The recent fluctuation in the value of the Indian Rupee is a topic of discussion in the world of finance. Between September and December 2021, it showed a decrease of 2.2% thanks to the extraction of $4 billion worth of global funds from the country’s stock market. This plummet in worth ranked the rupee as Asia’s worst-performing currency for the period.
Understanding Depreciation of Currency
Currency depreciation signifies a decline in the currency’s value within a floating exchange rate system. In India’s context, depreciation means that the rupee has diminished its value compared to the dollar. For instance, though $1 was equivalent to Rs. 70 before, it has now inflated to Rs. 76, highlighting that more rupees are required to purchase a dollar.
Implications of Currency Depreciation: Indian Scenario
For the Reserve Bank of India, depreciation of the rupee carries both positive and negative implications. On the positive side, a weaker rupee can boost exports during an economic recovery phase following a pandemic. Conversely, the downside includes a potential risk of imported inflation and challenges for the central bank to sustain low interest rates.
Appreciation versus Depreciation of Currency
In a floating exchange rate system, market forces like demand and supply essentially determine a currency’s value. While currency appreciation refers to an increase in one currency’s value concerning another, currency depreciation denotes a decrease in a currency’s value. Numerous factors, including government policies, interest rates, business cycles, and trade balances, influence these fluctuations.
Difference Between Devaluation and Depreciation
Although often used interchangeably, devaluation and depreciation carry distinct connotations. Both lead to a fall in currency value, making imports more expensive and exports more competitive. However, devaluation happens when a country’s central bank consciously downgrades its exchange rate in a fixed or semi-fixed exchange rate. In contrast, depreciation denotes falling currency value within a floating exchange rate.
Root Causes for the Current Depreciation of the Indian Rupee
Several factors have contributed to the current depreciation of the Indian Rupee. The first one is the record-breaking trade deficit, which reached an unprecedented $23 billion due to heightened imports. Oil price rebound largely drives this growing trade deficit.
Another cause is the policy divergence between the Reserve Bank of India (RBI) and the Federal Reserve. The strengthening of the US dollar favors better growth in the US economy and the Federal Reserve’s interest rates.
A significant outflow of foreign capital, primarily from stocks, also led to the depreciation. This outflow resulted in a 10% dip in the benchmark S&P BSE Sensex Index from its all-time high in October 2021.
Finally, concerns regarding the Omicron variant of the COVID-19 virus also played a significant part. This concern has created ripples in the global market, leading to economic instability and subsequent depreciation.
