ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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India at 75, Rupee at 80

A depreciating rupee will further add to inflation and weaken the external sector.

The current bout of rupee depreciation must be a humbling experience for the National Democratic Alliance that has often mocked at the United Progressive Alliance government’s inability to prevent the rupee depreciation during its regime. This is because the most recent trends show that the rupee depreciation has now further accelerated from around `74 per dollar in early January 2022 to reach a peak of `80 per dollar by the fourth week of July, a depreciation of around 8%.

To be fair, the Indian rupee is not the only currency that has depreciated against the dollar in the recent period. The global currency market has been in a flux since the synchronous raising of the interest rates as a part of the reversal of the soft money stance by the monetary authorities across the globe. The Federal Reserve of the United States (US) has cumulatively hiked rates by 150 basis points since March 2022. However, the trends in exchange rates of important currencies have varied sharply. In fact, some major currencies have appreciated or strengthened against the dollar in the first seven months of the year, including the Brazilian real (4.7%), the British pound (7.2%), and the euro (9.8%), even as the rupee depreciated by 4.3% during the period.

And some currencies have depreciated faster than the rupee. These include the Japanese yen (15.4%), the South Korean won (10.6%), the Thai baht (9.6%), the Philippines peso (8.5%), and the South African rand (7%). And a few other currencies that have depreciated much slower than the rupee include the Russian ruble (0.4%), the Chinese yuan (0.6%), the Singapore dollar (2.6%), and the Swiss franc (4.1%). At the overall level, the US dollar index, which measures the dollar value in terms of a basket of currencies, has strengthened with the index going up from 96.17 in early January 2022 to more than 106.7 in end July, an increase of around 11%. Certainly, the rupee has held its own despite the considerable strengthening of the dollar following the interventions of the Federal Reserve.

The major reason for the depreciation of the rupee is the growing mismatch between the demand and supply of dollars. An important factor contributing to the growing demand for dollars is the soaring imports that has sizeably widened the trade deficits. The trade deficits have increased from $17.3 billion in January to $25.6 billion in June 2022, primarily fuelled by the rising oil import bill. Though the current account deficits have reduced from 2.6% of the gross domestic product (GDP) in the third quarter of 2021–22 to 1.5% of the GDP in the fourth quarter, the forecasts are that the current account deficit is expected to more than double from 1.2% of the GDP in 2021–22 to 2.8% of the GDP in 2022–23.

Further, the outflow of dollars invested in the equity and debt markets has also contributed to the decline. Cumulative outflows of foreign portfolio investors have now surged up. Foreign portfolio investors have sold heavily for nine consecutive months with the cumulative outflows surging up to `1.2 lakh crore in the current fiscal year. And their holding of the central government securities and their investments in the corporate bond segment have also plunged much below their peak levels. In contrast, the supply of dollars has declined as the foreign direct investment inflows from abroad and external commercial borrowings by corporate firms have fallen marginally in the current fiscal year.

The Reserve Bank of India (RBI) has tried to meet this growing demand by selling dollars from its foreign exchange reserves. This has led to a sharp reduction in the size of reserves, which has plunged from a high of $642 billion in early September 2021 to $580 billion by the first week of July 2022. Though the foreign exchange reserves are still at fairly comfortable levels with enough funds to finance 9.5 months of imports, the central bank cannot afford to defend the rupee beyond a limit.

A depreciating rupee affects the economy differently. It is often claimed that the rupee depreciation will help exporters as it makes Indian goods cheaper in dollar terms and provides more rupee earnings to exporters. But it is unlikely to happen now. This is because the 40-currency real effective exchange rate (REER) of the rupee, which is the weighted average of the nominal exchange rate of currencies adjusted for prices differences, has gone up from 103.5 in 2020–21 to 104.7 in 2021–22 and only marginally declined to 104.1 now. The strong REER of the rupee can limit any gains on the export front.

More importantly, a depreciating rupee will have a negative impact on foreign investments and prices. Foreign investors, especially those in equity and debt markets, prefer stable exchange rates that allow them to repatriate funds profitably. However, the worst impact of the depreciating rupee will be on inflation as it will increase rupee prices of imports, especially that of oil and other essentials. Long-term trends in fact show that both the consumer and wholesale prices have usually spiralled up whenever the rupee depreciates sharply.

Given the scenario, the government and the central bank have announced a slew of measures to increase dollar inflows and curb outflows to stabilise the rupee exchange rate. The slower global growth forecast will hopefully reduce the international oil prices and shrink the dollar demand. However, the RBI would have to again raise rates if the US Federal Reserve continues to take an aggressive stance and pursue with the rate hikes. Overall, a stable rupee can be ensured only by pushing up exports over imports and correcting the imbalance on the trade front.


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Updated On : 6th Aug, 2022
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