One of the many news that has been a constant on every news portal over the past year is that of the falling rupee. There have been huge concerns, debates, and wide protests over the past many months regarding the falling rupee and the government’s action or inaction to arrest this fall. The Indian Rupee was among the worst-performing currencies in Asia and is currently trading close to Rs. 82. So why is there so much fuss about the falling rupee and how is it going to affect the life of an average Indian or the economy at large? Here are more details on the impact of rupee depreciation.
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What is Rupee depreciation?
Let us begin by understanding what a depreciating rupee actually means. A decrease in the value of the rupee essentially means that it has become less in value as compared to other currencies, in this case, the dollar. Consider the value of the INR last year in April 2022 when INR was approximately Rs. 76 per dollar. However, as of April 2023 the INR is trading around Rs. 82 per dollar which means we have to pay more rupees to buy a single dollar. This rupee depreciation affects its purchasing power and has huge repercussions as the rupee has become less valuable with respect to the dollar.
What are the reasons for the depreciation of the Indian rupee?
There are several reasons for the depreciation of the Indian Rupee over the past year. The covid pandemic, the ongoing war, and the looming threat of a recession across the major economies are among the prime reasons for the same. Given here are a few factors that have contributed to the fall or the depreciation of the rupee in the recent past.
1. Global factors
Global factors such as the US Fed rate hike, the Russia-Ukraine war, the Covid-19 pandemic, etc., have an impact on the exchange rate of the rupee. These factors can increase the volatility and uncertainty in the global financial markets and affect the sentiment and confidence of investors and traders. Such global factors can also affect the supply and demand of commodities such as oil and gold, which have a significant impact on India’s trade balance and foreign exchange reserves.
2. Trade deficit of the country
One of the main reasons for the fall in INR is that India imports more than it exports. This means that India has to pay more foreign currency (such as USD) than it earns from selling its goods and services abroad. This creates a trade deficit, which is the difference between imports and exports. A trade deficit reduces the demand for INR and increases the demand for foreign currency, which makes INR weaker.
3. Rise in crude oil prices
Another reason for the fall of INR is the rise in crude oil prices that have been increasing in the global market. India is a large consumer of oil and has to buy most of it from other countries using foreign currency. When oil prices go up, India has to spend more foreign currency to buy the same amount of oil, which puts pressure on the Indian rupee.
4. Outflow of FDI from the Indian markets
Over the past year, the Indian markets saw a huge capital outflow in the form of FDIs pulling out their investments. This was due to various reasons like the interest rate hike in the US and global uncertainty and increasing talks of recession across the globe.
5. Interest rate hike
There are many economies, including major economies of Europe and the US, that are facing inflation like never before and this has led to their governments taking many steps to curb the impact of the same. One of the first steps taken by the government is increasing the interest rates. The US government has taken a similar step over the past year and the Fed Rates have increased significantly. This has further led to the loss of FDI in the country and the increase in the overall cost index in the country further putting pressure on the INR.
What is the impact of the Indian Rupee depreciation?
The depreciation of the Rupee has both positive as well as negative impacts on the economy. Such impact is explained below.
Negative impact of the depreciation of the Indian rupee
Some of the negative impacts of the depreciating rupee are highlighted below.
Increased import cost
India is a major importer of crude oil, and when the rupee depreciates, the cost of importing oil increases. This leads to an increased trade deficit and a rise in fuel prices in the domestic market that have a direct impact on the cost of transportation and production. As a result, this cost is trickled down to the ultimate consumers who have to pay higher prices for essential goods and services, thereby impacting their overall standard of living.
A depreciating rupee leads to an increase in the cost of imported goods such as oil, machinery, and electronic goods as mentioned above. This, in turn, increases the prices of these goods in the Indian market, leading to higher inflation. Increasing inflation has a direct impact on the purchasing power of consumers further worsening the economic conditions of the country.
Increased cost of overseas borrowing
A weakening rupee can make it more expensive for Indian businesses and the government to borrow money from overseas lenders. When the rupee depreciates, the interest rates on foreign currency loans increase, which makes it harder for businesses and the government to access credit. The depreciating rupee leads to increased outflow of EMI on existing external loans as well as the higher cost of borrowing new loans. This can lead to a slowdown in economic growth as businesses may not be able to invest in new projects or expand their operations.
Increased cost of production for domestic industries
When the rupee depreciates, it makes imported raw materials more expensive for Indian industries, which increases their cost of production. To maintain their profit margins, businesses may need to raise their prices, which can reduce demand and affect their competitiveness. Alternatively, they may need to cut down on production or employment levels, which can have a negative impact on their growth and output. Overall, a weaker rupee can make it harder for Indian industries to compete globally and can affect the overall health of the Indian economy.
Positive impact of depreciation of Indian rupee
Some of the positive impacts of the depreciating rupee on the economy are highlighted below.
When the Indian Rupee depreciates, it makes Indian exports cheaper in the international market. This means that Indian businesses can sell their products at lower prices than their competitors, making them more attractive to foreign buyers. This can increase the demand for Indian goods and services and boost exports, which can have a positive impact on the Indian economy.
A weaker rupee can make it cheaper for foreigners to visit India, which can lead to an increase in tourism. This can bring in more foreign currency and generate employment opportunities for people working in the tourism industry. Additionally, a rise in tourism can help promote the Indian culture and heritage, leading to an increase in the country’s soft power.
Attracting foreign investments
A depreciating rupee can make Indian assets cheaper for foreign investors, making it more attractive to invest in the country. This can lead to an increase in foreign investment, which can help boost economic growth and create employment opportunities for people in the country. Additionally, foreign investment can also bring in new technology and knowledge, leading to a transfer of skills and expertise to the local population.
A depreciating rupee is not a healthy scenario for any country, especially a developing country like India. It is one of our major concerns and the government and RBI are taking many measures to correct this situation. Through multiple reforms, India has managed to arrest the freefall of the rupee more effectively and is also seen as one of the fastest-growing economies even in the post-pandemic and ongoing war scenario. Although the Indian rupee saw more than a 10% decline over the past year, experts believe that the fall will continue over 2023.
Printing more money to stop its depreciation is not a sustainable solution for a government to manage its currency’s value. However, this does not necessarily increase the real value of the economy or its goods and services. When a government prints more money, the total amount of currency in circulation increases. If the government prints too much money, it can lead to hyperinflation, which can have severe consequences for the economy and its citizens.
The appreciation of the rupee means that the value of the Indian rupee has increased in relation to another currency, usually the US dollar. In other words, one unit of the Indian rupee can buy more units of another currency, such as the US dollar, than before.
Some of the common factors that influence exchange rates between two countries include interest rates, inflation rates, political stability, trade balance, stable GDP, government policies, etc.
The immediate impact of the depreciating rupee on an average investor is rising inflation, the rising cost of imported goods, increased remittances, increased fuel prices, etc.