• Reason behind steep Indian Rupee Depreciation

    Indian Rupee has depreciated nearly 18% in last 4 months and touched the record low level of 53.50 INR per USD amid the current crisis time which has made Indian Currency as the worst performer among all the emerging economies. The Indian Rupee exchange rate against USD is shown in the below graph.

    Indian Rupee movement against USD

    The economists expect Indian Rupee to slide further until the macro-economic condition improves and euro zone debt crisis is resolved soon.

    Here in this article we will try to analyze the reasons behind this steep depreciation of Indian Rupee… Before doing the same we will first check why a currency is depreciated against another currency…

    Currency exchange rate is determined by Demand-Supply (most famous economics term) if it is not regulated by the Government. Chinese government regulates its own currency and thus controls its movement, but for India it is totally the Demand-Supply which determines the value of currency. We mainly specify exchange rate in terms of USD as it is the mostly used and reserves currency in the world. Currency exchange rate INR 45 per USD means we need INR 45 to buy 1 USD. So if the Indian Rupee depreciates or USD appreciates we will spend more INR to buy one USD (suppose INR 47 per USD) and if the Indian Rupee appreciates we will spend less INR to buy one USD (Suppose INR 42 per USD).

    This is completely controlled by the Demand-Supply of USD in the domestic currency market. If there is more supply of USD in the market, then USD will depreciate and INR will appreciate (as per demand supply rule of basic Economics knowledge). On the contrary if there is less supply of USD in the market then USD will appreciate and INR will depreciate…  In last 4 months, Indian currency or INR has depreciated more than 18%, which implies deep shortage of USD in the domestic currency market.

    If the logic behind Indian Rupee depreciation is clear here, we will now check the reasons behind low supply of USD in the domestic currency market. These reasons are sufficient to explain the steep INR depreciation.

    1. Current euro zone debt crisis which is worsening day by day by more credit rating downgrades and lower economic and industrial growth. Because of the uncertainty of the global economy the investors are pulling out their investment from the riskier markets like India and investing them in USD and Gold etc. Even the Euro has been depreciating due uncertain future and only USD is gaining out of it. Pulling out invested fund from the country has reduced the supply of USD in the domestic market. Among all the reasons, this is the most important reason behind INR depreciation which out of RBI’s control.
    2. Second reason should be internal macroeconomic problems. India’s internal growth story is struggling with high inflation, high interest rate and lower economic growth. Lower economic growth and high interest rate have reduced the demand for local currency in the domestic market. Rather than investing in new projects due to uncertainty and high interest rate, domestic investors and companies prefer to hold the cash for time being. Lower INR demand has increased the supply of local currency in the domestic market, leading to steep Rupee depreciation.
    3. Third reason should be lower foreign cash inflow in the domestic stock market. Lower sentiment and global economic uncertainty have led to steep correction in the stock market (nearly 20%). Foreign investors have invested less than USD 1 billion this year compared to USD 29 billion in last year. This negligible foreign cash inflow has kept the USD supply in the domestic market very low throughout the whole year. This can only be compensated by higher FDI in the country which is also being affected by lower confidence level and political deadlock in attracting new FDI.
    4. Fourth reason will be high USD demand by the oil importing companies. India imports more than 2/3rd of its total crude oil demand and all the state run oil marketing companies pay the massive import bill using US Dollar. Due to recent Indian Rupee devaluation, Oil marketing companies are buying extra US dollar in the domestic money market. Extra buying has reduced the USD supply in the domestic market significantly.

    Because of all these reasons, there is a huge scarcity of USD in the domestic money market which has led to steep Indian Rupee depreciation in recent times. With worsening euro zone debt crisis and global economic condition blended with adverse domestic macro-economic condition, Indian Rupee is expected to continue its slide in the immediate future as well. RBI is least expected to intervene much amid falling forex reserves during this crisis time.

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