Depreciation of Indian Rupee
In general, both the terms are often used interchangeably. They both have same effect – a fall in value of currency which makes imports more expensive, & exports more competitive.?
A devaluation occurs when a country’s central bank makes a conscious decision to lower its exchange rate in a fixed or semi-fixed exchange rate.
A depreciation is when there is a fall in the value of a currency in a floating exchange rate.
Points that would get covered here are:
(i) Reasons behind depreciation of Indian Rupee, how we landed to 3% depreciation every year;
(ii) US dollar strengthening or Indian Rupee weakening? ;
(iii) Impact of depreciation of Indian currency;
(i)(a)A quick insight into the USD/INR history:
- A lot has happened on the macroeconomic front since 1947 including economic stress in 1960s. Then came Indo-China & Indo-Pakistan which widened spending & gave birth to balance of payments crisis. Faced with high import bills, India was close to default as foreign exchange reserves had almost dried up. The, then Indira Gandhi-led govt. had to go for a steep devalue of rupee. Value of rupee depreciated from ?4.76/USD to ?7.5.
- In 1991, India again found itself in serious economic crisis as country was not in position to pay for its imports & service its external debt obligations. Again, India was on verge of default. To negate crisis, RBI reportedly devalued rupee in 2 sharp tranches - 9% & 11%, respectively. Post devaluation, value of rupee against USD was around 26.
- Between 2000 & 2007, rupee stabilised to an extent led by substantial foreign investments flowing into country but later declined during global financial crisis of 2008.
- Further looking at past, major depreciation started from 2009 onwards, from 46.5 to now at 82, 4.3% CAGR as compared to almost unchanged from 2000 to 2009, from 46.7 to 46.5.?
The value of the Indian Rupee against USD works on basis of supply & demand. When demand for USD increases, Indian Rupee depreciates & vice versa. When a country imports more than it exports, demand for $ exceeds its supply & local currencies such as Indian Rupee.?
Causes of Rupee depreciation over all those past years was balance of payments, current A/C deficit, currency wars, capital outflows from FPIs, FDIs, price of crude oil & other factors. Other factors could include strengthening of USD & G-SAP. More demand for $ caused rupee to weaken.
(i)(b) Now, what happened in 2022?
Indian Rupee depreciated by around 10% against the USD & rupee was worst-performing Asian currency in 2022. RBI heavily intervened in forex market to defend rupee. Since beginning of 2022, country’s foreign exchange reserves have fallen by USD 70Bn. Reserves have witnessed a bit of erosion but central bank is now starting to again build up its reserves & that would act as buffer in times of uncertainty.
Reasons behind rupee depreciation in 2022:
- US Fed aggressively raised int. rates by 425 bps in its fight against inflation. This led to higher int. rate differential between US & India,& investors pulled out money from domestic market & started investing in US market. They withdrew Rs 1.21 lakh Cr from stock markets & Rs 16,682 Cr from debt market in '22, putting pressure on rupee.
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-Russian invasion of Ukraine accentuated FPI withdrawals with global economic slowdown making inflows tougher.
All these factors when combined with what happened in history helps us in analysing the fact that on average USD/INR goes up by 3% every year.
(ii)(a) Now, the most memed question arises, “Is $ strengthening or Rupee weakening?” Is it due to the good performance of USD or due to bad performance of INR?
- Strength of USD, high price of crude oil & international capital outflows are main causes of the decline in Rupee. A stronger dollar & weak domestic growth prospects are prompting investors to flock to safe-haven greenbacks & dump riskier Indian assets. USD appreciated as global investors flocked to safe-haven currency, with US Fed tightening more than its peers. Risk aversion happened in global markets, meaning the money started flowing back to US.
- Rupee is declining against $, largely due to a widening trade deficit, with imports growing much faster than exports. Increase in imports is mainly due to sharp rise in crude oil prices followed by Ukrainian crisis.?
- Increase in coal & other commodities, especially raw materials, has inflated import bill. Weaker Rupee will make these imports more expensive, negatively impacting domestic production & overall GDP in short term.?
- Higher imports & lower exports mean higher demand for USD & lower demand for INR.
-Over the past year, Rupee has weakened against $ but strengthened against all major currencies. This indicates that Rupee is not decreasing.?
-On reviewing the performance of Dollar index, we saw that in?
October 2021: USD value against 6 major currencies = 93
October 2022: USD value against 6 major currencies = 112
This shows that Rupee is not depreciating but $ is strengthening.
(ii)(b) Also, interesting development is taking place in global currency market as there has been significant jump in trade in oil & other commodities in currencies such as Renminbi, Hong Kong $, & Arab Emirates Dirham at discounted rates. Dollar Distancing?is finally happening & it is time for India to pitch Rupee as credible, secular alternative in changing world order? RBI also seems keen to reduce dominance of USD as it earlier this year announced mechanism to settle payments for international trade in rupees, especially for India's exports. The mechanism if fructified may go a long way in internationalizing rupee in long run. Coming to share of USD in global foreign exchange reserves, it has been shrinking since start of 21st century, falling close to 59% as of end of Dec '21, from above 70% , 2 decades back.
(iii) Impact:?
Positive:
Negative:
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