In case of India, it may seem that FIIs and FDIs, which makes a lot of headlines, have a great role in moving Indian Rupee exchange rates. But it is quite far from reality. In last 5 years India has received very high inflows both in FPI and FDI while INR has moved structurally downtrend during the period. It is an important factor but not very dominating in long term movement of INR.
There has been a fundamental change taken place in recent decades in respect of the importance of exchange rate movements due to capital flows as against trade deficit and economic growth rate. The latter do matter but the former is primary determinant of day-to-day exchange rate movements.
| Yearly FPI (FDI) and NRI flows in India: FDI, FII flows failed to lift Indian Rupee; Capital flows |
It is very clear from the table that even high FDI and FPI inflows couldn't save INR from depreciating in long term.
So what is actually moving Indian Rupee?
It is the trade balance, notably the movement in crude oil and gold prices and export growth, that wields a greater influence on the Indian currency.For instance, in 2014, the country received the highest ever FPI and FDI inflows at $42 billion and $34 billion respectively. NRIs fused another $11 billion into bank deposits. But the INR lost 2.7 per cent against the USD. In 2009, when $18 billion of FPI flows lifted Indian equity prices from bear-market lows, INR gained around 4%. It implies that there are other more dominating factors taming Indian Rupee.
In 2012, a sharp increase in gold imports to $56 billion was one of the reasons why the INR reeled down. Moreover the crude oil, having greater share in imports, has more impact on INR movement than that of gold.
Interest rate hike by US Fed plus falling brent crude oil prices did support INR which was over however compensated by the low exports due to weak global demand especially in Europe (interestingly China doesn't have high impact on India as we have only around 3.8% exports to China) and exiting FPIs.
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