In News: Indian rupee recorded a historic low of 79.72 against the US dollar and it has declined nearly 6 per cent since January this year.
- Foreign exchange reserves fell by $8.06 billion to $580.02 billion during the week ended July 8 in the wake of the appreciation of the dollar and capital outflows from India, triggered by the rise in inflation and rate hikes by the US.
Why rupee is falling?
Demand and supply:
- If a country imports more than it exports, then the demand for the dollar will be higher than the supply and due to this, domestic currency will depreciate against the dollar.
- Global disruptions caused by the Russia-Ukraine war is making our imports costly, thus widening the current account deficit.
- Rising inflation depreciates domestic currency since inflation can be equated with a decrease in money’s buying power.
- As a result, countries experiencing high inflation tend to also see their currencies weaken relative to other currencies.
High crude oil prices:
- Increasing crude oil prices are further widening our trade deficit thus leading to decrease in the value of rupee.
Capital outflows from India:
- The US Federal Reserve recently increased the interest rates, and the return on dollar assets increased compared with those of emerging markets such as India.
- It has led to outflow of dollars from India to the US.
Increase cost of raw materials and imports
- Since, India imports many raw materials, the price of finished goods could go up thus impacting the consumers.
- India’s high import dependence for fuel means oil price trajectories affect most macro parameters, including inflation, growth, current account balances, fiscal management and the rupee.
- This leads to widening of the current account deficit (CAD).
- In an ideal scenario, devalued rupee could have led to increase in exports.
- However, in the current scenario of weak global demand and persistent volatility, exporters are not supportive of the currency fall.
- The falling rupee’s biggest impact is on inflation, given India imports over 80 per cent of its crude oil, which is the country’s biggest import.
- Travellers and students studying abroad will have to shell out more rupees to buy dollars from banks.
- Rupee depreciation may see foreign investors pulling out of Indian markets, resulting in a decline in stocks and equity mutual fund investments.
Floating exchange rate system
- Under the floating exchange rate regime, the market forces determine the value of domestic currency on the basis of the forces of demand and supply of the domestic currency.
Appreciation Vs Depreciation
- Currency Appreciation: It is an increase in the value of one currency in relation to another currency.
- Currencies appreciate against each other for a variety of reasons, including government policy, interest rates, trade balances and business cycles.
- Currency appreciation discourages a country’s export activity as its products and services become costlier to buy.
Depreciation Vs Devaluation:
- Currency depreciation is a fall in the value of a currency in a floating exchange rate system.
- Currency depreciation can occur due to factors such as economic fundamentals, interest rate differentials, political instability or risk aversion among investors.
- If the value of the Indian Rupee is weakened through administrative action, it is devaluation.
Source: The Hindu
Previous Year Question
Q.1) Which one of the following is not the most likely measure the Government/RBI takes to stop the slide of Indian rupee? (2019)
- Curbing imports of non-essential goods and promoting exports
- Encouraging Indian borrowers to issue rupee denominated Masala Bonds
- Easing conditions relating to external commercial borrowing
- Following an expansionary monetary policy
Q.2) Consider the following statements:
The effect of devaluation of a currency is that it necessarily
- improves the competitiveness of the domestic exports in the foreign markets
- increases the foreign value of domestic currency
- improves the trade balance
Which of the above statements is/are correct?
- 1 only
- 1 and 2
- 3 only
- 2 and 3