What moves Indian Rupee? —Effect of FDI, FII in deciding Indian Rupee exchange rate.

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.

Why Indian banks are reluctant to reduce their base rate even after 50 bps repo rate cut by RBI?

RBI in September 2015 in it's fourth bimonthly monetary policy review slashed repo rate by 50 bps while most banks cut their lending rates in the range of 20-40 bps, thereby not passing on the full benefit to the customers. What's holding the banks back?

 Shubham Saxena Grad. IIT Dhanbad

It is not exactly that banks don't want to cut their base rates, they really can't cut the base rates anymore. Let's see what is restraining them. RBI in September 2015 cut down repo rate by 50 bps while most banks cut their lending rates in the range of 20-40 bps, thereby not passing on the full benefit to the customers. RBI and government are alleging and compelling banks to pass on the full benefit of rate cut to the customers. The main reason cited for why banks are very reluctant to reduce lending rates is the high interest rates offered by the government on small saving schemes. These high rates purportedly makes it difficult for banks to reduce their deposit rates and consequently lending rates.

September 29, 2015: RBI Governor Raghuram Rajan announcing fourth bimonthly monetary policy review.
RBI cut down repo rate by 50 bps from 7.25% to 6.75% in a surprise outcome.

At present, small savings rates are linked to yields on government bonds of similar maturity. The rates are revised annually. Government pays a premium of 25-50 bps over and above average G-Sec yield. In falling interest rate regime, which we are currently witnessing, government may prefer to shield investors in small saving schemes from a volatile slide in interest by continuing linking the interest rates on schemes to G-Sec yields rather than repo rates or bank deposits. In falling interest rate cycle, small savings schemes become unattractive if they are linked to repo rate or bank deposit.

Just have a quick look at the interest rates provided on various small saving schemes like 

Post Office MIS:                      ~8.4% @5yr 
National Saving Certificate:      8.5% @5yr 
Post Office TDS:                       8.1%-8.5% @1,2,3,5 yr 
Post Office Saving Account:     ~4% (interest rate is tax free)
Senior Citizen Saving Scheme: ~9.2% @5yr. 

Further in most of the schemes the interest is tax free, no TDS. While currently, most banks in India are providing interest rate on FD below 8% and that is taxable too. 
It is obvious that if banks decrease their deposit rates, people will more frequently start mobilizing their funds into such schemes. This makes it very much difficult for banks to lower their base rates as it would badly effect their deposits and margin. The result is that banks are receiving less money in deposits and they don't want to lower their balanced interest margin between borrowing and lending.


Further, Indian government has floated ambitious programs like Make In India, smart cities, digital India in recent year. These would require over $400 billion (₹ 26 lakh crores) in next five years and 70% is likely to be debt financed. Going forward, the bulk finance will be catered to commercial banks that will put a considerable strain on balance sheet due to the mismatch between tenures of deposits and loans disbursed as infra and power loans have long gestation period. An increase in stressed loans is expected, however government and central bank, RBI have recently taken several steps to reduce NPA and stressed loans. It must me kept in mind that stressed loans, 10% as of Nov, 2015, has a significant impact on the outlook of the country's economy and banks, given by credit rating agencies. India's current credit outlook is 'stable' by Fitch. The outlook of most of the Indian banks on the IDRs (Issuer Default Ratings) is stable. Downgrade by even a notch would prove painful for the banking sector and subsequently for the economy.