A very steep fall in the value of the rupee against the dollar has triggered tensions in the Indian subcontinent. People are apprehensive about making investments, inflation is at an all-time high and the polity is struggling under the threat of economic strains. The continuous and uncontrolled fall in the rupee's value is attributed to a variety of reasons, a major one being the steps taken by the Fed in the USA.
As the US hits a decade-high inflation level, it is stimulated to undertake certain measures to cope with the rising prices. However, considering the global impact that the dollar’s value or US economy has around the world catalyzes a series of events in other economics, be it the developed or developing. In this article, the focus will be on the causes of rupee depreciation and how the US Fed has a humongous role in the same.
What is Depreciation?
Depreciation of domestic currency basically means a fall in the value of the domestic currency in terms of a foreign currency. For example, if 1$=Rs.70, and this current foreign exchange changes to 1$=Rs.75, then this implies that the rupee is falling.
In layman’s terms, more rupees are required to buy the same dollar. The further implication of this value depreciation is – since the rupee's value has fallen, it becomes possible for the foreign country to buy more goods in the domestic country with the same amount of foreign currency. Thus, it leads to an increase in imports. However, this is not the end of the story.
Matter of Concern
The current exchange rate stands at 1$=Rs. 79.29, compared to Rs. 78.20 on June 13. This clearly shows how rapidly the value of rupees is falling against the dollar. It is even expected to fall further by the experts. It is of critical importance to analyze the reasons behind this drastic fall.
Since an increase in imports isn’t necessarily a good omen for an economy, it is not smart to assume an economy is performing well just because it experiences higher imports. Therefore, in the next section, we look into other causes that are accountable for this depreciation.
Reasons
Surging interest rates: one of the major reasons is the surging interest rates by the US Federal Reserve. When interest rates start rising, it leads FII (Foreign Institutional Investors) to pull out their money from risky markets like India. This results in high sell-offs and dollar outflows from Indian equity markets and bond markets.
Safe havens: More capital is flowing to safe havens such as the US where hiked interest rates attract the borrowers’ interest. Further, the never-ending Ukraine crisis and the resulting supply chain disruptions in combination with spiralling oil prices have increased the cost of capital in countries such as India. This further encourages the FII to pull out their money which weakens the rupee.
Dollar Index: The US dollar index was established in 1973 to measure the value of the US currency against the Euro, Swiss franc, Japanese yen etc. If this index goes up, it indicates that the US currency is gaining strength against all the other currencies. This increase in the index implies an increase in the value of US assets. These include the stocks of American Companies, treasury bonds, and US government bonds.
Weakened rupee: An increase in the USD index causes the rupee to weaken. This weakened rupee makes the imports costlier than before and affects Indian Inc.s’ profitability due to increased costs of production. This triggers a chain reaction as increasing production costs lead to inflation, that is the general price level in the economy, which renders the common man a hard time making transactions for himself.
Oil prices: Added to this increasing Index are the surging oil prices in the world market. These prices add to the pressures on the weakening currencies. High oil prices give out imported inflation which impacts the profitability of domestic corporates and FII inflows.
Conclusion
As we are moving toward a COVID-free economy, our arena still remains fraught with tensions such as the weakening rupee value. A stronger policy foothold is required to tackle this increasing fall to the greatest extent. Since the US decision to hike its interest rates has caused a worldwide impact, the RBI has also formulated on increasing the interest rates on a transitory basis to cushion the fall of the Indian rupee.
However, as we looked into other factors that caused this fall, the current dispensation needs to buckle up and realize the need of the hour to help out the economy from an all-time high of a rupee-plunge.
Written By Udhai Rawat
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