Why is the Indian Rupee Falling Against the US Dollar?

  • December 22, 2024
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Why is the Indian Rupee Falling Against the US Dollar?

Sub :Eco

Sec: External sector

  • The exchange rate between the Indian rupee (INR) and the US dollar (USD) is influenced by the demand and supply dynamics of the two currencies in the global market.

What is the Exchange Rate?

  • Exchange Rate: The value of one currency relative to another.
  • Example: Currently, ₹85 = $1, compared to ₹61 = $1 in 2014.
  • Currencies behave like commodities; their value depends on demand and supply.

Factors Determining the Exchange Rate

  • Higher Demand for USD: If Indians demand more USD than Americans demand INR, the USD strengthens, and the INR weakens.
  • Daily Fluctuations: Repeated higher demand for USD causes the INR’s consistent depreciation.

Components Influencing Currency Demand

  • Trade in Goods:
    • If India imports more goods from the US than it exports, the demand for USD rises, weakening INR.
  • Trade in Services:
    • If Indians buy more US services (e.g., tourism) than Americans buy Indian services, INR demand drops.
  • Investments:
    • More US investments in India: INR appreciates.
    • More Indian investments in the US: INR depreciates.

Key Factors Affecting Demand for INR and USD

  • Trade Imbalances:
    • Example: High US tariffs on Indian goods reduce INR demand.
  • Inflation:
    • Higher Indian inflation reduces the rupee’s purchasing power, weakening INR against USD.
  • Capital Outflows:
    • Investors pulling money out of India due to better returns in the US (e.g., higher interest rates, lower inflation) reduce INR demand.

Current Scenario

  • The rupee’s exchange rate has breached ₹85/$1, compared to ₹83 in April 2024.
  • Contributing factors include:
    • Trade deficits, where imports exceed exports.
    • Rising inflation in India compared to the US.
    • Capital flight, with investors preferring US markets.

Conclusion

The Indian rupee’s depreciation reflects an imbalance in trade, investments, and inflation. Addressing these structural challenges through increased exports, lower inflation, and attracting foreign investments could stabilize the INR over time.

Types of Exchange Rates

TypeFeaturesImportance
Fixed Exchange RateMaintained by central banks; less volatile.Stability in trade but less flexible for market changes.
Floating Exchange RateDetermined by market forces (demand-supply); highly volatile.Reflects real-time economic conditions.
NEER (Nominal Effective Exchange Rate)Weighted average of exchange rates; no inflation adjustment.Measures currency’s strength across trading partners.
REER (Real Effective Exchange Rate)Adjusted NEER to reflect inflation differences.Indicates trade competitiveness; higher REER may signal loss in price competitiveness.

Difference b/w Appreciation, Depreciation and Devaluation

AspectAppreciationDepreciationDevaluation
DefinitionCurrency value increases.Currency value decreases.Central bank reduces currency value deliberately.
SystemFloating exchange rate.Floating exchange rate.Fixed/semi-fixed exchange rate.
CauseMarket forces (demand/supply).Market forces (demand/supply).Policy decision by central bank.
Impact on ExportsMakes exports costlier.Makes exports cheaper.Makes exports cheaper.
Impact on ImportsMakes imports cheaper.Makes imports costlier.Makes imports costlier.
economy Why is the Indian Rupee Falling Against the US Dollar?