Approach:
- Introduction
- Mention the reasons for the fall in rupees.
- Describe the concerns related to rupee depreciation.
There has been a consistent deterioration of Indian Rupee’s (INR) exchange rate with respect to the US Dollar ($) over the last few month. It breached the psychologically significant exchange rate level of INR 80 to a US$ in early trade on 19th July, 2022, although it recovered to close at 79.90. The fall in Rupee has been going on since the war in Ukraine began, and crude oil prices started going up.
Reasons for fall in value of rupee:
- The U.S. Federal Reserve has been raising its benchmark interest rate since March 2022. With higher interests rates in the US, investors can get better returns by investments in the US. Hence, they have started to pull-out their money from emerging markets such as India. This, in turn, has put pressure on emerging market currencies which have depreciated significantly against the US Dollar so far this year. Even developed market currencies such as the Euro and the Yen have depreciated against the Dollar and the Dollar index is up more than 9% so far this year.
- Second, India’s current account deficit is expected to hit a 10-year high of 3.3% of GDP in the current financial year. The import bill has been rising due to high oil prices since the Russian invasion of Ukraine. The war has also resulted in steep rise in prices of other commodities which has made the situation worse.
- Third, a major reason for Rupee depreciation has been consistently higher domestic price inflation in India. Higher inflation in India suggests that the RBI has been creating Rupees at a faster rate than the US Federal Reserve has been creating Dollars.
Concerns over the fall in rupee: Forex reserves have fallen by over US$ 50 billion between September 2021 and June 2022. RBI has noted that the drop in forex reserves is due to a fall in the Dollar value of assets held as reserves by the RBI. When the Rupee depreciates, importing goods & services becomes costlier. Since a large proportion of India’s imports (like oil) are Dollar-denominated, these imports will get costlier. Costlier imports, in turn, will widen the trade deficit as well as the current account deficit, This will put further pressure on the exchange rate.
The Ministry of Finance has hinted that India’s fertilizer subsidy bill for 2022-23 (FY23) could rise to around INR 2.5 trillion against Budget Estimates (BE) of INR 1.05 trillion (almost 2.5 times). The rise is because of a global supply shortage in the midst of war in Ukraine and rising exchange rates. Since Rupee is not the only weakening against the Dollar, the net effect on exports will depend on how much has the other currency lost to the Dollar. If the other currency has lost more than the Rupee, the net effect on exports could be negative.
India is already facing high inflation and continued depreciation may be making matters worse. Costlier imports add to the cost-push inflation and enhance domestic inflationary process. A weakening Rupee hurts foreign investors, as well as Indians, who have loans abroad.