Currency depreciation is a drop in the overall value of a currency within a floating exchange system. In this context, rupee depreciation implies that the rupee has lost its value against the dollar. The decreasing value of the rupee means it now requires more rupees to purchase a single dollar. For example, if USD 1 once equaled Rs.70 and now equals Rs.77, it suggests that the rupee has depreciated relative to the dollar.
Impact of Depreciation of The Indian Rupee on The Economy
Depreciation of the rupee is a double-edged sword for the Reserve Bank of India (RBI). On the positive side, a weaker rupee could theoretically improve India’s exports by making them more competitively priced in global markets. However, in an uncertain economic environment with weak global demand, a fall in the rupee’s external value may not necessarily result in higher exports.
The downside includes the risk of imported inflation, potentially making it harder for the central bank to maintain interest rates at a record low for an extended period. India relies heavily on imports to meet over two-thirds of its domestic oil needs, and as one of the top importers of edible oils, a weaker rupee could further increase the prices of imported edible oil, leading to higher food inflation.
Distinguishing Currency Appreciation Vs Depreciation And Depreciation Vs Devaluation
In a floating exchange rate system, market forces – demand and supply of a currency – determine the currency’s value. Currency appreciation occurs when one currency increases in value compared to another due to government policy, interest rates, trade balances, or business cycles. This discourages a country’s export activity as its products become more expensive.
On the other hand, if the value of the Indian Rupee is weakened by administrative action, it is termed devaluation. While the processes differ for depreciation and devaluation, the impact is similar.
Factors Leading To The Current Depreciation Of The Indian Rupee
Several factors contribute to the current depreciation of the rupee. A sell-off in the global equity markets triggered by the U.S Federal Reserve’s interest rate hike, war in Europe, and growth concerns in China due to the Covid-19 surge have all contributed to the rupee depreciating. Other factors include the outflow of dollars due to high crude oil prices and a correction in equity markets, and the RBI’s monetary policy tightening steps taken to counter rising inflation.
The Overall Economic Impact of Rupee Depreciation
Rupee depreciation is likely to widen the current account deficit, deplete foreign exchange reserves, and weaken the rupee further. With higher landed costs of crucial imports like crude oil, the economy is slowly moving towards cost-push inflation. This type of inflation occurs when overall price increases are due to wage and raw material cost increases. Consequently, companies may be unable to pass on high cost burdens fully to their consumers, which affects government dividend earnings and raises budgeted fiscal deficit questions.
UPSC Civil Services Examination: Past Questions on Rupee Depreciation
Previous year UPSC examination questions have revolved around measures that the Government/RBI might take to stop the slide of the Indian Rupee. One question posited whether curbing non-essential goods imports and promoting exports; encouraging Indian borrowers to issue Masala Bonds; easing conditions relating to external commercial borrowing; or following an expansionary monetary policy would help control rupee depreciation. Another question considered the effects of a currency’s devaluation.