Depreciation of Indian Rupee

• 22 Dec 2021

For Prelims: Appreciation vs Depreciation of Currency, Depreciation of Indian Rupee.

For Mains: Reasons for Current Depreciation of Indian Rupee, Impact of Depreciation of Indian Rupee.

Why in News

The Indian currency declined 2.2% in the Sep-Dec 2021 quarter. This depreciation of currency is due to global funds worth $4 billion having been pulled out of the country’s stock market.

• This downfall of currency makes the Indian rupee as Asia’s worst-performing currency.

Key Points

• About Depreciation:
  • Currency depreciation is a fall in the value of a currency in a floating exchange rate system.
  • Rupee depreciation means that the rupee has become less valuable with respect to the dollar.
    • It means that the rupee is now weaker than what it used to be earlier.
    • For example: USD 1 used to equal to Rs. 70, now USD 1 is equal to Rs. 76, implying that the rupee has depreciated relative to the dollar i.e. it takes more rupees to purchase a dollar.
• Impact of Depreciation of Indian Rupee:
  • Depreciation in rupee is a double-edged sword for the Reserve Bank of India.
    • Positive: While a weaker currency may support exports amid a nascent economic recovery from the pandemic.
    • Negative: It poses risk of imported inflation, and may make it difficult for the central bank to maintain interest rates at a record low for longer.

Appreciation vs Depreciation of Currency

• In a floating exchange rate system, market forces (based on demand and supply of a currency) determine the value of a currency.
• Currency Appreciation: It is an increase in the value of one currency in relation to another currency.
  • Currencies appreciate against each other for a variety of reasons, including government policy, interest rates, trade balances and business cycles.
  • Currency appreciation discourages a country's export activity as its products and services become costlier to buy.
• Currency Depreciation: It is a fall in the value of a currency in a floating exchange rate system.
  • Economic fundamentals, political instability, or risk aversion can cause currency depreciation.
  • Currency depreciation encourages a country's export activity as its products and services become cheaper to buy.

Devaluation And Depreciation

• In general, devaluation and depreciation are often used interchangeably.
• They both have the same effect – a fall in the value of the currency which makes imports more expensive, and exports more competitive.
  • However, there is a difference in the way they are applied.
• A devaluation occurs when a country’s central bank makes a conscious decision to lower its exchange rate in a fixed or semi-fixed exchange rate.
• A depreciation is when there is a fall in the value of a currency in a floating exchange rate.

• Reasons for Current Depreciation of Indian Rupee:
  • Record-High Trade Deficit: India’s trade deficit widened to an all-time high of about $23 billion in November amid higher imports.
    • This growing trade deficit is driven by a rebound in oil prices.
  • Policy divergence Between RBI and Federal Reserve: The strengthening of USD in line with expectations of better growth in the US economy and favorable interest offered by the Federal Reserve (US’ Central bank).
    • The RBI has been continuously buying dollars to build its reserves and prepare itself for any volatility.
  • Outflow of Capital: Foreign capital exodus from stocks have led to the benchmark S&P BSE Sensex Index falling by about 10% below an all-time high touched in October 2021.
  • Omicron Concerns: When concerns about the omicron virus variant are roiling the global markets.

Source: IE