The Indian rupee recently hit a new low, breaking the Rs. 72.5 per dollar mark. The Reserve Bank of India (RBI) intervened in an attempt to stop this steep decline by injecting dollars into the market, aiming for stabilization. However, India’s currency has emerged as one of the worst performing in major emerging markets in 2018, even considered the most poorly performing in the Asia-Pacific region. Several factors have contributed to this decline, including rising crude oil prices, impending state elections, trade wars between the US and China, and domestic inflation.
Rupee Depreciation: Causes
The rupee’s depreciation can be attributed to several causes. The prices of crude oil have been steadily increasing, resulting in more expensive imports for the country. Coupled with the upcoming state elections, this uncertainty further destabilizes the market. Internationally, the ongoing trade war between the US and China has created ripples in global economy, affecting numerous currencies including the rupee. Additionally, the nation’s macroeconomic fundamentals such as high domestic inflation are also playing a role in its susceptibility to global spillovers.
Depreciation Impact: Expensive Imports
The falling rupee has resulted in an increase in the cost of imports as Indian companies now need to pay more dollars for the same amount of goods. This price increase is especially concerning for essential commodities such as crude oil. A prolonged period of high import costs precipitates inflation and risks depleting forex reserves.
Potential Benefits: Export Growth
Not all effects of currency depreciation are negative. Exporters stand to benefit as they earn more rupees when converting their dollar earnings back into Indian currency. While this could give a boost to the export sector, the overall impact of this benefit may be limited considering that India imports exceed its exports.
Widening Current Account Deficit (CAD)
As the rupee grows weaker, the country’s CAD also expands. A weakening currency makes imports more expensive compared to exports, leading to a wider CAD. This affects the economy’s health and could result in investors pulling out their investments from India, causing further depreciation of the currency.
Government Intervention
The RBI can use sterilization as a measure to check currency volatility, a process in which it removes existing money from the banking system to neutralize new incoming funds. However, the RBI’s interventions to date have been limited. Another proposal by the Finance Ministry involves implementing a Deposit Scheme for Non-Resident Indians to attract more foreign investment into the country.
Possible Outcomes: Interest Rate Hikes
To attract Foreign Portfolio Investors (FPIs), the RBI could potentially increase interest rates. However, this solution has its downfalls. Higher interest rates may deter domestic investment as credit becomes more expensive for Indian companies.
