The Rupee Freefall - Decoded

Rupee is in a free fall! Everyday we get news about rupee touching historic lows in exchange market. This means being a net importer country, its significance is huge - the rupee outflows will be much higher to make purchase in dollar. Before we get there, let us look into fundamentals which drive these currency valuations.

How are international exchange rates decided?

International currency exchange rates tell how much one unit of a currency can be exchanged for another currency. Currency prices can be determined in two main ways: a floating rate or a fixed rate. A floating rate is determined by the open market through supply and demand on global currency markets. Therefore, if the demand for the currency is high, the value will increase. Most of the countries have adopted floating rate exchange after the collapse of Bretton Woods system between 1968 and 1973.

Currency rate can be of fixed type, where currency can be pegged (or fixed) to another currency or price of gold, in which case they still float, but they move in tandem with the currency to which they are pegged.?

There can be countless geopolitical and economic factors that can affect demand and supply of particular currency thereby impacting exchange rates are countless geopolitical and economic factors that affect the exchange rates between two countries. Some of the major factors can be interest rates, inflation, GDP growth, commodities, country’s current account/ balance of payments, trade, political stability etc.

The Dollar Benchmark: The US Dollar and Euro are two of the most popular and globally accepted currencies. The US Dollar’s share of foreign currencies in international banks is more than 64 per cent. For the Euro, it’s about 20 per cent. In 85 per cent of international trade, including crude oil, the US Dollar is involved.

What has driven current Rupee decline?

Russia-Ukraine war has serious impact on rupee valuation. Crude oil prices are consistently trading above 100 USD per barrel since the start of war in February this year. India is third largest importer of crude oil after US and China importing around 80% of its oil needs. This high oil prices coupled with high inflation worldwide, strong dollar overseas and consistent outflow of foreign capital is contributing to the decline of Rupee.

?The US dollar has been strengthening as investors pile up on safe haven currency coupled with Federal bank tightening its monetary policy. The dollar index which tracks its currency against basket of major currencies, is up by 9% this year. Risk aversion during these uncertain times means funds are flowing back to US.

The foreign institutional investors (FIIs) have sold shares worth $28.4 billion so far this year, surpassing the $11.8 billion sell-off recorded during the Great Financial Crisis of 2008. In addition, there have been significant outflows of foreign funds from domestic markets.

Impact on common man and businesses

Being net importer country, decline in rupee valuation will impact both people and businesses. The biggest impact of rupee falling will be inflation as India imports 80% of its crude oil needs. Oil prices consistently trading above 100 USD per barrel. This means we need to pay even more rupees to make purchase in dollars. Rise in transportation cost will indirectly cause increase in prices of daily household items. Also, this will lead to higher travel cost to overseas, higher cost for abroad studies etc.

For exporters depreciation in currency exchange means gain because they get paid in dollars which reflects higher when converted to rupee. But with weak demand and high input cost in country due to high inflation is impacting exports businesses. India’s key export items like gems & jewellery, petroleum products, automobile & machinery can be affected. However, industries liked with IT & Pharma may benefit from depreciation.