The currency of India, the Indian Rupee, recorded an approximate depreciation of 10% against the US dollar in 2022. It was also the worst-performing Asian currency during that year. This major dip was primarily driven by the appreciation of the US currency, which has become a safe haven amid fears of a global recession, inflation in numerous parts of the world, and the Russia-Ukraine war.
In 2022, the Indian Rupee hit a lifetime low of 83.2 against the US dollar. However, the depreciation of other Asian currencies like the Chinese Yuan, Philippine Peso, and Indonesian Rupiah was relatively less, around 9%. Others such as South Korean Won and Malaysian Ringgit saw drops of nearly 7% and 6% respectively.
RBI’s Role and the State of Forex Reserves
The Reserve Bank of India (RBI) played a crucial role in this context, heavily intervening in the forex market to protect the Rupee. From the beginning of 2022, India’s foreign exchange reserves came down by USD 70 billion, standing at USD 562.81 billion as of 23rd December 2022. Even though these reserves have undergone erosion, the RBI is taking steps to rebuild them, thereby acting as a buffer during uncertain times.
The Trigger for Capital Outflows
One of the main reasons for capital outflows from India was the aggressive interest rate hike by the US Federal Reserve (Fed) by 425 basis points during 2022 in a bid to combat inflation. This rate differential led investors to withdraw money from the domestic Indian market and invest it in the USA for better returns. In 2022, Foreign Portfolio Investors (FPIs) pulled out a record Rs 1.34 lakh crore from the Indian markets, increasing the pressure on the Rupee. The Russian invasion of Ukraine compounded this situation by triggering more FPI withdrawals.
The Impact of Rupee’s Depreciation on the Indian Economy
While a weaker rupee theoretically boosts India’s exports, global uncertainty and weak demand may prevent higher exports despite the depreciated currency. Additionally, it risks imported inflation and could hinder the central bank’s ability to maintain low interest rates. With India importing over two-thirds of its domestic oil requirements and being one of the leading importers of edible oils, a weaker currency can escalate edible oil prices and trigger a rise in food inflation.
Outlook for the Indian Rupee in 2023
Despite the rupee’s shaky performance and outlook, experts argue that the depreciation may not continue for long because India remains the fastest-growing economy. The expectation of the terminal interest rate for the US Fed has already been factored in, and once the US Fed ends its tightening phase, the situation will likely turn around for the better.
Understanding Currency Appreciation and Depreciation
In a floating exchange rate system, market forces based on a currency’s supply and demand determine its value. Currency appreciation means an increase in the value of one currency concerning another, which can discourage export activity as products get costlier. On the other hand, currency depreciation corresponds to a fall in the currency’s value, which can encourage exports as products get cheaper.
Distinguishing Between Devaluation and Depreciation
The terms devaluation and depreciation are often used interchangeably as both lead to a decrease in the value of a currency, making imports expensive and exports competitive. However, they vary in the way they are applied. A devaluation is a conscious decision made by a country’s central bank to lower its exchange rate in a fixed or semi-fixed exchange rate, whereas depreciation occurs when a currency’s value falls in a floating exchange rate system.
Last Modified: February 19, 2024