Rupee depreciation

Rupee depreciation

Subject: Economy

Context:

During the year, the rupee fell to a lifetime low of 83.2 against the dollar.

Details:

• The rupee was the worst-performing Asian currency in 2022, witnessing a fall of around 10 per cent against the dollar.
• Compared to rupee, depreciation of other Asian currencies was to a lesser extent.
  • During the same period–Chinese Yuan, Philippine Peso and Indonesian Rupiah fell around 9 per cent. South Korean Won and Malaysian Ringgit declined by nearly 7 per cent and 6 per cent, respectively.

Cause:

• Sharp appreciation of the dollar due to the US Federal Reserve monetary policy tightening (rise in fund rate)  to check inflation.
  • This led to a higher interest rate differential between the US and India, and investors pulled out money from the domestic market and started investing in the US market to take advantage of higher rates causing rupee depreciation
  • In 2022, foreign portfolio investors (FPIs) pulled out Rs 1.34 lakh crore from the Indian markets – the highest-ever yearly net outflow.
• Russian invasion of Ukraine accentuated the FPI withdrawals with the global economic slowdown making inflows tougher.

Currency depreciation 

• It is a fall in the value of a currency in a floating exchange rate system.
• In a floating exchange rate system, market forces (based on demand and supply of a currency) determine the value of a currency.
• Rupee depreciation means that the rupee has become less valuable with respect to the dollar.
• For example: USD 1 used to equal to Rs. 70, now USD 1 is equal to Rs. 76, implying that the rupee has depreciated relative to the dollar i.e. it takes more rupees to purchase a dollar.
• A currency depreciates with respect to foreign currency when the supply of currency in the market increases while its demand falls.
  • Balance of payment deficit
    • Decrease in net export i.e. Export-Import.
    • Net capital outflow i.e. capital outflow- capital inflow.
  • Fall in relative rate of interest in India (comparatively higher rate of interest in foreign capital market lead to capital outflow)
  • Higher crude oil prices/ higher global price of any imported goods that would  increase import bill.
  • Wars/Pandemic leading to global supply chain disruption and uncertainty in consumer-investment expectation. For example-recent Ukraine War.
  • Fall in the currencies of emerging market peers.
  • Higher foreign denominated external debts- it will increase demand of foreign currency relative to domestic currency.

Impact-

Positive: While a weaker currency may support exports as export becomes cheaper for foreign countries against which currency has been depreciated.

Negative: 

• It poses risk of imported inflation, and may make it difficult for the central bank to maintain interest rates at a record low for longer.
• The currency’s weakness makes imports costlier.
• It will be costlier for students studying in overseas universities as this is the time when they purchase dollars towards fees.
• A falling rupee can be a worry for those planning a holiday abroad.
• Importers of capital goods will see shrinkage in margins.
• Repayment of external debt becomes costly.