Devaluation of Indian Currency: Implications on the Indian Economy

“Higher prices are the symptom, not the cause, of currency collapse.”

― James Rickards, Currency Wars: The Making of the Next Global Crisis

Introduction

Over the past 20 years, there have been significant changes to the Indian rupee. The rupee (Rs), which had unexpectedly increased in value at the end of the 2006–2007 fiscal year, making it one of the best-performing Asian currencies, lost territory and saw one of its biggest falls versus the dollar the following year. The rupee reached a nine-year high against the US dollar on April 16, 2007, when it traded at 41.86. Surprisingly, the dollar surged rather strongly against practically all other currencies at the end of May 2007, but the rupee was left unimpressed.

The value of the Indian rupee had increased by 20% by mid-October 2007 from Rs. 49 to $1 in 2002 to Rs 61.18 (IMF 2007). Although analysts and economists anticipated a higher rupee in 2008, the trend changed at the start of the year. In 2008, the rupee lost more than 20% of its value. Currency depreciation, which often occurs in a floating exchange rate regime, is the decline in the value of a nation's currency in relation to one or more foreign reference currencies.

India is thought to occupy a sweet spot in a severely damaged global economy with significant uncertainties. This article examines the actual effects of the rupee's depreciation on the Indian economy and demonstrates that, in the long run, the Indian economy stands to lose more and gain less from a weaker currency. But there are looming issues in India as well that require quick attention, including high inflation, and an expanding current account deficit (CAD).

The International Financial System and India's Devaluation History

A devaluation of one's own currency by a country is nothing new. It is as old as the gold, and silver currency. Whenever republics, kings, or emperors were in need of some extra money but did not have the billions needed for additional coinage they resorted to devaluation or debasement of the existing currency. This would deceive or deprive none but the people concerned. But the effect was always short-lived. However, the experience was never due to any commercial transaction.?

Such political measures for diluting currencies were frequent in the course of history, but at the end of the 18th century, some traders of whom David Ricardo was the most prominent demanded that the management of the Treasury be put into those of a non-political body subject to parliamentary control. They also wanted some sort of automatic management. This movement led England to enact the Banking Act of 1844 which created the Bank of England the custodian and manager of the money of the country. And the gold standard. The step was soon followed by all the industrializing nations of the West, irrespective of the losses inflicted by it on the rest of the world who used silver currencies. Of course, the gold standard did not stop the appreciation or depreciation of currencies; but the fluctuations were kept within some limits so long as the volume of circulating money was strictly governed by the rule of reserves.?

Similarly, India as a colonial nation enacted the Reserve Bank of India Act 1934 which states to establish the motive of taking over the managing currency from the central bank and taking the business of banking in line with the provision of this act.?

Since 1947, a lot has occurred in terms of macroeconomics, including economic hardship in the 1960s brought on by a decline in food and industrial production. When Indo-China and Indo-Pakistan conflicts arrived, expenditure increased and the balance of payments issue was born. India was on the verge of going into debt due to its high import costs because its foreign exchange reserves were nearly depleted. As per reports, the then Indira Gandhi-led government had to go for a steep devaluation of the rupee.?

The value of the rupee depreciated from ?4.76 against the US dollar to ?7.5. Then, in 1991, India had another severe economic crisis as a result of its inability to pay for imports and fulfill its obligations under its external debt. India was once more on the point of default, which made it necessary to implement the urgent reforms that opened the economy of the nation. According to reports, the Reserve Bank of India sharply depreciated the rupee by 9% and 11%, respectively, to address the situation. After the devaluation, the rupee's exchange rate to the US dollar was somewhere about 26. The rupee has lost 75 percent of its value in the last 75 years, going from 4 against the then-benchmark Pound sterling at the time of Independence to roughly 79 or 80 versus the US dollar today.

Impact of Devaluation on Domestic Inflation

In a country, a rise in the price of goods and services over time is referred to as domestic inflation. It exists in the majority of economies, and when it does, there are basically no negative consequences. Inflation often decreases living standards and purchasing power if it rises faster than the economy. Currency exchange rates have a direct impact on the price of imported goods and materials, which in turn has a direct impact on inflation. Currency fluctuations may influence or discourage investors from making investments and reduce the amount of money that is available for usage by governments.

The prices of products and services can be significantly impacted by the devaluation of a nation's currency. A currency is said to be devalued when its value has grown in comparison to other currencies. Due to the higher cost of buying imported items with the devalued currency, this may result in an increase in their pricing. At the same time, exports from the nation become more affordable for other nations to purchase, increasing their allure.

Inflation results from the rise in import prices because it now costs more money to buy the same things as before the devaluation. This may have a knock-on effect on the economy, forcing individuals to spend more on necessities and lowering their purchasing power. As a result, companies might also need to raise prices to cover the greater expenses of imported items.

When the INR is devalued, foreign currencies gain value because it is incredibly lucrative for foreign nations to import goods from India. Due to the fact that a certain quantity of foreign money will now buy more items, foreign nations are more inclined to purchase commodities at lower prices from India. Additionally, because Indian exports are more accessible and typically cost less, more overseas clients choose to purchase from India. The depreciation of the INR also enables Indian enterprises to decrease their product pricing far more aggressively on the global market, making them very appealing to overseas customers.

Devaluation of a currency, however, may also have some advantages, such as increasing export competitiveness, which will help the economy of the nation. As the assets of the nation become more affordable for international investors to purchase, it may also draw more foreign investment.

Expansion of Current Account Deficits (CAD)

It appears that the current account balance is a complex economic notion. The current account, however, is where political realities and global economics intersect in nations whose outlays are significantly higher than receipts. Businesses, trade unions, and lawmakers frequently accuse trading partners of unfair tactics and point accusing fingers at them when nations have huge deficits.

In India, the wholesale price index has been in double digits for the past 12 months, with March 2022 figures coming in at 14.55 percent. For the first time since August 2018, higher inflation led the RBI to raise interest rates. The action is expected to increase India's cost of capital, increasing the cost of house loan EMIs among other things.

Still, exporters are content. India's exports increased by 24.22% to a new high of $38.19 billion in April 2022 thanks to strong performances from chemicals, electronics, and petroleum products. However, the increase in exports hasn't helped India manage its trade imbalance, which increased to $20 billion in April from $15.29 billion the previous month. According to a report released by Nomura last month, India's current account deficit for the fiscal year 2022 is predicted to increase from 1.7% of GDP this year to 2.6% of GDP in 2022-2023.

According to Sandeep Bagla, CEO of Trust AMC, a weaker rupee will result in higher import costs since a rise in the cost of crude oil, which is India's largest import, will widen the country's current account deficit. India imports 85% of the crude oil required to meet its needs.

"Over the past several weeks, the value of emerging market currencies relative to the US dollar has fallen precipitously. The Indian rupee, which was stable in comparison, has recently dropped to new lows. It has a detrimental effect on the markets as well as the economy. The cost of our imports rises, increasing the current account deficit. Because import costs are higher when the currency is weak, domestic inflation is pressured".

However, according to the Economic Survey 2022-23 tabled in parliament, the threats to the current account balance arise from a variety of factors. The country's CAD increased to 4.4 percent of GDP in the third quarter of 2022, up from 2.2 percent in the first quarter of 2022 (RBI 2022). Amid global tensions and the US Fed's tightening of monetary policy, the Indian rupee has been under pressure, even breaching the 83-mark to the US dollar.

Conclusion

The depreciation of the Indian rupee makes it extremely beneficial for foreign nations to buy goods from India because it lowers their costs relative to other currencies and increases their ability to compete globally. Additionally, the depreciation of the INR enables Indian companies to sell their goods at a more appealing price to global buyers, increasing their appeal.

It is definitely crucial for the Indian economy to understand that a devaluation of the Indian rupee will harm the nation more than benefit it. Making informed economic decisions requires an understanding of the damaging effects of the Indian rupee's depreciation on the Indian economy. Before implementing any policies that could cause the rupee to lose value, it is crucial to take into account the possible repercussions.