On June 20, the value of one US dollar was approx. 78. However, just nine days later, on June 29, it was priced at . was close to 79, the lowest level ever. This means that the rupee is depreciating rapidly against the dollar.
This is happening despite the Reserve Bank of India (RBI) intervening in the foreign exchange market by selling dollars and buying rupees from its forex kitty. RBI sells the dollar and buys the rupee to ensure that there are enough dollars moving in the system and that the rupee does not lose value rapidly.
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It comes at a cost. In fact, in the two weeks between June 3 and June 17, RBI’s foreign currency assets, of which the dollar is a major component, fell by nearly $10 billion to $526.9 billion.
In this scenario, RBI will have to be slow to intervene in the foreign exchange market. This is simply because RBI cannot make dollars out of thin air. Only the US Federal Reserve, the US central bank, can do that.
A falling rupee makes imports expensive, especially energy imports, which increases the rate of inflation or price rise. The government has tried to control high fuel prices in two ways. One, it has cut excise duty on petrol and diesel. Two, state-owned oil marketing companies have been instructed not to increase the prices of petrol and diesel and these have been stable since May 22.
On the other hand, a weaker rupee may help in controlling the widening trade deficit. Trade deficit is the difference between imports and exports. If we look at the imports of non-oil non-gold non-silver, they are increasing rapidly. Between January and May, imports of non-oil non-gold non-silver goods rose nearly 32% year-on-year to $188.4 billion. A weak rupee will make these imports costlier and, in the process, hopefully, reduce their demand and help in controlling imports and the widening trade deficit.
This is important because imports are paid for in dollars and other foreign currency. This money first needs to be earned mainly through exports. However, exports are likely to come under pressure this year, as the wealthy western world is expected to grow slowly or hit a recession.
This will affect dispatch as well. Indians working abroad send money to their families, bringing a lot of foreign exchange into India. In addition, foreign institutional investors who invest in stocks and bonds usually bring in foreign exchange. However, in 2022, they have already withdrawn $28.3 billion from India. This sale is expected to continue.
Venture capitalists (VCs), when they invest in technology startups, bring foreign exchange into India through the foreign direct investment route. However, with interest rates rising in the wealthy world, money coming through the VC’s way is expected to come under pressure. To save cash, technology startups in India are firing people and burning less cash than before.
The point is that in an environment where dollars and other foreign currencies are not coming into India like before, imports may not grow as fast. As explained in the RBI’s latest State of the Economy report: “Foreign exchange reserves … as on 3 June 2022 were roughly equivalent to 10 months of imports projected for 2022-23.” The import cover at the same point last year was around 19 months. ,
A high trade deficit can lead to macroeconomic instability and needs to be avoided. A devaluing rupee can take care of this to some extent. However, it will have consequences, including higher energy import prices.
It is the same thing with economics. At the end of the day, it’s all about the trade-off.