Implications of the Recent Fall of Rupee

—By Charu Latha

The Indian rupee hit an all-time low against the US dollar on July 19, 2022 when it crossed Rs 80. Exactly ten years ago one US dollar was equivalent to Rs 57 while in 2020, it was equivalent to around Rs 70. Within two years, the exchange rate has crossed the 80 mark especially when the economy is recovering from the slowdown caused by the COVID-19 pandemic. Since January 2022, the Indian rupee has reduced by around 7 per cent against the dollar. The finance minister mentioned that the causes for such a situation could be weak global financial controls and global factors such as the Russia-Ukraine war and rising crude oil prices. The rupee has been declining also due to foreign capital outflows. The depreciation of the rupee could have many repercussions on the Indian economy.

An exchange rate is a rate at which one currency will be exchanged for another currency and affects trade and the movement of money between countries (Investopedia). The exchange rate between currencies is determined by many factors such as economic activity, interest rates, inflation, unemployment rate, GDP, etc. The change in the exchange rate can take place on an hourly or daily basis. There are two types of exchange rates, fixed exchange rate and flexible exchange rate. A fixed exchange rate system is where the central bank of a country determines and fixes an exchange rate based on the economic conditions prevailing in the country. The flexible exchange rate is determined by the market forces of supply and demand of the currency. Currently, a flexible exchange rate system is followed by most of the countries in the world. India shifted to a market-determined exchange rate system in 1993 as part of liberalisation.

Fluctuations in the exchange rate have a direct effect on the import and export trade between countries. Change in exchange rate impacts interest rates, inflation, national politics, and the economy. Apart from these, it indirectly impacts consumption, exports, imports, productivity, investments, and policy making.

Benefits of Depreciation

The benefits of depreciation are as follows:

1. Boosts exports: Generally, it is assumed that depreciation negatively affects the economy. But there is one important positive aspect to it. Currency depreciation makes the goods exported from the country cheaper and encourages the importers of the goods to import more because the importing countries have to pay less for the same product.
2. Tourism: Currency depreciation makes it cheaper for tourists who would want to visit the country and it effectively reduces the cost of living for them.
3. Remittances: The remittances families get from people living abroad could increase as they get a higher amount of rupees for the same amount of foreign currency.

Drawbacks of Depreciation

Following are the drawbacks of depreciation:

1. Expensive Imports: Since India, like most countries, pays the exporters to India in US dollar, all the commodities India imports become costlier. One of the reasons for the depreciation of the rupee against the dollar is rising crude oil prices. But due to the depreciation of the rupee, the crude oil imports become even costlier as the country has to pay more amount of rupees for the same quantity of oil.
2. Inflation: With imports becoming pricey, especially crude oil (India imports about 80 per cent of its oil), the commodities in general become expensive. The prices of commodities that require the import of raw material or intermediate goods also increase. With already existing inflation rates (7.8 per cent as of April 2022, according to RBI), the inflation in the country could rise further. One of the measures to control inflation is to raise the interest rate. So, RBI could raise the repo rate thereby increasing interest rates further which makes loans expensive.
3. Market disruptions: Due to an increase in prices, the cost of living increases all over the country. The effects of an increase in prices will be reflected in the consumption patterns. Higher inflation could lead to the labour force demanding more income. There could be disruptions in the supply and demand of labour and unrest among the general public. Not only this, but the government will also have to face the consequences of dissatisfaction of people. So, depreciation and inflation are not only economic problems but also political problems.
4. Current account deficit: The price of imports rises due to the depreciation of the currency. If the size of exports does not increase proportionately to compensate for the price rise, it widens the current account deficit of the country.
5. Others: Foreign travel, as well as overseas education for students studying abroad, becomes costlier. Also the interest rates on debts of government taken in dollars increase. Drastic and quick depreciation could lead to a further withdrawal of investments from international investors.

There are both pros and cons of currency depreciation. But most of the time, the negatives outweigh the positives.

According to several analysts, the rupee can further decline if oil prices rise. To prevent this, the RBI has to intervene and take action. The RBI regularly monitors the foreign exchange market and intervenes when there is excess volatility. In recent months, interest rates have been raised by the RBI as it makes holding Indian currency attractive for residents and non-residents.

The RBI is said to have sold its dollars from the foreign exchange reserves and expanded its foreign exchange reserves to prevent the rupee from falling drastically.

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