The Indian Rupee recently hit a nine-month low, depreciating to 75.4 against the US dollar. This represents one of the most significant drops among emerging market currencies, with the rupee losing 4.2% against the USD in the three weeks following March 22nd, 2021.
Underlying Reasons for the Indian Rupee’s Decline
There are numerous factors that have led to the fall of the Indian Rupee. The surge in Covid-19 cases has surfaced as a major concern. The consideration of stricter lockdown measures by several states has investors worried about a delay in economic recovery. Notably, the economy suffered greatly during the pandemic in 2020-21.
A strengthening USD is also adding pressure on the Rupee. Improved growth prospects for the US economy are supporting the rise of the USD.
The Reserve Bank of India’s (RBI’s) Government Securities Acquisition Programme (G-SAP) announcement is another force exerting additional pressure on the Rupee. The G-SAP intends to infuse liquidity into the market. This action has been interpreted as a type of quantitative easing policy. With this, the RBI is set to back the government’s elevated borrowing program through the infusion of liquidity.
The declining support provided by the Foreign Portfolio Investors (FPIs) also puts extra pressure on the Rupee. While FPIs invested a net amount of Rs. 1.94 lakh crore in the Indian markets between October 2020 and February 2021, they have reportedly withdrawn Rs 2,263 crore in April 2021 alone.
The Consequences of a Depreciating Rupee
A falling Rupee has differing impacts on different segments of the population. Losers in this scenario include individuals importing goods from overseas and those seeking foreign education or medical treatment abroad. Other affected groups include those traveling or investing overseas.
On the other hand, some people benefit from a depreciating Rupee. This includes those exporting from India, and people receiving remittances from Non Resident Indians (NRIs). Foreign tourists are also gainers as their travel to India becomes less expensive owing to the falling Rupee.
Understanding Currency Depreciation
Currency depreciation refers to the fall in the value of a currency in a floating exchange rate system. Demand and supply dynamics determine the value of a currency in such a system. When the Rupee depreciates, it becomes less valuable compared to the dollar, meaning it takes more Rupees to purchase a dollar.
Factors influencing the value of a currency include inflation, interest rates, trade deficit, macroeconomic policies, and equity market conditions.
A depreciated currency can boost a nation’s export activity as its products and services become cheaper for international buyers. To counteract a weak domestic currency, the Reserve Bank of India (RBI) intervenes in the currency market to bolster the Rupee and manage the country’s import bill.
There are several methods by which the RBI can intervene. These include direct intervention in the currency market through buying and selling dollars, or indirectly via monetary policy adjustments. For instance, changing the repo rate or adjusting the liquidity ratio can help control the value of the Rupee.