On 18th August 2018, the Indian currency, Rupee witnessed the historic intra-day low of 70.40 before closing at a life time low of 70.15 per dollar. Aggravating the situation, on 27th August it hit a record closing low of 70.16.
Before we deep dive into “why the Indian Rupee is depreciating, what are its impacts & measures to control it”; knowing “Rupee depreciation & who fixes the value of Rupee” is vital.
When Rupee becomes less valuable compared to U.S. Dollar, it is called as Rupee depreciation. It simply means that, more Rupee is required per dollar. In other words, buying dollar becomes costlier.
Example: One dollar costed for Rs. 49.45 in 2012 and as on 27th August 2018 it costs more. i.e. Rs. 70.16.
Who fixes the value of Rupee?
Most of the people think that either Indian government or RBI fixes the value of Indian Rupee. But in reality currency market decides its value. The Supply & Demand of Indian Rupee in the global currency market decides its value. If the demand of Indian Rupee is less relative to its supply, it will depreciate & if the demand is high relative to its supply, it will appreciate.
For example: Say, India is going through inflation phase (High prices of goods & services). To lower the prices, suppose RBI increase the interest rates (It is the amount charged to borrower by lender). As interest rates are high, people will be less keen to take loan to buy goods & services. Rather, they will be depositing more money into banks to get more interest returns. This will attract foreign investors to deposit their money into Indian banks. That means the demand for Rupee will increase & hence Rupee will appreciate. This type of system is called as Floating Rate System.
India has adopted “Managed Floating Rate System” to minimise the extreme fluctuations in the exchange rate of Rupee. That means if there is a sudden inflow or outflow of money, RBI will use its policies to maintain the steady exchange rate.
Reasons for Rupee depreciation:
In the recent past, number of events has reduced the demand of Indian Rupee in the currency market which led to the Rupee depreciation. Some of these events are:
Fall in currencies of emerging market peers:
The crisis such as Eurozone crisis, Turkish crisis has depreciated their respective currencies Euro & Lira. This has created an atmosphere of doubt and sowed the seeds of negativity in the minds of the investors. As a result, investors find it safer to invest in Dollar rather than any other currency or assets. Due to which demand of Dollar has increased tremendously leading to further increase of its price. As Dollar became more valuable its value in Rupee has gone up leading to depreciation of Rupee.
US-China Trade War:
Imposing 25% duties on about $34 Billion in Chinese machinery, electronics & high tech equipment including computer hard drives, LEDs on July 6, 2018, started the US- China trade war. This in turn resulted Indian Rupee to depreciate due to outflow of money from India which has been discussed in detail further. Due to higher import duties, Chinese manufacturers have increased the cost of selling products which has led to inflation in U.S leading to inflation striking a six-year high to fight inflation, U.S. Federal Reserve has increased the interest rates twice in this year due to higher interest rates investors are willing to deposit more money into banks, in order to earn more income. So, foreign investors has been pulling out money from Indian market & putting it into U.S. market which has reduced the demand of Indian rupee leading to its depreciation.
Impacts on Indian Economy:
Imports have become costlier:
As the value of Rupee has increased to 70.16, more rupee has to be paid to buy the same imports which could have been bought cheaper earlier.
Example: As on 28th August 2018, Oil (WTI) Price Per 1 Gallon is 1.21 USD. If this rate was same 1 year earlier when USD/INR was 63.80, we would have costed 77.198 Rs (1.21*63.80) Per Gallon. But as on 28th August 2018, it cost 84.89 Rs(1.21*70.16) Per Gallon. That means for the same amount of Oil India needs to pay more Rupees when currency depreciates.
Exports have become cheaper:
Due to plunge in Rupee price, exporters get more money per dollar.
The rise in Current Account Deficit (CAD):
A deficit on the current account means that the value of imports is greater than the value of exports. India’s CAD in 2017-18 was $48.7 billion. That means we are spending more on imports than we get from exports. This in turn reducing forex reserve we have which is leading India to ask for more dollars from foreign markets which in turns increasing dollars demand and hence depreciating Rupee value further.
The rise in fiscal deficit:
Fiscal deficit occurs when government’s expenses become more than its incomes. On March 2017, India’s external debt was placed at US$ 471.9 billion. Due to Rupee depreciation, the government will have to pay a higher amount (in rupees), to repay its debt (in dollars). This has increased the expenses & hence fiscal deficit.
The rise in Inflation:
Rising import prices along with rising crude oil prices will increase the retail fuel prices. This will have cascade impact (as fuel is required to transport goods & services) on every industry in turn increasing prices of goods & services. It will lead to inflation. According to RBI, for every 5% fall in Rupee, retail inflation will increase by 20 basis points.
Foreign education has become costlier. Foreign touring has become costlier.
Do we really need to be worried about this?
Moody’s, a credit ratings agency said that , “India is among the 5 countries which are least vulnerable to currency pressures amid strengthening of the US dollar, because of low dependence on external capital inflows”. Some of the reasons could be as follows:
In recent years, India has build-up its forex reserves which act as a buffer to mitigate external vulnerability risk. As on June 2018 India has around $410.07 billion of forex reserve. India has low dependency on foreign borrowings to fund its debt. India has managed to get funding through Equity inflows through FDI. Also Indian domestic finance market has created large savings which has lowered the dependency on external market & hence has mitigated the risk.
At present, Indian government & RBI should not worry about the Rupee depreciation but should worry about the volatility in the currency exchange rate. Stabilization of Rupee is more important. High volatility situation like Rupee being 69 one day and 71 the other day; creates Rupee more risky & fosters the negativity in the minds of the counter parties which do business with India. It becomes difficult for them to do long term business considering high volatility in the currency & also becomes difficult to track the Profits & Losses.
RBI intervention in the Forex market is the short term solution. As we have discussed, when demand of any currency increases; that currency gets costlier. Using the same principal, RBI can sell dollars from its Forex Reserves and can buy more Rupees. As demand of Rupee increases it gets strengthened.
In long run, reducing dependency on imports & improving exports is the solution.
(This article has been written by Yogesh Kurle, a first year management student at SIMSREE)