Explainer | free fall of rupee

the story So Far: The Indian rupee hit an all-time low against the US dollar this week and on Wednesday weakened to a level of 79 against the dollar and sold at 79.05 against the dollar. Many analysts believe that the rupee will weaken further in the coming months and cross 80 to reach the dollar mark. In fact, the International Monetary Fund (IMF) expects the rupee to weaken from Rs 94 to the dollar level by FY29.

What’s up with Rs.

The Indian rupee has seen a steady decline this year, having depreciated over 6% against the US dollar since the beginning of 2022. India’s foreign exchange reserves have also gone below $600 billion, having fallen by over $50 billion since September 3, 2021. Foreign exchange reserves remained at an all-time high of $642 billion. The fall in India’s forex reserves is believed to be mainly due to the steps taken by the Reserve Bank of India to support the rupee. However, RBI officials have noted that the fall in foreign exchange reserves is due to a fall in the dollar value of assets held as reserves by the RBI. For example, if a part of the reserves is in euros and the euro depreciates against the dollar, this will lead to a fall in the value of foreign exchange reserves.

It should be noted that, as a matter of policy, the Indian central bank has generally tried to slow or smooth rather than reverse or halt the decline in the exchange value of the rupee against the US dollar. RBI’s policy aims to allow the rupee to find its natural value in the market, but without undue volatility or creating unnecessary panic among investors. State-run banks are usually instructed by the RBI to sell dollars to give some support to the rupee.

Thus by selling dollars in the open market against the rupee, the RBI can improve the demand for the rupee and reduce its fall.

What determines the value of Rs.

The value of any currency is determined by the demand as well as its supply. When the supply of a currency increases, its value falls. On the other hand, when the demand for a currency increases, its value increases. In the broader economy, central banks determine the supply of currencies, while the demand for currencies depends on the amount of goods and services produced in the economy.

In the foreign exchange market, the supply of the rupee is determined by imports and demand for various foreign assets. Therefore, if there is a high demand for importing oil, it may lead to an increase in the supply of the rupee in the foreign exchange market and a fall in the value of the rupee. On the other hand, the demand for rupee in the foreign exchange market depends on the foreign demand for Indian exports and other domestic assets. So, for example, when there is great enthusiasm among foreign investors to invest in India, it may increase the supply of dollars in the foreign exchange market thereby increasing the value of the rupee against the dollar.

What is the reason for the fall in the value of Rupee against Dollar?

Since March this year, the US Federal Reserve has been raising its benchmark interest rate, prompting investors looking for higher returns to pull capital from emerging markets like India and back to the US. So far this year, it has declined significantly against the US dollar. Even developed market currencies such as the euro and yen have depreciated against the dollar and the dollar index is up more than 9% so far this year. In fact, some analysts believe that RBI’s surprise decision to raise rates in May may be to protect the rupee by preventing any rapid outflow of capital from India. In 2013, the rupee fell 15% against the dollar in nearly three months after the US Federal Reserve’s decision to cut its bond buying program scared investors, which had helped keep long-term interest rates low.

Further, India’s current account deficit, which measures the difference between the value of imports and exports of goods and services, is expected to hit a 10-year high of 3.3% of GDP in the current fiscal. This means that India’s import demand amid rising global oil prices could negatively impact the rupee unless foreign investors infuse enough capital into the country to meet the deficit. But foreign investors are unlikely to capitalize in India, as US yields on the US 10-year Treasury are rising, for example, from about 0.5% in mid-2020 to 3% now. has become more.

The rupee, it should also be noted, has been steadily losing value against the US dollar for the past several decades. A major reason for this has been the persistently high home price inflation in India. High inflation in India suggests that RBI is making rupee at a faster rate than US Federal Reserve making dollar. Therefore, while capital and trade flows receive a great deal of attention in discussions on the value of the rupee, differences in the rates at which the US Federal Reserve and the RBI regulate the supply of their currencies can play a huge role in determining the value. . Rupee in the long run

what is next?

Analysts believe that in the long run, the rupee is likely to continue depreciating against the dollar, given the significant divergence in long-term inflation between India and the US.

Right now, as the US Federal Reserve raises rates to combat historically high inflation in the country, other countries, and especially emerging markets, are forced to raise their interest rates to avoid disruptive capital outflows and protect their currencies. Will be done. It should be noted that inflation in the US reached a 41-year high of 8.6%.

The RBI is also trying to rein in domestic consumer price inflation, which hit a 95-month high of 7.8% in April, by raising rates and tightening liquidity. As interest rates rise around the world, the risk of a global recession increases as economies adapt to tighter monetary conditions.