Depreciation of Rupee

In News

• The Indian Rupee has depreciated 3.5 percent against the US dollar in 2022. In this past month alone, the Rupee has depreciated by over 1.2%. 
  • The depreciation is expected to impact the economy in general and various segments such as imports, mainly fuel prices, and push up inflation.

Reason for Rupee Falling

• Russia-Ukraine War: 
  • Since the time Russia invaded Ukraine, the rupee has depreciated about 4 percent while currencies in other emerging markets have depreciated 4-7%. 
• Rise in dollar index: 
  • The rupee has been hitting fresh all-time lows of late due to a rise in the dollar index and concerns around global economic growth.
  • The weak economic data around the world, especially in China, has put pressure on the dollar index, which hit a nearly two-decade high. 
• Rising interest rates: 
  • Higher interest rates can discourage new investment, encourage saving, and consequently dampen output and inflation. 
  • A rise in interest rates in the US will result in further outflows.
• Exit of foreign investors: 
  • A depreciation in the rupee is never good for the overall equity market. It may affect foreign investors pulling out of Indian markets, resulting in a decline in stocks and equity mutual fund investments.
  • Domestically, the country is witnessing an outflow of funds as investors move funds to high-yielding investment instruments. 
  • Investors are worried about the exit of the foreign investors and its impact on the rupee’s decline.

Impact of  Rupee Falling

• Negative: 
  • Rising import costs and a growing current account deficit: 
    • They have been key reasons for the weakening of the rupee. 
    • India’s merchandise trade deficit widened to $20.1 billion in April.
  • Rising inflation: The jump in Brent crude oil prices to 14-year highs and the ongoing conflict in Ukraine triggered the recent fall. 
  • Plunging markets: The US Federal Reserve’s decision to tighten the monetary policy and hike interest rates has led foreign portfolio investors (FPI) to pull out Rs 168,000 crore since January 2022.
  • Costly oil: 
    • Oil and other imported components will get costlier, which will further lead to even higher inflation. 
    • India imports nearly 80% of its fuel requirements. 
  • Sectors most affected: Auto, real estate, and infrastructure sectors would be worst hit whereas IT and banks will be impacted positively.
  • Students abroad: Travellers and students studying abroad will have to shell out more rupees to buy dollars from banks.

• Positive: 
  • Export: A strong dollar is good for export-oriented companies, but bad for import-oriented industries like oil, gas and chemicals. 
    • It is also bad for companies which pay foreign companies royalties for franchises in India
    • Exporters may benefit as the depreciation in currency improves the competitiveness of Indian goods and services. 
    • However, since most of the competing currencies are also depreciating against the US dollar, the benefit could be limited. 

How to Reduce the Impact?

• Hedging is the only way for importers to protect themselves, but the rising cost of hedging limits this protection. The hedging cost is around 4%. 
  • One should check the forward cost and only if it’s less than the depreciation in currency does it make sense.
• Exporters would benefit only if they enhance their efficiency and reduce their production cost, improving their competitiveness vis-a-vis exporters from competing countries.

Will the Rupee fall further?

• The currency is expected to face pressure as inflation is on an upward spiral, raising concerns about further rate action by the central bank. 
• Persistent FPI outflows are also expected to weigh on the currency. 
• The US dollar is expected to remain strong amid risk aversion in the global market. 
• Additionally, the outlook for the global economy is looking gloomy amid supply chain disruptions, the lockdown in China, and the war in Ukraine, which are expected to keep the safe-haven dollar in demand.
• So, the rupee is expected to remain under pressure amid a strong dollar and elevating inflationary pressure in India. 

Conclusion

• Relief is possible only if the dollar index cools off. 
• Hence, the rupee can be seen as weak till the time it’s below 76.50 and it can touch 78 in the coming sessions, which might create fresh short unwinding in the dollar, making the rupee even weaker.

Source: IE