor confidence and lower borrowing costs for the government.
- The recovery helps reduce imported inflation and improve investor confidence, but it remains vulnerable to global uncertainties, geopolitical tensions, and domestic challenges.
Factors Responsible for the Rupee Recovery
Decline in Global Crude Oil Prices
- One of the biggest reasons behind the rupee’s appreciation is the fall in international crude oil prices.
- India imports nearly 85% of its crude oil requirements.
- Lower crude prices reduce India’s import bill.
- Reduced demand for US dollars by oil importers strengthens the rupee.
- Lower fuel prices also help in controlling inflation.
- Since petroleum products are essential for transportation, manufacturing, and electricity generation, cheaper crude oil benefits the entire economy.
Fall in Fertilizer Prices
- Global fertilizer prices have declined considerably.
- This has resulted in:
- Lower fertilizer subsidy burden on the government.
- Reduced fiscal pressure.
- Improvement in government finances.
- Better investor confidence.
- Lower subsidy expenditure allows the government to allocate resources for infrastructure and developmental activities.
Increase in Foreign Capital Inflows
- Foreign Portfolio Investors (FPIs) have returned to India’s debt market after a period of outflows.
- The government and RBI have encouraged foreign investments through:
- Investment in Government Securities (G-Secs)
- Relaxation of FCNR(B) deposit norms
- Liberalization of External Commercial Borrowings (ECBs)
- As foreign investors bring dollars into India, the supply of foreign exchange increases, thereby strengthening the rupee.
Improvement in Government Bond Market
- The yield on India’s benchmark 10-year Government Security has declined.
- This indicates:
- Increased demand for government bonds.
- Improved investor confidence.
- Lower borrowing costs for the government.
- Better macroeconomic outlook.
- Since bond prices and yields move in opposite directions, rising bond prices automatically reduce yields.
Government Securities (G-Secs)
- Government Securities are debt instruments issued by the Government of India to finance its fiscal deficit.
- Types
- Treasury Bills (Short-term)
- Dated Securities (Long-term)
- Importance
- G-Secs are among the risk-free investments because they are backed by the government’s ability to repay.
- G-Sec yields act as a benchmark for determining interest rates on loans, bonds, and other financial instruments in the economy.
- The government issues G-Secs to raise funds for infrastructure, welfare schemes, and other public expenditures.
- They help the government manage its fiscal deficit.
Bond Yield
- Bond Yield represents the return earned by investors.
- Important Rule:
- Bond Price ↑ → Bond Yield ↓
- Bond Price ↓ → Bond Yield ↑
External Commercial Borrowings (ECBs)
- ECBs are loans borrowed by Indian companies from foreign lenders.
- Features
- Borrowed from foreign banks, financial institutions, or investors.
- Usually taken for business expansion and infrastructure projects.
- Regulated by the Reserve Bank of India (RBI).
- Benefits
- Provides access to foreign capital.
- Can offer lower borrowing costs compared to domestic loans.
- Supports infrastructure development and business growth.
Challenges
Geopolitical Risks
- The biggest concern is the continuing instability in West Asia.
- Any escalation of conflict may:
- Disrupt crude oil supplies.
- Increase global oil prices.
- Widen India’s trade deficit.
- Put pressure on the rupee.
- The Strait of Hormuz, through which nearly one-fifth of global oil trade passes, remains highly vulnerable to geopolitical tensions.
Volatile Foreign Investments
- Foreign Portfolio Investment is highly volatile.
- FPIs generally withdraw money during periods of:
- Global uncertainty
- Higher US interest rates
- Geopolitical conflicts
- Financial market volatility
- Large-scale withdrawals can weaken the rupee and create instability in capital markets.
Monsoon and El Niño Risks
- India’s agriculture remains dependent on the southwest monsoon.
- An El Niño event may lead to:
- Weak rainfall
- Lower agricultural production
- Higher food inflation
- Reduced rural demand
- Food inflation can force the RBI to maintain higher interest rates, slowing economic growth.
Fiscal Challenges
- Government expenditure on food subsidy, fertilizer subsidy welfare schemes may increase if global commodity prices rise again.
- Higher expenditure without corresponding revenue growth can widen the fiscal deficit and reduce investor confidence.
Foreign Portfolio Investment (FPI)
- FPI refers to investment by foreign investors in a country’s financial assets such as shares, bonds, and securities.
- Features
- Investors do not get management control over the company.
- It is mainly for earning returns through financial markets.
- Highly volatile because investors can quickly buy or sell assets.
- Sudden withdrawal of FPI can affect the stock market and currency value.
Foreign Direct Investment (FDI)
- FDI refers to foreign investment where an investor establishes or acquires a long-term interest and control in a business.
- Features
- Involves ownership and management control in a company.
- Creates employment opportunities.
- Brings new technology, skills, and capital.
- More stable compared to FPI because it is a long-term investment.
Foreign Currency Non-Resident Bank Deposits
- FCNR(B) deposits are bank deposits made by Non-Resident Indians (NRIs) in foreign currencies.
- Features
- Maintained by NRIs in Indian banks.
- Deposited in currencies like US Dollar, Euro, Pound, etc.
- The amount and interest are paid in foreign currency.
- Exchange rate risk is borne by banks, not by the NRI depositor.
- Importance
- Helps increase India’s foreign exchange reserves.
- Provides foreign currency funds to Indian banks.
Way Forward
- India should not depend excessively on temporary foreign portfolio inflows.
- Instead, the country should focus on:
- Attracting stable Foreign Direct Investment (FDI)
- Continuing structural economic reforms
- Improving ease of doing business
- Expanding manufacturing under initiatives like Make in India
- Maintaining fiscal discipline
- Reducing the debt-to-GDP ratio
- Diversifying energy sources to reduce dependence on imported crude oil.
- Such long-term measures will strengthen India’s external sector and improve resilience against global economic shocks.
Key Takeaways
UPSC Prelims Practice Question
Consider the following statements:
-
- Bond prices and bond yields generally move in opposite directions.
- A sustained increase in crude oil prices generally puts downward pressure on the Indian rupee.
- A stronger rupee helps reduce the cost of imports and can moderate imported inflation.
Which of the statements given above is/are correct?
a) 1 and 3 only
b) 2 and 3 only
c) 1 and 2 only
d) 1, 2 and 3
Answer: d) 1,2 and 3
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