Rupee Depreciation

Rupee Depreciation

Subject :Economy

Section :External Sector

Context:

After the 1991 crisis, which led to the devaluation of the rupee, there has been no crisis originating in India that has impacted the country’s external sector to an extent that would lead to rupee weakness.  Yet the rupee has depreciated 492 per cent since — from ₹13/$ in 1991 to ₹76.98/$ in 2022.

Causes:

• A chronic balance of trade deficit.-
• Impact of external financial crisis-overseas: the Asian crisis (1997), the Russian debt default and the LTC meltdown (1998), Y2K (2000), the 9/11 attack (2001), the GFC (2008), European crisis (2011), Taper Tantrum (2013), Covid-19 (2020) and the Russia-Ukraine war (2022)- Led large scale uncertainty in developing countries and capital outflows. (Capital outflows leads to the depreciation of currency)
• Policy of depreciation to expand growth-RBI has actively prevented the rupee strengthen on several occasions as it increases export (price of export falls in international market) and reduces imports.

Impact:

• Imported inflation- imports become expensive due to depreciation
• Rise in rate of interest– to arrest capital outflows.
• Exchange rate fluctuations-hampers trade in general

Alternatives:

The RBI, as the forex market regulator, should actively work for the welfare of importers and exporters-

• Make it mandatory for all banks to route all their customer trades through the FX Retail platform in order to increase volumes and promote usage.
• Allow corporates to transact forex with any bank of choice, and not be mandatorily tied to the bank through which the underlying trade transaction is routed.
• Allow delivery against exchange traded currency futures.

Concept:

How does a trade deficit cause currency depreciation?

Under flexible (or floating) exchange rates, the disequilibrium in the balance of payments is automatically solved by the forces of demand and supply for foreign exchange.

A deficit (or surplus) in the balance of trade/payments is automatically solved by a depreciation (or appreciation) of a country’s currency.

Example– D is the India demand curve of foreign exchange representing its demand for British imports, and S is the India supply curve of foreign exchange representing its exports to Britain. At P the demand and supply of the India foreign exchange is in equilibrium where the rate of exchange between Indian rupee and British pound is OE and the quantity of exchange is OQ.

Suppose the deficit develops in the balance of payments of India in relation to Britain. This is shown by a shift in the demand curve from D to D1 and the incipient deficit equals PP2. This means an increase in India’s demand for British imports which leads to an increase in the demand for the pound. This implies depreciation of the Indian rupee and appreciation of the British pound. As a result, import prices of British goods rose in India. and the prices of Indian exports fall. Thus, BOP deficit correction led to depreciation of the Indian rupee.

FX-Retail:

Reserve Bank of India (RBI) through Clearing Corporation of India Ltd (CCIL) has rolled out an electronic trading platform ‘FX-Retail’. This enables Bank customers to buy and sell foreign exchange* across all tenors up to 13 months in USD/INR currency pair.

FX-Retail platform provides for an order driven dealing in the USD/INR currency pair for the Customers of banks. The Customers can access the platform through the Internet to place buy/sell orders in the USD/INR currency pair as per their requirement. The customers can book contracts in CASH (same day currency settlement), TOM (Next day currency settlement), SPOT (Trade +2 days currency settlement) and FORWARD (beyond SPOT currency settlement) instruments upto a period of 13 months including broken dates and Option period (not exceeding a period of 30 days).