The past couple of months have seen a significant decrease in the value of the domestic currency. Specifically, July and August 2019 have been marked by this downwards trend. An immediate consequence of this economic phenomenon might be imported inflation.
Understanding Imported Inflation
In layman’s terms, imported inflation refers to the scenario where a general rise in the price levels within a country is attributed to an increase in the prices of imported commodities.
Key determinants of India’s import structure include items such as crude oil and gold. The prices of these elements play a pivotal role in determining the country’s import bill. Given the current global growth prospectus, the prediction is that crude prices will remain benign. However, higher demand for gold may lead to increased prices.
The depreciation of the domestic currency can potentially contribute to rising inflation as well. Simply put, this means that the cost of imported items in terms of rupees goes up. So, if the Rupee deflates by 20% against its US counterpart within a specific period, the landed rupee cost for an imported product rises by the same percentage. This directly affects the overall price levels and inflation figures.
The Driving Forces behind Current Currency Depreciation
One major factor is the growing risk aversion amongst investors. This has led to widespread losses in the currency values of Emerging Markets (EM). The Rupee, in particular, has taken a hit due to escalated tensions in Kashmir and a repo rate cut by the RBI that was larger than expected.
Your Quick Guide to Currency Depreciation
The term ‘currency depreciation’ signifies a reduction in the value of a country’s currency compared to one or more foreign reference currencies. This typically happens in a floating exchange rate system, where the currency value is determined by market forces.
For instance, if $1 previously equated to Rs.60, but now equals Rs.72, we can say that the Rupee has depreciated in relation to the Dollar. Now, more Rupees are needed for buying a dollar due to changes in supply and demand factors. This makes exports more competitive, while imports get pricier.
This is different from ‘devaluation’, a conscious decision by a country’s government to decrease its exchange rate, usually in a fixed or semi-fixed exchange rate system.
The Differentiation between Fixed and Semi-Fixed Exchange Rates
Fixed exchange rate refers to a situation where the government keeps the value of a currency stable in relation to another currency. A semi-fixed exchange rate, on the other hand, allows for the value of the currency to fluctuate within a narrow band as pre-determined by the government.
Important Facts: Currency Depreciation and Imports
| Fact Category | Key Information |
|---|---|
| Main Imported items of India | Crude Oil and Gold |
| Impact of Currency depreciation | Makes exports more competitive and imports more expensive |
| Current cause for depreciation | Risk aversion amongst investors, Kashmir conflict, RBI’s larger-than-expected repo rate cut |
| Depreciation Vs Devaluation | Depreciation is market-driven; devaluation is government-driven |
Source of Information
The information presented in this article is sourced from Mint, a highly trusted and widely-accessed business news provider.