Context
Recently, the Indian Rupee hit a historic low, crossing the ₹94.80 per US Dollar mark on March 31. This slump is primarily attributed to a widening trade deficit and escalating energy prices triggered by geopolitical tensions in West Asia. The currency has witnessed a significant decline this fiscal year, prompting the Reserve Bank of India (RBI) to intervene in the foreign exchange market to curb excessive volatility.
1. Defining Rupee Depreciation
Rupee depreciation refers to the fall in the value of the Indian Rupee in terms of a foreign currency (usually the US Dollar) in a Floating Exchange Rate System.
- Market-Driven: It occurs due to the market forces of demand and supply. If the demand for Dollars exceeds the supply of Dollars in the Indian market, the Rupee weakens.
- Depreciation vs. Devaluation:
- Depreciation: Happens in a market-determined system.
- Devaluation: A deliberate downward adjustment of the official exchange rate by the Government or Central Bank in a Fixed Exchange Rate System.
2. Major Causes of Depreciation
The current trend is driven by a combination of domestic and global factors:
- Surging Crude Oil Prices: India imports over 80% of its crude oil. Higher oil prices increase the demand for Dollars to pay for these imports, weakening the Rupee.
- US Federal Reserve Policy: When the US Fed raises interest rates, investors pull capital out of emerging markets like India (Foreign Portfolio Investment outflows) to seek higher, safer returns in the US.
- Trade Deficit: A persistent gap where imports exceed exports leads to a higher outflow of foreign currency.
- Safe-Haven Demand: During global geopolitical crises, investors flock to the “safe” US Dollar, causing it to strengthen against all other currencies (DXY Index rise).
3. Impact on the Indian Economy
The effects of a weaker Rupee are a double-edged sword:
| Impact Area | Effect of Depreciation |
| Imports | Become more expensive. This leads to “Imported Inflation” as prices of oil, electronics, and fertilizers rise. |
| Exports | Become more competitive (cheaper) in the international market, potentially benefiting IT, Textiles, and Pharma sectors. |
| External Debt | Indian companies with External Commercial Borrowings (ECBs) find it harder to repay as they must shell out more Rupees for every Dollar owed. |
| Remittances | Non-Resident Indians (NRIs) sending money home see their foreign earnings converted into more Rupees, benefiting recipient families. |
| Current Account | Initially, the Current Account Deficit (CAD) may widen due to higher import bills. |
5. RBI’s Role in Management
- India follows a “Managed Float” system. The RBI does not target a specific level for the Rupee but intervenes to prevent “wild swings.”
- Forex Intervention: RBI sells Dollars from its reserves and buys Rupees to suck out excess supply.
- Monetary Policy: Raising interest rates can make Indian bonds more attractive to foreign investors, encouraging capital inflows.
- Easing Inflows: Relaxing norms for ECBs and NRI deposits to bring more Dollars into the economy.
Q. With reference to the Indian economy, consider the following statements regarding the depreciation of the Rupee:
1. A persistent depreciation of the Rupee generally leads to a decrease in the burden of External Commercial Borrowings for Indian corporates.
2. If the Real Effective Exchange Rate (REER) of the Rupee is increasing, it indicates that India's exports are becoming more price-competitive.
3. The Reserve Bank of India typically intervenes in the forex market by buying Dollars when the Rupee is depreciating rapidly.
4. Depreciation of the currency can lead to 'Imported Inflation' particularly in a country that is a net importer of essential commodities.
How many of the statements given above are correct?
(a) Only one
(b) Only two
(c) Only three
(d) All four
Correct Answer: (a) Only one
Solution:
• STATEMENT 1 IS INCORRECT: Depreciation increases the burden of ECBs because companies have to pay more Rupees to service the same amount of Dollar debt.
• STATEMENT 2 IS INCORRECT: An increasing REER implies that the currency is becoming overvalued relative to trading partners, making exports less competitive.
• STATEMENT 3 IS INCORRECT: To support a depreciating Rupee, the RBI sells Dollars (to increase Dollar supply) and buys Rupees. Buying Dollars would further weaken the Rupee.
• STATEMENT 4 IS CORRECT: This is the standard definition of imported inflation; as the Rupee weakens, the cost of importing essentials like crude oil rises, pushing up domestic price levels.
