Why is Rupee falling?

Why is Rupee falling

Why is Rupee falling

The BJP-led National Democratic Alliance (NDA) came to power on 26th May, 2014, after winning the 16th Lok Sabha elections. In its manifesto, one issue that BJP had strongly criticised UPA for, was the free fall of Rupee i.e. its sharply declining value against the US Dollar.

When NDA came to power, the exchange rate stood at 58.66. In simpler words, 1 Dollar= Rs. 58.66. Over the years, however, the Rupee has undergone continuous changes, with the latest one being the all time low value of Rs. 74.07 (as on 5th October, 2018). Let’s take a look at the Rupee journey under the Modi regime:

(The value of $1 in Indian Rupee)
26 May 2014 – 58.66
26 May 2015 – 63.97
26 May 2016 – 66.93
26 May 2017 – 64.51
26 May 2018 – 67.72
15 Aug 2018 – 70.39
30 Aug 2018 – 70.82
06 Sep 2018 – 71.96

05 Oct 2018 – 74.07

As we can see, there has been a clear upward trend in the Dollar value, set against INR. The question becomes why. Why is the value of Indian Rupee continuously depreciating, reaching its lowest ever?

What is currency depreciation and how does it work?

Currency depreciation is the fall in the value of a currency in the exchange market. So, what do we mean when we say the value of Indian Rupee has depreciated against US dollars, as we are regularly told by the news portals? In layman’s terms, it means now one Dollar can be exchanged for more Rupees than before.

For instance, on May 26th, 2014, you could get 58.66 Rupees in exchange for one Dollar. However, on 5th October 2018 – four years later, you would be entitled to 74.07 Rupees in exchange for one Dollar. That is the depreciation of Rupee and a simultaneous appreciation of Dollar.

Rupee at an all-time low. Here’s why.

1) The Lira connection

Turkey, the middle-eastern country, is going through a financial turmoil right now. Its relations with the US are infringes, leading to a very weak currency. Lira – the official Turkish currency has fallen 40 percent against the US Dollar in the first half of 2018. As is often the case, the turmoils of a financial crisis in one country do not stay confined to the national borders. The Lira crisis has made the global market anxious about its spillover effects. Developing countries tend to be more exposed to crisis like these, making the situation a tricky one for India.

2) Dependency on oil import

India is the third largest crude oil importing country in the world, coming only after US and China. India imports more than 80% of its crude oil requirements, thereby making it more vulnerable to changes in the international oil market. For example, if the crude oil prices increase, our total import cost will also increase, affecting our current account balance which in turn affects the currency market.

3) Huge current account deficit

In June 2018, India’s current account deficit rose to 42%, approximately $160 billion. Current account deficit is the difference between imports and exports of goods and service of a country. A huge dependency on crude oil imports and its increasing price, as mentioned before, affects our current account health, making the deficit larger.

How does a current account deficit impact Indian Rupee?

In simple words, an increasing current account deficit (of India) leads to an increase in the demand for Dollar. Why? Because we need more Dollars than before to finance our growing deficit, also paying for the imports. An increase in the demand for a currency leads to its appreciation. And if the US Dollar is appreciating against Indian Rupee, it means our domestic currency is depreciating.

4) US Fed (Federal Funds) rate changes

Since national economies share an intricate bond, the effects of US Fed rate hikes are felt in the Indian market as well. A hike in the fed rates (as was observed four times in 2018), strengthens the US Dollar, which in turn leads to a depreciation of the Indian currency.

5) The global market

The United States and China have been experiencing a trade war in 2018. As both are among the world’s largest economies, the trade war is set to affect the global economy. While the ball could fall on either side of the court for India, the situation has definitely created a growing unease among global investors and Indian economists.

How will the fall in Rupee affect Indian economy?

1. Cost of oil imports: Crude oil can be called a major engine for the growth and working of the Indian economy with its vast utilities. Since India imports more than 80% of its oil needs, a depreciation of Rupee will increase the cost of our humongous oil imports. This, in turn, can cause our current account deficit to worsen.

2. An increase in the import cost will directly affect the Indian corporate market for the worse.

3. Inflation: Domestic currency appreciation and inflation work in the opposite directions. So, a depreciation of the domestic currency means a potential increase in inflation.

4. To ward off an increasing inflation, the central bank of a country generally increases the interest rates. Consequently, people are able to borrow less money, and hence, they also have less to spend, keeping the inflation in check. Reserve Bank of India (RBI) might resort to increased interest rates too, further increasing the effect on corporates.

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