Explained | Why the Indian Rupee is depreciating

Representational Image
Representational Image

With a depreciation of more than 7 per cent this year, the currency exchange rate is slated to hit the low point of Rs 80 per dollar in India. Some of the key reasons for the currency oscillating from one low point to the other are listed below.

US Fed rate hike

With consumer price inflation surging to a 40-year high in the United States, the country is expected to hike interest rates further. In June, the country had hiked the interest rate by 100 basis points and the US dollar was sent flying to a 20-year high. Interest rates are usually spiked by central banks to lower the consumer demand and rein in inflation.

Inflation of 9.1 per cent in the US, way above the forecast of 8.8 per cent, is likely to catapult the US Federal Reserve on to the path of an aggressive monetary policy ridden with rate hikes. This will be a reversal of the expansionary policy which has been in place in the US since 2020 to revive the pandemic ridden economy.

This hike will affect developing countries like India due to capital outflows towards stronger economies with better returns. Investors tend to borrow from developed economies and invest money in emerging market economies for a higher rate of interest. But an interest hike in the US would make India a less attractive prospect for these investors.

Since spiralling inflation is the norm in most economies, other developed economies like United Kingdom have also adopted a tighter monetary policy in the recent past making India a less safe bet.

Massive FI outflow

The Russia-Ukraine war has affected the Indian economy in myriad ways and foreign investments were the worst hit. Foreign portfolio investors (FPIs) have pulled out more than Rs 2 lakh crore from Indian markets so far. 

The fall in forex reserves has also made it difficult for the RBI to control the depreciation of the rupee.

Crude price and inflation

The Ukraine war has severely affected the oil supply and crude oil prices worldwide. For a country like India, which is heavily dependent on oil imports, this proved to be a severe strain leading to higher inflation.

The annual inflation rate in India rose to 7.8 per cent in April 2022, the highest since May 2014. Burdened by inflationary pressures, the Reserve Bank of India (RBI) was unable to keep interest rates low to retain foreign investors. Unimpressed by India's growth story, outflows continued.

Rising consumer inflation arrested consumer spending and the current account deficit of the country. Driven by an increase in the trade deficit, the CAD stood at 1.2 per cent of GDP in 2021-22.

The falling rupee has expanded India's import bills, raised production cost leading to further rise in inflation.

A depreciated rupee can benefit the Indian economy by boosting exports. But in the current scenario of depressed global demand, it is unlikely to benefit the country.

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