May 19, 2022
  • May 19, 2022

How does the depreciation of the rupee affect the economy?

By on March 13, 2022 0

The rupee is under pressure: it fell 3.5% against the dollar in 2022 and hit all-time lows. The reason is twofold: first, the Russian-Ukrainian war, and second, the expected rise in US interest rates. Mint examines the state of the rupee.

What is currency depreciation?

When the value of a currency against other currencies weakens due to market forces, i.e. the demand and supply of foreign currency, it is called a depreciation. On the other hand, if it is weakened by an administrative action, it is a devaluation. Although the process is different for depreciation and devaluation, there is no difference in terms of impact. India used to follow the administered or fixed exchange rate until 1993 when it switched to a market determined process or a floating exchange rate. China still adheres to the former.

What factors influence the fluctuation of currencies?

It depends on the net inflows and outflows of foreign currencies due to foreign trade, foreign investments, round trips, remittances back and forth by expatriates, and receipt and granting of loans and foreign aid. The shares of foreign institutional investors (FIIs) have been the main cause of rupee fluctuations since mid-1996, when India opened its capital markets. The recent depreciation is due to the fact that the US Federal Reserve rates are expected to be raised soon, leading to the withdrawal of FII from the Indian markets, and also because of the Russian-Ukrainian war. High oil and commodity prices are also a factor.

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Free fall

What has been the evolution of the external value of the rupee?

The rupee, which opened at a record high of 76.984 on March 8, was stabilized by the central bank’s timely $5 billion swap auction on the same day. In 2022, it depreciated by 3.5% against the dollar. The financial crisis of 2008, the Eurozone debt crisis of 2011-2012 and the taper tantrum of 2013 are some examples of strong downward pressures on the rupee.

What does a weaker rupee mean for trade?

In a normal situation, the depreciation of the national currency helps to stimulate exports. The Reserve Bank of India also avoided intervening in the market to help exports. Indian imports have been hit hard, be it crude oil or other crucial commodities. Given the Organization of the Petroleum Exporting Countries basket price of $127.93/barrel, the landed crude oil price on March 8, 2022 increased to 9,836.53 per barrel ($1= 76.89) versus 9,657.81 per barrel ($1= 75.49) as of February 28, 2022.

What is the impact on the global economy?

The current account deficit is set to widen, depleting foreign exchange reserves and weakening the rupee. With higher landed prices for crude oil and other crucial imports, the economy is definitely heading towards cost-driven inflation. Oil marketing companies may not be allowed to fully pass the burden of high cost of supply onto people, affecting government dividend income, raising question mark over budgeted budget deficit .

Jagadish Shettigar and Pooja Misra are faculty members of BIMTECH.

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