[Burning Issue] Free-fall of Rupee and its impact on Indian economy

Why in news?

Recently rupee witnessed a significant depreciation in its value. It’s value against the dollar has fallen by more than 5% since the start of 2018 and the fall is continuing to gain momentum. India is not the only country to face currency depreciation, but also others like Indonesia, Argentina, Mexico, and Turkey.

Causes of depreciation

The U.S. Federal Reserve is expected to tighten its monetary policy stance further through slowing down the growth in U.S. money supply is considered as the main reason. The slowdown in the growth of U.S. money supply affects the value of other currencies in two ways

    1. Interest rates in the U.S. will begin to rise as the Federal Reserve’s demand for different assets begins to decrease. This causes a rush among investors to sell their assets in other countries and invest the money back in the U.S. where they could earn higher returns. The resultant flow of capital from emerging markets to the U.S. rise the selling pressure on emerging market currencies and buying pressure on the dollar.
    2. When the Fed tightens the money supply, the availability of dollars in the global market begins to decrease which increases the demand for dollars among speculative traders and a decrease in demand for other currencies.

Negative Impacts

  1. It keeps the cost of oil imports high. India imports more than 70% of its crude oil requirements. Thus fall in rupee value, means India have to give a higher amount to buy oil from suppliers.
  2. Falling rupee increases current account deficit since import expenditure will be higher than export earnings.
  3. It will increase inflation in the country since the increase in oil import costs would mean higher fuel costs and it will cause pressure on overall economic activity, thus increasing inflation.
  4. The declining rupee would impact corporate revenue due to higher import costs. This would means lower wages or salaries for employees, thus affecting the standard of living.
  5. Fall in rupee value will affect the inflow of foreign investments.
  6. Importers and oil marketing companies are the biggest losers since they import their main raw material, that is, crude oil.

Positive impacts

  1. A cheaper rupee will incentivise Indian companies to export more. It will also help them substitute some of the costlier imported goods in the domestic market with local products. Thus, rupee depreciation can help in developing the manufacturing base of the economy.
  2. Travel to India gets cheaper and the tourism industry may benefit from it.
  3. Indians working abroad can gain more on remitting money to their family in India. Ultimately, this will result in reducing the current account deficit to an extent.

Way forward

  1. To solve the currency problem, Reserve Bank of India (RBI) can influence the value of rupee through effective regulation of money supply through its monetary policy stance.
  2. Benchmark interest rate can be used effectively to attract the foreign capital into the country and in result increasing the value of the currency.
  3. Direct intervention of RBI in the forex market can also help reduce the selling pressure on the rupee

Practice question

  1. What do you understand by the currency depreciation? How does the fall in rupee affect Indian economy? Discuss.

By Explains

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4 years ago

Very useful article!