Rupee Depreciation- Why Rupee is Depreciating?

Rupee Depreciation: Everybody talks about this subject in recent times. We are experiencing a tough time with Rupee depreciation every day. RBI is trying to arrest the fall, but the effect is very small. Let us analyze the effect of Rupee depreciation:

How the Rupee depreciation against the Dollar is calculated?

Let’s replace rupee with potatoes. Today, one US dollar can buy 45 potatoes. Next week, 1 US dollar can buy 52 potatoes. Does this mean that potatoes have become cheaper, since you can buy more potatoes for the same one US dollar?  No, it does not mean that potatoes have become cheaper.It means that potatoes have depreciated in value.

The same is true for the Rupee. When one US dollar can buy 45 rupees today and 52 rupees next week, it means that the value of the rupee has depreciated.

Rupee Depreciation

The past year has been disastrous for the rupee value against the dollar. The value of rupee against dollar has moved from 45 during August 2011, to almost 55 in November 2012. As per the experts, the Rupee will be volatile for some more time.  This kind of increase in dollar value will have a drastic impact on the economy of a country like India, which depends too much on oil and other raw material imports.

How the currency value is decided?

There are many economic factors, which decides the value of a currency. A currency will tend to become more valuable when its demand is higher than supply. Exchange rates are expressed as a comparison of two currencies and it is always relative. Interest rates, rate of inflation and exchange rates are correlated.

What are the main reasons for Rupee depreciation now?

Volatile Stock Market

When the economy is performing well and the stock market is performing better than other countries, overseas investors will become heavy investors here. It is a known fact that Indian stock market is dominated by overseas investors. To invest here, they need Rupee. This will increase the demand for Rupee and will result in higher value for rupee. On the other hand, when these investors are pulling out money from the Indian stock markets, Rupee will be depreciated. Indian market is in a bad shape for the last 2 years. The sentiments after the US downgrade and the European crisis etc. resulted in overseas investors selling rupee,buying dollars and the resultant effect was rupee depreciation.

In a bad performing market, when there is a depreciation in rupee, it will bring down the overseas investors real returns. So they will start selling, which will again worsen the situation.

The dollar is still the safest paper currency in the world! So, there is more demand for dollar in volatile condition like this. This will add to the rupee depreciation.

High Gold Prices

Very high prices of gold have created a panic among investors and fearing a bubble there, investors started moving towards dollar. This demand for dollar is also causing depreciation of rupee.

Inflation causing Rupee Depreciation

Another reason affecting the currency value is inflation. We are experiencing very high inflation now. This will decrease the purchasing power of Rupee against other currencies which will lead to rupee depreciation. 

Current Account Deficit

A current account deficit occurs when a country’s total import exceeds the total exports. This makes the country, a net debtor to the rest of the world. This is not good for the country because, the country needs to buy more foreign currency. More demand for the foreign currency will cut the value of that country’s currency. India’s current account deficit now is more than the projected level and this also contributes to the depreciation of the Indian rupee.

Political paralysis – A major reason for Rupee Depreciation

The Parliament is unable to transact any meaningful business and reforms occupy a back seat. Coalition politics make things difficult for the government to push the much-needed reforms in many sectors. This is creating a panic among overseas investors who want to invest in India.

Why and how RBI controls the Exchange Rate?

RBI will interfere in this area because a steady value of rupee is essential for the orderly growth of the economy. A depreciating rupee will harm all import oriented businesses. This may help the exporters, who get their payment in dollars.

RBI will be watching the developments and interfere to stabilize the currency value. In case of depreciation, RBI will sell foreign currency from the reserve and this will help in arresting the fall of rupee to some extent.

But there is a limit for RBI action, until the government is able to take some strong action on reforms.

Does Rupee depreciation affect us in any way? What is your view on Rupee depreciation?

Rupee Depreciation- A depreciating rupee is an opportunity, not weakness


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