Reasons for Indian Rupees Depreciation

The Indian rupee has been depreciating against the US Dollar since 1966. It is a myth that INR 1 was worth USD 1 when India gained freedom on August 15, 1947. In 1947, India was not engaged in trade and had no external borrowings, so it was possible for INR 1 to be equal to USD 1. Besides, India had weak growth of 0.8% at that time, so it was not possible for the INR to have the same value as the USD.

Crude oil prices

The prices of crude oil has always had a significant impact on the value of the INR against the USD. The INR depreciates when the price of crude oil increases. In the same way when crude prices decline, the INR appreciates because India imports around 80% of her crude oil and pays for those imports in USD. In present time crude oil prices highly increase due to Russia- Ukraine conflict, so rupee depreciates.

Capital flows

Foreign direct investment (FDI) and Foreign portfolio investment (FPI) have affect the value of Indian rupee. High FDI flows have given stability to the Indian rupee. The US Dollar is in high demand when foreign investors withdraw their funds from India. Investors have migrated increasingly toward safe havens like the US since the Ukraine-Russian conflict started. “ The US never had to defend the dollar because of its dominance. US by default was a stable for investors. Moreover after the war, investors tend to invest in the safe haven”, said Sankhanath Bandyopadhyay, economist, Infomerics Ratings.

The Dollar Index

The Dollar Index (DXY) is an index of the US dollar’s strength against a basket of hard currencies. It also measures the weakness of other currencies against the US Dollar. The Indian rupee declines as the dollar index rises and vice versa.

The Federal Reserve’s Monetary Stance

The monetary stance of the Federal Reserve (Fed) of the US decides the future direction of interest rates emerging markets. When the Fed raises interest rates, the US Dollar strengthens. Global investors’ decisions are influenced by the Fed’s position. They don’t need to invest in riskier emerging economies if they can generate higher profits by purchasing safe US Treasuries.

Current account and Balance of payments

The current account of a country reflects its balance of trade and earnings on overseas investments. It reflects all the transactions including imports, exports and debt. When a nation spends more of its currency on imports than it does on exports, it has a current account deficit. Higher imports of crude oil, gold, raw materials etc. can make the INR depreciate against the USD.

Rate hike by the US Fed

In the forthcoming meeting, the Federal Reserve is anticipated to aggressively raise rates by 75 basis points or one point. “The recent inflation print in the US has raised the expectations of a more aggressive rate hike by the Fed, lending further strength to dollar”, added Shashank Mendiratta, an economist from Delhi. “This coupled with increasing risks of a global recession have contributed to a strengthening US Dollar which will put further pressure on INR”, said Aditi Gupta, economist, Bank of Baroda.

Government Debt

The central government’s debt is also known as the national debt, public debt or government debt. A country with high government debt is less likely to attract foreign capital. Overseas investors will sell their bonds in the open market if government debt is expected to rise, causing a decline in the value of the currency.

Political Stability

The strength of the currency is influenced by political stability and economic performance. Foreign investors will flock to a nation with less political unrest risks. Growing foreign capital flows make the value of the currency appreciate. If a country has sound trade and financial policies, there is more certainty about its currency.

Terms of Trade

The “terms of trade” is the ratio of export prices to import prices. It is related to the balance of payments and current account. If export prices increase at a higher rate than import prices, the terms of trade of the country will improve. Better terms of trade increase the revenue, causing more demand for the country’s currency and appreciation in its value.

There are a number of domestic and international reasons that can cause the Indian rupee to weaken against the US dollar. The exchange rate have a profound impact on the economy. The RBI targets a particular exchange rate and it may choose to actively intervene in the market by buying or selling US Dollar.

Impact of Indian Rupee’s Depreciation

A currency’s level has a direct impact on the following aspects of the economy :-

Inflation

The biggest impact of a weakening rupee is inflation because India imports more than 80% of its crude oil. Imports are discouraged by depreciation since the cost of imported items increases as the rupee’s value falls. Rising inflation results from the increasing cost of the commodities. India’s central bank assumed in its April monetary policy report that the rupee will trade around 76 per dollar during financial year 2022-23, adding that a 5% decline from this would raise inflation by 20 basis points. The rupee has already down over 2% from this assumption, implying higher inflation going ahead. Global crude hitting record highs due to Ukraine- Russia conflict, it will feed into the domestic retail inflation through higher prices of petrol and diesel, thereby increasing the price of goods.

India relies on imported commodities for its needs because it is a net importer. Since they are imported and paid for US Dollar, the landed price rises and leads to “ imported inflation”. Two- Thirds of all our imports are fossil fuels. These are called “ multiplier commodities”. Inflation in their prices multiples inflation across food, shelter, clothing.

Household expenses go up

Due to India’s reliance on crude oil imports, fuel prices—including those for cooking gas, diesel, and gasoline—which are currently high, would continue to rise. The price of the everyday household goods you use will indirectly increase as transportation prices rise. They will be more expensive as a result of rising production and transportation expenses related to oil. Electronics set are also to be expensive. Devices like mobile phones, laptops, TV and solar plates among other household electrical goods, will cost you more since several components of such devices are imported”, explained Adhil Shetty, CEO of Bank Bazar.

Impact on Business, Imports and Exports

Every time the rupee depreciates against the dollar exporters gain (Eg. Software companies, consumable items exporters etc.). Since exports become more lucrative because they end up earning more rupees when exchanging the dollar. But Importers suffer because they have to pay more to buy the same quantity which they were buying before the rupee got weaker. For example, sectors like oil and gas, food and beverages that import raw materials or capital intensive sectors suffer the most when rupee depreciates. Industries linked to exports like pharma and IT benefit with depreciation, whereas those industries linked to imports have to bear higher input cost which is ultimately passed to the end users. Petroleum is India’s largest import item, any price rise in oil has a trickle- down effect on the cost of goods where transportation is an important component of the cost.

Current Account Deficit
Since India imports more than 80% of its oil needs, a depreciating rupee will bloat the current account deficit (CAD). CAD is a trade measurement where a country’s imports of goods and services exceed its exports. When CAD widens, India has to dip into its foreign exchange reserves to finance this deficit in the absence of dollar inflows by foreign investors into the country. The goods trade deficit has a major impact on India’s current account deficit. Given that imports are rising faster than exports, this is anticipated to widen.
FPI outflows
Widening CAD, persistent risk- off sentiment owning to geopolitical tensions, strengthening dollar index and continuous sell- off by foreign portfolio investors (FPI) has put depreciating pressure on the rupee.
Overseas education, foreign trips and remittances
A falling rupee could also impact those who looking for to study overseas or those who plan to travel abroad. Tuition fee, accommodation and other living expenses would cost more in rupee terms as the rupee weakens while foreign trips would cost more making shopping and other spends more expensive.
The value of the remittances which Indians get from abroad will rise. So if an NRI send money from abroad, you will get more money in hand in rupee terms.