GS Paper 3
Syllabus: Indian Economy and related issues
Source: IE
Direction: The article highlights the reasons behind the depreciation of the Indian Rupee and presents an outlook for 2023.
Context: The Indian rupee depreciated by around 10% against the US dollar in 2022.
Depreciation reduces the value of a country’s currency when compared with the currency of other countries (say $), measured by the exchange rate of the local currency (wrt $)
The performance of the Indian rupee in 2022:
Worst-performing Asian currency in 2022:
- It witnessed a fall of around 10% against the US dollar, falling to a lifetime low of 83.2 the dollar.
- Compared to the rupee, the Chinese Yuan, Philippine Peso and Indonesian Rupiah fell by around 9% and the South Korean Won and Malaysian Ringgit declined by nearly 7 and 6%, respectively.
Reason for this decline in India:
- The US Fed aggressively raised interest rates (by 425 basis points (bps) in 2022) in its fight against inflation, leading to a higher interest rate differential between the US and India
- As a result, investors pulled out money from the domestic market and started investing in the US market to take advantage of higher rates.
- For example, foreign portfolio investors (FPIs) pulled out Rs 1.34 lakh crore from the Indian markets in 2022, putting pressure on the rupee.
- The Russian invasion of Ukraine accentuated the FPI withdrawals with the global economic slowdown making inflows tougher.
Steps taken to arrest this decline:
- The Reserve Bank of India (RBI) heavily intervened in the foreign exchange (forex) market to defend the rupee.
- As a result, the country’s forex reserves have fallen by $70 billion ($562.81 billion as of December 23, 2022) since the beginning of 2022.
- However, the central bank is now starting to again build up its reserves and that would act as a buffer in times of uncertainty.
The outlook on the rupee for 2023: India remains the fastest-growing economy and Indian Rupee will recover
Insta Links:
Why is it essential to contain domestic inflation?
Mains Links:
Q. How would the recent phenomena of protectionism and currency manipulations in world trade affect the macroeconomic stability of India? (UPSC 2018)
Prelims Links: (UPSC 2022)
With reference to the Indian economy, consider the following statements:
- An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of the rupee.
- An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
- An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.
Which of the above statements is/are correct?
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- 1 and 2 only
- 2 and 3 only
- 1 and 3 only
- 1, 2 and 3
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Ans: 3
Explanation: An increase in the Real Effective Exchange Rate (REER) indicates a loss in trade competitiveness. An increase in the REER implies that exports become more expensive and imports become cheaper.
