Depreciation of Indian Rupee

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    In Context 

    • The Indian rupee breached the psychologically significant exchange rate level of 80 to a US dollar in early trade.

    What is the rupee exchange rate?

    • The rupee’s exchange rate vis-à-vis the dollar is essentially the number of rupees one needs to buy $1. 
      • This is an important metric to buy not just US goods but also other goods and services (say crude oil) trade in which happens in US dollars.
    • Broadly speaking, when the rupee depreciates, importing goods and services becomes costlier. 
    • But if one is trying to export goods and services to other countries, especially to the United States, India’s products become more competitive because depreciation makes these products cheaper for foreign buyers.

    Reasons 

    • Global factors such as the Russia-Ukraine conflict, soaring crude oil prices and tightening of global financial conditions are the major reasons for the weakening of the Indian rupee against the US dollar.
      • Significant dollar demand from oil importers amid elevated crude oil prices and concerns about swelling trade deficit have also been key catalysts behind the steep descent seen in the Indian currency.

    Impacts 

    • Imports will become more expensive: 
      • When the dollar strengthens against the rupee, importers will have to pay more for the same number of dollars. And since international trade is mostly in the US dollar, importers have to pay higher prices. 
      • So, a depreciating rupee will increase the cost of imports, putting extra pressure on people’s pockets in the country which has an import-oriented economy. 
        • Oil and Gas will  be the most adversely impacted sector as India imports over 85% of oil and half of the gas it consumes.
          • It will expand the country’s current account deficit .
        • Renewable Energy 
          • Indian solar plants depend heavily on imported solar cells and modules
          • Project costs would rise, tariffs higher in future bids Margin compression for upcoming projects Every Re 1 fall vs Dollar leads to 2 paisa/unit increase in tariff.
      • A weaker rupee directly impacts India’s trade balance and inflation through higher cost of imports. 
      • Costlier imports  will widen the trade deficit as well as the current account deficit, which, in turn, will put pressure on the exchange rate.
      • Costlier imports are also pushing up inflation domestically. 
    • Exports get cheaper: 
      • When a domestic currency depreciates, its exports will become cheaper as exporters will get more rupee against the foreign currency.
      • In short, industries linked to exports like pharma and IT benefit with depreciation.

    Role of Reserve Bank of India(RBI)

    • RBI regularly monitors the foreign exchange market and intervenes in situations of excess volatility.
    • RBI has taken several measures recently to ensure foreign currency inflow and prop up the rupee, such as higher overseas borrowing limits for companies and easier foreign ownership rules in government bonds, the rate of returns in the bond yields in the USA has been more compared to the rate of returns in any Indian investment.
    • RBI has also proposed the rupee settlement mechanism, under which foreign companies can make foreign payments in rupees, unlike the US dollars.
      • This is expected to reduce the need for US dollars for foreign trade, stabilising its value.

    Options available for RBI and policymakers 

    • It is neither wise nor possible for the RBI to prevent the rupee from falling indefinitely. 
      • Defending the rupee will simply result in India exhausting its forex reserves over time because global investors have much bigger financial clout.
    • Most analysts believe that the better strategy is to let the rupee depreciate and act as a natural shock absorber to the adverse terms of trade.
    • The RBI should focus on containing inflation, as it is legally mandated to do, and the government should contain its borrowings”. 

    Conclusion 

    • The depreciation of the currency is likely to enhance export competitiveness, which  in turn impacts the economy positively. 
    • The rupee is still more resilient than it was in some of the previous crises such as the Global Financial Crisis of 2008 and the Taper Tantrum of 2013.
    • Although the rupee has depreciated against the US dollar, it has appreciated against other major currencies such as euro and the Japanese yen. 
    • Under normal circumstances, rupee depreciation is good for the current account deficit because it leads to higher exports. 
    • But at present, India is already facing high inflation and continued depreciation may be making matters worse.
      • There are chances that the central bank may intervene further as the rupee sees a further decline. 

     

    Mains Practise Question 

    [Q] Discuss major reasons and the impacts of weakening of  Indian rupee against the US dollar on trade patterns of the economy.