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Currency Depreciation

GS Paper 3

Syllabus: Indian Economy and related issues


Source: livemint

Direction: This article is in the continuation of yesterday’s article on Oil and the Dollar.


Context: Out of 34 currencies tracked by The Economist every week only four currencies – issued by Russia, Brazil, Mexico and Peru – have appreciated against the US dollar since October 2021. The Indian rupee depreciated by more than 10%.


What Is Currency Depreciation?

Currency depreciation is a fall in the value of a currency in terms of its exchange rate versus other currencies.

Orderly currency depreciation can increase a country’s export activity as its products and services become cheaper to buy. However, Currency depreciation in one country can spread to other countries.


Factors affecting Indian Currency depreciation:

  • Structure of trade: India being the net importer of commodities, the price of its import basket has risen more than the price of its export basket, or a negative terms-of-trade shock. This has led to more dollars going out and thus currency depreciating.
  • The state of the Current Account Balance (CAD): Countries that have CAD are less likely to experience a sudden outflow of foreign money. India has a wide current account deficit right now (of about $120bn).
  • Foreign exchange reserves: As the currency depreciates, RBI has to pump more dollars into the market to stabilize it. This reduces the forex reserve.
  • The extent of borrowing: Since external debt has to be paid in dollars, it means dollars will go out of the country with higher external debt. Thus depreciating currency further. Indian government borrowed close to $10bn from multi-lateral agencies in FY 21.

Way forward: 

India still has adequate foreign exchange reserves in terms of standard metrics such as import cover, foreign debt that is due within a year and the stock of broad money. However, the substantial fall in foreign exchange means that the exchange rate will have to play a bigger role in economic adjustment.


What Is the Current Account Balance?

The current account balance (CAB) is part of a country’s financial inflow and outflow record. It is part of the balance of payments, the statement of all transactions made between one country and another.

The balance of payments (BOP) is the place where countries record their monetary transactions with the rest of the world.


Mains question:

Q. Examining the current account balance of a country’s BOP can provide a good idea of its economic activity. Discuss.