01 Oct How the fall of the Indian rupee hurts economic stability of the country

Depreciation of the Indian Rupee and Its Effects on Economic Stability

The topic is based on the Depreciation of the Indian Rupee. This Article talks about how the depreciation of the Indian Rupees hurts the Economic Stability of the Country. 

CONTEXT

The Indian Rupee (INR) has been depreciating at a fast pace against the US dollar crossing the 81 mark. The recent decline in the exchange rate of the INR against the US Dollar (USD) has been worrying economists as it affects the macroeconomic stability of the country. 

CURRENCY APPRECIATION AND DEPRECIATION

• Currency depreciation takes place in the foreign exchange market when the domestic currency loses its value in front of foreign currency.
• It occurs due to the demand for dollars increasing its supply. For example, earlier $1 = Rs.70, now $1 = Rs.81. The demand for the dollar is more, and hence the value of the dollar is increasing.
• This happens when there is an increase in imports or a fall in exports.
• On the other hand, if the value of domestic currency increases in comparison to foreign currency, it is referred to as Currency appreciation
• Currency appreciation takes place when there is a surplus of the dollar in the market and hence, the supply of dollars exceeds its demand. For example, if $1 = Rs.81 today and later $1= Rs.70, then we can say that there has been an appreciation in the value of INR.
• This is seen when there happens to be a rise in exports and a fall in imports.

REASONS FOR THE FALL OF RUPEE

The Government has stated global factors to be the reasons behind the fall of the rupee Prominent global factors are -the Russia-Ukraine conflict, soaring crude oil prices, and the tightening of global financial conditions. All these have led to an outflow of foreign funds from India.

• Russia- Ukraine War: Any war leads to economic instability. Investors fear losing money due to war. Hence, ever since the Russia-Ukraine War broke out, investors shifted their investments to safe havens like the USA instead. The USA being a stable market attracts investors.
• Increasing Crude oil Prices: Countries that purchase crude oil have to make payments in USD to the countries that produce oil. This system is known as the petrodollar system and it negatively affects the importing country.
• The rate hike by US Federal Reserve: This move further strengthens the dollar as investors move their money to the USA since they are getting a better return on their investment

ISSUES WITH THE DEPRECIATION OF RUPEE

• To control Rupee Depreciation, the RBI has been intervening in the forex market.
• This has led to the decline of forex reserves rapidly. From USD 642 billion in October 2021, India now has USD 545.6 billion in September 2022. 
• This decline in forex reserves corresponds to a decrease in import cover.  Import cover measures the number of months of import that can be covered with foreign exchange reserves available with the Central Banks of the country. 
• India’s forex reserves were earlier sufficient enough to cover 16 months of imports in October 2021. Now, this has declined to 9 months of import cover as of September 2022 
• The fall in Rupee impacts the following impacts:       

Pic: Effects of Falling Rupees

• Impact on Inflation: Depreciation of INR means the amount we are paying towards the import of goods increases.  Thus import becomes costly. and this leads to higher inflation as being a net importer, India depends on overseas goods for its requirements. This phenomenon is known as import-led inflation. Given the fact that India imports more than 80% of its crude oil, inflation in the country increases. As per RBI’s Report, a 5% depreciation of the currency would add about 15 basis points to domestic inflation. Due to the increase in the price of oil, transportation costs increases which has an indirect impact on daily household items. Daily goods like vegetables, soap, flour, etc go up.
• Impact on Investments:  When the rupee depreciates against the dollar, it effectively means an additional return on one’s investments in the US market. Hence, rupee depreciation against the dollar works in favor of investors. In order to invest in the US stock market, the investor’s money is converted into dollars and then back to INR when he redeems it. So, if one invested ten years ago when $1=Rs.53, and withdrew today, he gains an additional amount since now the same $1=Rs.81
• Impact on Imports and Exports: The depreciation of the rupee impacts imports negatively and exports positively. If earlier $1=Rs.75 and now $1=Rs.81, that means now importers would have to pay Rs.6 more for the same commodity. Similarly, on exporting goods worth $1, exporters would earn Rs.6 more compared to earlier when $1 was for Rs.75
• Impact on Current Account Deficit (CAD): The current account measures the flow of goods, and services into and out of the country. It is a record of visible and invisible. Even though currency depreciation means exports become profitable, India being an import-dependent country has more imports than exports. This negatively affects the trade balance and leads to the widening of the current account.
• Impact on External Commercial Borrowings: A depreciating rupee poses risk to external commercial borrowing (ECB), as the cost of borrowing increases. ECB having lower interest rates compared to domestic banks are a favored route for Indian companies to raise funds. The fall in the rupee means their cost of borrowing increases and may have to look for other options to raise funds.

RBI INTERVENTION

In order to halt the sliding rupee, RBI has taken various steps like liberalizing the norms for foreign investments in government and corporate bonds, easing the limits for foreign currency borrowings, and easing norms to help banks attract greater deposits from non-residents. It has RBI has been selling dollars from the forex Reserves. By doing so, it has been able to ensure that there is no large-scale Rupee Depreciation. However, this has depleted our forex reserves at high speed.

WAY AHEAD

For a long-term solution and to make the INR stronger and more stable, there should not be sole reliance on buying dollars to curtail the depreciation. Instead, a multi-pronged strategy is needed. The following steps can be taken for this :

• Change in norms to attract inflow of dollars: This can be done by easing the ECB norms, attracting NRI Deposits, increasing the FPI investment limit in G-
  Secs etc.
• Increasing the interest rate: the policy rates should be hiked to reduce the interest difference between US and India. This will attract more FPI inflows
• Limited RBI intervention: The Central Bank intervention should be limited to cases where there is large-scale volatility. India should have enough import cover for times of crisis. Hence, regular intervention by RBI by purchasing dollars with India’s forex reserves should be decreased.
• Reserve Bank of India will have to ensure price stability and prevent further weakening of the rupee

SOURCES

• The Hindu 
• Times of India
• The Print

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