Sunday, May 13, 2012

Will the falling rupee hurt your investments?

The Indian Rupee has been tumbling down in recent times. There are plenty of reasons being cited for it. Politicians and the government insist that it is due to the weak macroeconomic signals in the broader global economy. The economists say that this is a result of weakening economic conditions in India. Whatever it is, the bottom line remains the same. Indian rupee has weakened. So should you as an investor be worried about it?

The answer is yes. A falling rupee has a direct impact on your investments. Allow us to explain how this happens. When the value of rupee falls, there are two things that happen. First is that the exports from the country become more attractive to global consumers. This means that the exports should go up. When this happens, it is good because the income of the country and hence its GDP goes up. But what happens if the global demand itself is depressed? Well this is exactly what happened with India. The demand from the developed world especially from US and Europe, which are the biggest markets for Indian goods, was depressed during the whole of last year. And it still continues to be depressed. As a result exports remained tepid.

The second impact of the falling rupee is on the imports. Companies that import their raw materials and key items, end up seeing their costs go up. Now during happier times, these companies are able to pass on the increase in costs to their customers. But in times like the ones we are living in right now, domestic demand too continues to be depressed. High inflation as well as high interest rates are some reasons for the same. So when domestic demand is low, these companies find it difficult if not impossible to pass on the increase in costs to the customers. As a result they end up taking a hit on their margins.

The same concept applies to inflation as well. If the rupee devalues, then the country's import bill, particularly its oil bill, goes up. That means that the very dear fuel costs spiral upwards and end up fuelling the inflation in the country. This inflation has its own adverse impact on the investments by depressing the companies' profit margins as well as leading to monetary tightening. If inflation does remain stubbornly high then the Reserve Bank Of India (RBI) may find it difficult to rollback the interest rates which in turn would mean that liquidity remains tight. And capital investments get deferred.

All in all, the falling rupee would have an adverse impact on the investments. Now the question that would come to your mind is what should an investor do? The investors need to do their homework before investing. Identifying companies that have a resilient business model is the need of the hour. And the company has to have pricing power for its goods or services. To add to this if it has fully integrated manufacturing facilities then it would remain insulated from high import related costs to a large extent. Investing in such companies at the right valuations is the key to long term investment gains.

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