Reasons behind depreciation of Indian Rupee against US dollar

By Shanu Kumar

In the last one week the Indian Rupee has been sliding against US dollar. The Rupee plunged to all-time low and breached the barrier of 77 against US dollar. There are concerns raised as if the weakening of Rupee signaled a warning sign for Indian economy. There are mainly domestic and international factors behind this fluctuation but this time external factors are mainly responsible for the depreciation.

The main reason behind the drop in the value of rupee could be blamed on rising crude oil prices, heavy foreign outflows, widening trade deficit and current account deficit. It is not the only Rupee but most of currencies are struggling as dollar is strengthening.

The ongoing geopolitical tension between Russia and Ukraine followed by sanctions imposed by western countries is also a significant factor in Rupee decline. As Russia is world’s second-largest crude oil exporter, supply has been disrupted leading to price hikes of essential commodities and inflation worldwide. India faced the brunt of this crisis as it is the world’s largest oil consumer behind US and China. Apart from this, we know China is our second-largest trading partner. Stringent lockdowns in various cities of China due to Covid have badly affected economic activity there and India is naturally facing the consequences.

The continuous withdrawal of money by foreign portfolio investors from stock and bond market and flight of FII’s from Indian markets also led to the decline of Indian Rupee. This time it is happening because of global uncertainties caused by Russia’s Ukraine war. Also, positive sentiments developed after strengthening of dollar and expectations of better growth in US economy have pressurized the Rupee.

The biggest impact of weakening of Rupee is on inflation as import prices will increase and commodities will get more expensive. India has recorded a food inflation of 7.7 percent in last few months. The major import items like crude oil, edible oils, and fertilizers are largely affected by this thereby affecting the common people. As we are import oriented country this leads to depletion of our forex reserves because imports get costlier. This reduces our ability to import other goods that we need. On the positive side of a weaker currency is that it benefits export sector because products and services will be cheaper for foreign nationals. However, weakening global demand will offset this positive aspect. So our export sector is unlikely to benefit from this.

Foreign currency exchange rates in India are floating and depend on market factors like demand and supply with little or no intervention from RBI. The Reserve Bank of India is using monetary policy tools and intervening in the forex market to stabilize the currency from falling further. It directly intervenes in the currency market by buying and selling dollars. India’s foreign reserves have fallen below $600 Billion for the first time in a year as RBI intervened in the market to contain the volatility. Recently RBI also raised the repo rate by 40 basis points. The increase in repo rate leads to a higher interest rate in the economy. This result in incoming of foreign investment in the economy increases the demand for and value of home currency. The rise in repo rate also leads to a rise in bond yields and return on debt papers, drawing more investor money to chase better returns.

Disclaimer: The author is a PhD Candidate in Economics and a nonresident research scholar at the BRICS Institute New Delhi. The opinion expressed are his personal view and may not reflect the official view of the INSTITUTE.

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