Depreciation of Indian Rupee and its Implications

The Indian rupee plunged to a record low for a second time this week at 77.63 against the dollar amid a broader decline in Asian currencies. A year ago, the rupee was 73.50 per dollar but now to buy one dollar one needs to shell out 77.58 rupees – a 5% loss on currency value.

Let us look at the reasons for rupee depreciation…

Currencies, like any other commodities, also have a marketplace where people buy and sell it. The supply and demand mechanism dictate the price fluctuations. The current depreciation is due to US Federal Reserve’s consistent interest rate hikes resulting in Foreign Institutional Investors (FIIs') withdrawal from Indian Markets, the Russia-Ukraine conflict and high oil and commodity prices. International investing acts as a hedge against rupee depreciation. With the recent rupee fall, Indian investors in US markets will stand to benefit.

What is the impact of rupee depreciation on the economy?

According to RBI projections, a 5% depreciation in the rupee adds around 10-15 basis points to inflation. Given that inflation is already very high, and the RBI has been slow to raise interest rates to combat inflation, the future for the Indian rupee is not promising.

India imports 80% of crude oil and the crude prices do not seem to come down anytime soon. This will add pressure on the current account deficit. Inflation and currency depreciation is never good news for an economy because the competitiveness of country’s exports reduces, which further widens the current account deficit. With high prices of crude oil and other crucial imports, the economy is definitely approaching cost-push inflation. The inflation in the country is already so high, any further depreciation in the rupee is going to hit the common people through higher inflation. As the significant population of our country is below the poverty line, human welfare is going to get affected adversely.

What are the possible measures that RBI will take to tackle this situation?

The RBI can sell the dollars from the forex reserves and buy rupees. By doing this, it will intervene in the market to pull out the excess supply of rupees and help stabilize the value of currency. The negative consequence of this action is that RBI will see depletion of foreign exchange reserves. India’s forex reserves have already fallen by over $40 billion — to $597 billion!

Thank you.

Regards,
Akash Rathod,
Kautilya,

IBS Mumbai. 

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