- Prelims: Indian Economy, Interest rate, IMF, RBI etc
- Mains GS Paper III: Fiscal policy, Monetary policy, Impact of free fall of the rupee.
- The Indian rupee has depreciated by around 7% against the U.S. dollar, since the start of the year, in response to various domestic and global factors.
- Specifically, a widening current account deficit, persistent risk-off sentiment as a result of geopolitical tensions, ‘a strengthening dollar index, and continuous sell-off by foreign portfolio investors have all put pressure on the rupee’.
- In fact, the International Monetary Fund (IMF) expects the rupee to weaken past the 94 rupees to a dollar markby FY29.
INSIGHTS ON THE ISSUE
- Currency depreciation is a fall in the value of a currency in a floating exchange rate system.
- Rupee depreciation means that the rupee has become less valuable with respect to the dollar.
- It means that the rupee is now weaker than what it used to be earlier.
- For example: USD 1 used to equal to Rs. 70, now USD 1 is equal to Rs. 77, implying that the rupee has depreciated relative to the dollar i.e. it takes more rupees to purchase a dollar.
Impact of Depreciation of Indian Rupee:
- Depreciation in rupee is a double-edged sword for the Reserve Bank of India.
- Boost to India’s exports: Weaker rupee should theoretically give a boost to India’s exports, but in an environment of uncertainty and weak global demand, a fall in the external value of rupee may not translate into higher exports.
- Risk of imported inflation: It poses risk of imported inflation, and may make it difficult for the central bank to maintain interest rates at a record low for longer.
- Dependence on oil imports: India meets more than two-thirds of its domestic oil requirements through imports.
- Edible oil imports: India is also one of the top importers of edible oils. A weaker currency will further escalate imported edible oil prices and lead to a higher food inflation.
Reasons that led to slump in Indian rupee:
- Geopolitical risks: Uncertain global conditions have triggered a risk appetite for the weakening of rupee.
- In fact, the rupee has been under significant pressure ever since the disturbance of geopolitical situations owing to Russia’s invasion of Ukraine.
- With crude oil prices soaring to record highs in wake of supply restrictions, India, which is the third largest importer of oil in the world, witnessed a significant rise in its import bill.
- Rising bond yields: India’s 10-year benchmark bond ended at a high of Rs 93.69 last month, yielding 7.46 percent after reaching a high of 7.49 percent earlier.
- The government has now asked RBI to either buy back the bonds or conduct open market operations to cool yields that have hit their highest since 2019.
- Inflation concerns: Russia’s invasion of Ukraine, combined with renewed Covid-19 lockdowns in China, have exacerbated inflationary pressures.
- The Fed’s policy committee last week raised the key rate by a half point, the biggest hike since 2000, and said more big increases were likely.
- Low forex reserves: India’s foreign exchange reserves have slumped below the $600 billion mark for the first time in almost a year.
- FIIs continue to withdraw funds: Foreign investors have been net sellers in the domestic equity markets since the past 7 months now.
- Heavy bouts of selling by the foreign investors are usually a sign of weakening of the rupee against the dollar.
Effects of a weak rupee:
- Positive impact on India’s exports: The concomitant depreciation of currencies of some of India’s competitors such as South Korea, Malaysia and Bangladesh against the dollar, along with a high import intensity of some of its key export segments (petroleum, gems and jewellery and electronics), is likely to have a positive impact on India’s exports.
- Boost for domestic demand: Exports become cheaper, more competitive to foreign buyers. Therefore, this provides a boost for domestic demand.
- Travel to India gets cheaper: It will eventually benefit the local industry.
- More remittances: Those working abroad can gain more on remitting money to their homeland.
- Ultimately, it assists in reducing the current account deficit
- Incentivise Indian companies: A cheaper rupee will incentivise Indian companies to export more besides helping them substitute some of the costlier imported goods in the domestic market with local products.
- Better yield on foreign investment: Foreign investment both through the secondary market and direct investment into sectors which are relatively sheltered from a weak currency can yield better returns over the long run.
- A stronger dollar would give the investor more rupees in his hand and thus an opportunity to buy more shares.
- Destination for medical tourism and others: Though India does not attract the masseuse, a weak currency can make the destination attractive for in-bound traffic. Medical tourism can get a shot in the arm.
- Boost to Indian companies abroad: A number of Indian companies now have sizable international presence apart from direct exports. A stronger foreign currency helps boost their consolidated numbers
- Indirect shelter on account of a weak currency: Import substitutable products get an indirect shelter on account of a weak currency.
- Metals, especially steel, were affected by imports from other Asian countries, but a weak rupee has increased the landed price of these products.
- A number of sectors and companies that price their products on import parity basis will benefit.
- Spending decisions of households: The falling rupee is most likely to impact spending decisions of households as certain things may become expensive.
- Push up in the price of importing goods: For imports, payments are made in terms of dollars. A depreciating rupee would push up the price of importing goods.
- Rise in oil prices: Oil prices may rise further since India imports a major chunk of its oil needs.
- Short term inflation: Other imported items like luxury cars, car components or even products that require parts to be imported from abroad like mobile phones and appliances may also become expensive. Thus, it might add to the overall inflation in the short-term.
- Rising interest rates: The Reserve Bank has already started undertaking measures to tame inflation. Further hikes in policy repo rates would push up interest costs further. The banks will start raising their lending rates, thereby requiring people to pay higher EMIs on their loans.
- Students face hike in fee: For people looking to study abroad during this time, the fee amount will rise as a dollar would now cost more in terms of rupee than earlier. Prospective students or even existing ones may face a hike in their spending.
- Sending more in terms of rupee: In terms of remittances, or the money that people residing abroad send to their families back home in India, it would cost more as they will end up sending more in terms of rupee.
- Spending higher on abroad travels: Another major impact of the falling rupee might be felt on the tourism sector. With summer holidays round the corner and Covid-19 cases remaining in control, many people would want to resume their abroad travel plans. Such people might end up spending much higher than they would have a few days back.
What determines the rupee’s value?
The RBI’s measures:
Apart from intervening in the forex market to arrest the fall in the rupee’s value, the RBI announced a slew of measures recently to liberalize foreign inflows into the country and make them more attractive.
- Measures taken:
- Promoting trade settlements between India and other countries in rupee terms
- Offering higher interest rates on fresh Foreign Currency Non-Resident (Bank) and Non-Resident External deposits
- A widening of investable universe of government and corporate debt
- A relaxation of the interest rate and amount ceiling for External Commercial Borrowing loans, among others, have contributed to arresting the rupee’s slide against the greenback.
|Appreciation Vs Depreciation:
● In a floating exchange rate system, market forces (based on demand and supply of a currency) determine the value of a currency.
● Currency Appreciation: It is an increase in the value of one currency in relation to another currency.
● Currencies appreciate against each other for a variety of reasons, including government policy, interest rates, trade balances and business cycles.
● Currency appreciation discourages a country’s export activity as its products and services become costlier to buy.
Financial Action Task Force(FATF)
● An inter-governmental body established in 1989 during the G7 Summit in Paris.
● It assesses the strength of a country’s anti-money laundering and anti-terror financing frameworks.
● It sets standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system.
● Its Secretariat is located at the Organization for Economic Cooperation and Development (OECD) headquarters in Paris.
● The FATF currently has 39 members including two regional organizations – the European Commission and Gulf Cooperation Council.
● India is a member of the FATF.
- RBI’s interventions in the spot and forward foreign exchange markets: The Reserve Bank of India (RBI) has stepped in to arrest a large depreciation in the currency, with interventions in the spot and forward foreign exchange markets.
- Consequently, India’s foreign exchange reserves have moderated by almost $55 billion from a high of $635 billion seen this year.
- Confidence to investors: A continuously sliding exchange rate discourages foreign investors from making fresh investments, which keep losing value in dollar terms.
- For this reason, it is ideal to provide confidence to investors by arresting a continuous slide in the exchange rate.
- Of course, any target should be avoided, as global forces remain fluid and market forces should be allowed to play.
- Government encouragement: The Government could encourage some of the large market cap companies (private and public sectors) to be included in the major global indices such as MSCI and FTSE.
- This will help increase the weight of Indian equities in these indices, compensating for foreign portfolio outflows to some extent as investors are unlikely to be underweight on India.
- India’s entry into bond indices: The Government could also expedite India’s entry into bond indices such as J.P. Morgan’s Emerging-Market Bond Index and Barclays Global Bond Index.
- This will not only lead to forex inflows but also have a benign impact on interest rates.
- Mitigating measures to arrest the slide: Overall, even as the rupee is expected to remain under pressure in the near term because of global uncertainty, high commodity prices and rising U.S. interest rates, mitigating measures have to be taken to partly arrest the slide.
- The maintenance of the U.S.-India interest rate differential along with timely forex market interventions by the central bank to manage volatility will prove to be salutary in preserving the rupee value against the greenback.
QUESTION FOR PRACTICE
- How would the recent phenomena of protectionism and currency manipulations in world trade affect macroeconomic stability of India?(UPSC 2018)
(200 WORDS, 10 MARKS)
- Even as the rupee has fallen sharply against the dollar, the depreciation has been relatively lower unlike previous times. Discuss
(200 WORDS, 10 MARKS)