. 14/10/2024 4:34 PM
On October 11, 2024, the Indian rupee closed at 84.07 per US dollar, marking the first time it surpassed the 84 mark, with intraday trading touching a high of 84.10. The depreciation came after the rupee closed at 83.98 the previous day. This record low was influenced by a combination of foreign investor outflows, escalating oil prices, and strong demand for the US dollar from foreign banks. The currency's weakening highlights a convergence of global and domestic factors, impacting various sectors and economic indicators in India.
When reports indicate that the rupee has fallen to a specific level against the US dollar, such as 84, it essentially means that ₹84 is required to purchase one US dollar. In a free-market economy, exchange rates are primarily determined by the supply and demand for the respective currencies. If the demand for dollars exceeds that of the rupee, the rupee weakens while the dollar strengthens. However, in India, the exchange rate is not entirely dictated by market forces alone, as the Reserve Bank of India (RBI) occasionally intervenes in the forex market to curb excessive volatility.
Rising Crude Oil Prices
The increase in oil prices has been a significant factor in the depreciation of the rupee. India imports nearly 80% of its crude oil needs, meaning that higher oil prices increase the cost of imports, widen the trade deficit, and stoke inflationary pressures. Additionally, geopolitical tensions in West Asia contribute to oil market volatility, influencing currency stability.
Foreign Institutional Investor (FII) Outflows
In recent months, FIIs have been withdrawing from Indian equities and debt markets. In October 2024 alone, foreign investors offloaded ₹58,711 crore worth of equities and ₹1,635 crore in debt. This strategy of ‘Sell India, Buy China’ emerged following China's announcement of monetary and fiscal stimulus measures aimed at rejuvenating its slowing economy. The movement of funds away from India has reduced forex inflows, putting further pressure on the rupee.
Increased Demand for the US Dollar
The demand for the US dollar, particularly from foreign banks, has surged. As foreign entities and investors increase their dollar holdings, the rupee faces depreciation due to the heightened demand for the American currency.
Weak Domestic Markets
The performance of India’s stock markets also plays a role. Declining domestic equity markets can discourage investor confidence, leading to capital outflows and reducing support for the rupee. Conversely, any rebound in local markets can offer temporary respite for the currency.
Global Currency Trends and Central Bank Policies
Strengthening of the US dollar in the global market, driven by the Federal Reserve's monetary policy stance and inflation concerns in the US, has also pressured the rupee. As the dollar appreciates against most Asian currencies, the rupee is not immune to the broader regional trend of currency depreciation.
Inflationary Pressures
The most immediate impact of a weaker rupee is on inflation. As India imports a large portion of its crude oil and other commodities, the cost of these imports increases, which can cascade through the economy, raising input costs and consumer prices. With inflation already hovering around 7%, a weaker rupee could exacerbate price rises, making it more challenging for the RBI to manage inflation targets.
Widening Current Account Deficit
Since a significant portion of India's imports, including oil, are denominated in dollars, a depreciating rupee makes these imports costlier. This leads to a wider trade deficit, contributing to a larger current account deficit, which in turn can put further downward pressure on the rupee.
Higher Costs for Imports and Foreign Loans
The depreciation of the rupee increases the cost of imports ranging from essential goods like oil and electronics to luxuries. Additionally, companies with foreign currency loans will face higher repayment costs, potentially affecting corporate profitability.
Impacts on Overseas Education and Travel
For Indian students studying abroad, the falling rupee increases tuition and living expenses, while international travelers face higher costs for foreign travel and purchases.
Positive Aspects: Boost to Remittances and Exporters
On a positive note, remittances from Indians working abroad become more valuable in rupee terms, encouraging more inward remittance flows. Exporters may also benefit as a weaker rupee makes Indian goods more competitively priced in international markets. However, this advantage is offset if exporters rely on imported raw materials, which become costlier.
The Reserve Bank of India has been actively involved in preventing a sharp fall of the rupee by intervening in the forex market. Over the past two months, the RBI has been defending the 84-per-dollar level, evidenced by its intervention on September 12, 2024, when the rupee touched 83.99. The central bank has been selling dollars to increase supply and stabilize the currency. While this helps in the short term, it also reduces foreign exchange reserves.
RBI Selling Dollars to Support the Rupee
By selling a significant amount of dollars, the RBI can temporarily increase the supply of dollars in the market, thereby reducing the pressure on the rupee.
Raising Interest Rates
Increasing interest rates can make Indian assets more attractive to foreign investors, encouraging capital inflows and supporting the rupee. However, this must be balanced against the impact on economic growth.
Removing Reserve Restrictions on Dollar Deposits
Allowing banks to hold higher dollar deposits can reduce the demand pressure on the dollar in the forex market.
Promoting Rupee-Based Trade Settlements
Encouraging the use of the rupee in international trade agreements can reduce dependence on the dollar for trade settlements, thereby lowering demand for the US currency.
Analysts expect the rupee to continue facing volatility in the near term, driven by uncertainties surrounding crude oil prices, FII behavior, and global geopolitical developments. The strength of the US dollar, coupled with the evolving situation in West Asia, will influence the rupee's trajectory. While RBI interventions may prevent a drastic fall, sustained pressure from external factors may make it challenging to maintain stability.
The depreciation of the Indian rupee to a record low against the US dollar is a reflection of complex interdependencies involving domestic economic factors, global currency trends, and geopolitical dynamics. Although there are potential benefits for certain sectors, the broader impact could be an increase in inflation and a widening current account deficit. Effective policy measures, along with timely interventions by the RBI, will be crucial in managing the challenges posed by a weakening currency and in maintaining economic stability.
