Falling Rupee Value

Exchange rate is the price of foreign currency (USD, Yen, Euro, Pound etc) in terms of domestic currency (rupee) i.e. amount of domestic currency needed to buy one unit of foreign currency. Currently price of 1$ = 53.74, which means 1$ can be purchased in exchange of 54.

Exchange rate tells us the value of domestic currency in relation to one unit of foreign currency. 1$ is worth 53.74. Rupee prices keep fluctuating all the time. Sometimes we need more rupees to buy one unit of foreign currency and sometimes we need fewer rupees to buy one unit of foreign currency. This change in rupee price is known as rupee appreciation or depreciation.

Rupee appreciation is when value of rupee increases (becomes expensive) and fewer rupees can buy one unit of foreign currency. This is also known as strengthening of rupee as now INR is worth more than foreign currency. Suppose exchange rate changes to 1$ = 50, we say rupee has appreciated as 1$ can buy fewer INR.

Rupee depreciation is when rupee value decreases (becomes less expensive) and more rupees can buy one unit of foreign currency. This is also known as weakening of rupee as now INR worth is less than foreign currency. If exchange rate changes to 1$ = 55, we say rupee has depreciated as 1$ can buy more INR. Currency price is always stated in relation to another currency. So when one currency appreciates the other currency depreciates.

Exchange rate determination process between the Indian rupee and US dollar

The rate of exchange of the rupee against the US dollar is determined by the demand and supply of the US dollar in our country. It is worth knowing that the US dollar is primarily demanded by importers and the Foreign Institutional Investors (FIIs). The US dollar is also demanded for the Foreign Direct Investment (FDI). Foreign Institutional Investors (FIIs) put their money in the stock market of the domestic market while Foreign Direct Investment (FDI) is the capital which is invested in the companies of the domestic country.

The supply or earning of dollar comes mainly from the exports of goods and service and the inflow of remittances by the Non-Resident Indians (NRIs). That is why when the importers demand more of the dollars for the international payments than their supply, the rupee weakens vis-à-vis dollar. Consequently the value of Indian rupee falls down against the US Dollar (US$).

On the contrary, with the fall in the demand for dollars, which is again driven by myriad factors, the value of rupees appreciates and that of dollars decreases. No doubt, besides the fundamental theory of market forces of demand and supply which is also called as the price mechanism, there are more other factors like those of social-political, diplomatic and foreign policies of a country which play substantial role in the determination of the value of Indian rupees against US Dollars.

Price of crude oil

With the fast development and trajectory of high rate of growth of the Indian economy, the demand for petrol and petroleum products has been consistently rising and as a result we require importing more of crude oil annually from various foreign countries. Oil is the second largest fuel after coal. India imports close to 70 per cent of its oil requirements from more than 8 countries. The rest 30 per cent of oil is met through domestic production. Saudi Arabia and Iran top the list of the countries from where we import most of the crude oil. The prominent oil companies of India require approximately 330 million dollars every day for the import of crude oil and gas and this figure very strikingly shows how much dollars we require every month to purchase it from the various oil producing countries of the world. Thus, increase in the demand for the dollar leads to its appreciation and decrease in the value of the Indian rupees.

Current Account Deficit (CAD)

The current account shows the records of exports and imports of both the material goods and services of a country with the rest of the world. Export and import of goods are totally different from the export and import of services. While goods are tangible and called as merchandise or visible trade, and of which records are available at the ports. Services are non-tangible and called as invisible trade the records of which are not available at the ports. In fact, the current account deficit is the difference between the visible and invisible exports and visible and invisible imports of a nation with the rest of the world. Shipping, banking, insurance, investment and compensation of employees are main items which make the parts of services that are exported and imported by a nation with the foreign countries. When our receipts are less than the payments which we make for the purchase of both the goods and services we face the deficit in our current account. As per the latest data, India’s current account deficit has increased to 15.8 billion US $ or 2.4 percent of the GDP. The drastic decrease in the exports has added fuel to troubled waters. They say that unnecessary delay in the clearance and approval of various development proposals too has aggravated the situation and we face the problem of dollar crunch. Consequently we are forced to spend from the foreign exchange reserves for making the payments for all the imports.

What makes the current account deficit more distressing is the ever-increasing import bill of oil and gold. The heavy purchase of gold and crude oil puts heavy pressure on the foreign exchange reserves and finally our current account deficit goes on worsening. That is why there is unprecedented rise in the demand for the dollars which results in the appreciation of its value and finally the value of rupee weakens.

Withdrawal by investors

In the recent past, numerous development projects that were to be started in the country have been withdrawn by the foreign investors due to problems like uncertain delays in the approval of proposals and bottlenecks in the acquisition of land. So many such other projects which could not be approved by the government of India were withdrawn and due to which demand for the dollar abruptly went up. In case of approvals of these proposals, India would have received huge investments. Consequently, the demand for the Indian rupee and its values would have substantially increased. Because when any foreign company invests in India it needs rupees in exchange of US Dollar for the various transactions in the country.

Increasing import bill of India

In the post reformed milieu of the Indian economy, the import bill has been consistently rising every year. The share of gold import is one of the important factors. The huge rush for gold, brought about by the preference of the people to invest in it, has further worsened and weakened the Indian rupees against the US dollars. According to the latest survey, the gold import alone makes the 10 per cent of India’s import bill. This is really a surprising fact that 141 tons of gold were imported in April 2013 which increased to 162 tons in the month of May this year. The import of gold has increased to 750 tons in the current year of 2018. This consistent increase in the demand for gold means a rise in the demand for more US dollars in comparison with the rupees. That is why the value of the US dollar appreciates and that of the Indian rupees goes down.

Slump in the Indian economy

In the recent years the overall production in all the three sectors of the Indian economy – primary, secondary and tertiary has recorded very poor growth and consequently the production in them has substantially gone down. Investors from the foreign countries do not find India a country of lucrative businesses. Decrease in the export, brought about by fall in the production in agriculture, manufacturing and mining, leads to decrease in the earning of dollars. This finally ends up increasing the demand for dollars and raising its value against the Indian currency.

Problem in the equity market

In the critical condition of consistent fall in the value of rupees against the dollars investors prefer to deposit their money in the safe havens of US treasuries, Swiss franc, gold and so on to avoid losses to their investments. This alarming situation of shifting of investment from India to other destinations leads to redeeming of their investments from the country, and consequently the demand for the dollar goes up which brings down the values of rupee.

Increasing fiscal deficit

Generally fiscal deficit shows the dependence of a country on the foreign debt to match the expenses which exceed the revenues of the government. It is the estimated borrowing by the government to meet the increased expenditures in a year. For this the government borrows from the international financial institutions like World Bank and the International Monetary Fund. It is often expressed as the percentage of the GDP. It shows the excess of expenditure over the government receipts other than borrowings. Greater fiscal deficit means greater borrowings. For the payment of all these foreign debts along with interest accrued to them, we require dollars and this ends up raising the value of dollar vis-à-vis the Indian rupee.

Steps To Stop Falling Of Indian Rupee

However, certain measures can and should be taken to arrest this rather drastic fall, some are suggested below:

1. Increase Foreign Investment

The most obvious way to offset distribution is to increase growth and bring more dollars into the system, thus reducing the CAD. Relaxing of norms for FII investments is one of the more obvious ways to do it. Providing infrastructure and local support to the investors is another, admittedly more difficult avenue that can be explored in this regard.

2. Making government bonds available to a wider investor base

Making government bonds available to non-resident investors will also increase the inflow of dollars in to the country and help contain the CAD, and in turn, the depreciation of rupee.

3. Strengthening the rupee by RBI measures

The Reserve Bank, in its capacity as India’s central banking institution and monetary policymaker, has, at its disposal a number of instruments with the capability to arrest depreciation. Some examples of such measures are: Deregulation of interest rates on deposits from non-resident Indians, introducing measures to curb speculative trading and sale of dollars from forex reserves.

In today’s day and age, when financial networks span continents and financial decisions and measures are made keeping in mind a global outlook, linking nationalism and economics is a colossal mistake. Although some measures are necessary to protect people against the adverse effects of drastic depreciation, drastic measures such as curbing imports should be avoided as they may create more problems than they solve. Nations and governments should realize that depreciation and appreciation are phenomena created by the immense interconnected ecology of the global free market and stick to policies that do the simple thing: create infrastructure and promote inclusive growth.