The free fall of the rupee

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The free fall of the rupee

  • Indian rupee hit an all-time low at 79.05 against U.S. dollar and will weaken further
  • IMF expects rupee to weaken past 94 rupees to dollar mark by FY29.

What is happening with the rupee?

  • Indian rupee is witnessing a steady decline this year against U.S. dollar.
  • India’s forex reserves have dropped below $600 billion.
  • Reason:
    • Due to steps taken by RBI to support rupee.
    • Fall in dollar value of assets held as reserves by RBI.

Policy of RBI

  • It has tried to smoothen fall in exchange value.
  • Aim: allow rupee to find its natural value in market without volatility or causing panic among investors.
  • State-run banks are instructed to sell dollars to support rupees.
  • By selling dollars in open market in exchange for rupees, RBI can improve demand for rupees and cushion its fall.

What determines the rupee's value?

  • Value of any currency is determined by its demand and supply.
  • When supply increases, its value drops.
  • When demand increases, its value rises.
  • Central banks determine the supply of currencies.
  • Demand depends on the amount of goods and services produced in the economy.
  • In forex market:
  • Supply is determined by demand for imports and foreign assets.
  • Demand depends on foreign demand for Indian exports and other domestic assets.

Reasons for loss in value of Rupee

  • Rising benchmark interest rate. by U.S. Federal Reserve:
  • Investors seeking higher returns are pulling capital away from emerging markets such as India putting pressure on their currencies.
  • High Current account deficit:
  • Expected to hit 10-year high of 3.3% of GDP in current financial year.
  • India’s import demand amid rising global oil prices will negatively affect rupee.
  • Higher domestic price inflation:
  • RBI has been creating rupees at a faster rate than U.S. Federal Reserve has been creating dollars.

Way ahead

  • Rupee will continue to depreciate against dollar because of differences in long-run inflation between India and U.S.
  • As U.S. Federal Reserve raises rates to tackle high inflation, emerging markets will raise their own interest rates to avoid disruptive capital outflows and to protect their currencies.
  • As interest rates rise across the globe, threat of a global recession also rises as economies readjust to tighter monetary conditions.