The Indian rupee is hitting all-time lows, Impact on people

Indian currency hit 77.55 INR this Thursday, leaving a direct impact on the Reserve of the central bank, prices of goods, trade, and equities.

Indian rupee nosedived hitting an all-time low of ₹77.55 against the US dollar on May 12, 2022. Earlier last week, the Indian rupee had appreciated eight paise after the Reserve Bank of India, increased interest rates by 40 basis points on May 04, only to tumble further below this week.

This depreciating rupee, which is a fall in the value of a currency in terms of its exchange rate versus other currencies, is likely to have a direct impact on the daily expenditure of people. Imports are now more expensive, while exports are cheaper

With a small dip in the Indian currency, the Indian government has to pay a little extra for the same goods it was importing earlier. So, importing items gets more expensive. Oil imports will get costlier, which has a direct impact on the prices of many other things.

If foreign investors pull out of Indian equities, the Indian currency depreciates, leading to a sharp decline in equity markets. 

Foreign investors have already pulled out over ₹6,400 crores from the Indian equity markets in the first four trading sessions of May when the Reserve Bank of India (RBI) and US Federal Reserve raised interest rates. Given the headwinds in terms of elevated crude oil prices, inflation, and monetary tightening market volatility is expected to remain high as foreign investors could continue to withdraw funds.

Foreign education could get more expensive, International travel will be now more expensive. During summer, the travel sentiment is high among consumers. As the rupee loses value against the US dollar, people’s plans to travel abroad will burn a deeper hole in their pockets.

A weaker rupee results in expensive imports and contributes to inflation. India’s retail inflation surged to an 18-month high in April, largely driven by rising fuel and food prices and staying well above the RBI’s upper tolerance limit for a fourth consecutive month, a Reuters poll found.

To keep inflation in check, RBI resorts to increasing its interest rates. If the RBI expects that inflation will rise beyond its tolerance limit, it hikes the rate at which banks borrow money from the RBI, which is also known as the repo rate.

But what has caused the decline of the Indian rupee?

The value of any currency depends on its demand in the market. If the demand increases, its value goes up, which is known as appreciation. And if the demand for a currency declines, its value depreciates.

If more foreign investors invest in Indian businesses and projects, the demand for Indian currency goes up. To be able to invest in India, foreign companies have to first convert their currency into Indian rupees. This increase in demand for the rupee strengthens its value against the US dollar.

Recently, more and more overseas investors have pulled out a big chunk of their money from the Indian market, consequently affecting market sentiment and currency decline.

The Federal Reserve has raised interest rates for the first time since 2018, as the US central bank struggles with soaring inflation, the impact of the war in Ukraine, and the COVID crisis. As interest rates soar, investors start pulling money out of riskier investments like equities, commodities and foreign markets, etc.

Therefore, foreign investors are exiting their investments in India and shoring up their investments in the relatively safer markets in the US.

On the other hand, when Indian businesses and companies import foreign goods and products, such as crude oil, gold, and consumer electronics, among other things, they convert their rupees into dollars, which is the global currency for international trade. If imports exceed exports, demand for the dollar goes up and the rupee weakens against it.

Since India has been a net importer, we import more than we export, and the rupee has gradually depreciated over time. E.g. one had to shell out ₹64 in May 2017 for 1 US dollar but today, you have to pay ₹77.26 in exchange for a dollar.

The Ukraine war is another significant factor in the Rupee’s decline. Russia is the world’s second-biggest crude oil exporter. Naturally, supplies have been disrupted and prices spiked. And India is hit hard as it’s the world’s third-largest oil consumer behind the US and China.

Another factor weakening the rupee is after the US, China is our biggest trade partner. Stringent lockdowns across various Chinese cities have badly affected economic activity there. India is naturally bearing the brunt.

Why is Dollar crucial in the global order as a currency?

It is because US Dollar has become the global currency. The US Dollar’s share of foreign currencies in international banks is more than 64 percent. For the Euro, it’s about 20 percent. The US Dollar reflects the strength of America’s economy.

In 85 percent of international trade, including crude oil, the US Dollar is involved. About 40 percent of loans globally are sanctioned in dollars.

WHO DECIDES VALUE?

 No one in particular does. Foreign currency exchange rates are floating and depend on daily market factors like demand and supply, with zero or little intervention from the countries involved. The more the demand, the greater the value. For example, heavy imports, which mean more dollars purchased, decrease the value of our currency. Similarly, in the case of heavy exports, more dollars will flow into India, and become cheaper for us to buy through the Rupee.

GOVT’S OPTIONS LIMITED

So, cannot the government do anything when there is a significant fall in the Rupee’s value? It can but the options are limited. The government can try to reverse the Rupee’s low demand by, through state-run banks, buying India’s currency from the market using US dollar reserves that it keeps. More dollars in circulation means lower value. Fewer rupees in circulation mean higher value.

But this may also backfire. When the government empties its forex reserves, it won’t be able to import all of the necessary goods that people and industry need. This will lead to a price rise and pinch us all. So, it’s a vicious cycle.

 The other option is, that the Reserve Bank of India (RBI) could increase the rate at which it lends money to banks. A higher interest rate will mean more investors buy government bonds and interest-rate products because of higher returns. The Rupee will be in greater demand and its value will increase.

Similarly, when the US increases interest rates, investors from other countries flock there and the Dollar strengthens. But those taking housing, car, and other loans will be negatively affected because they will be paying back more.

WHY NOT PRINT MORE?

Finally, a question that some may ask: why cannot the government print more currency? This is because when the government prints money to meet its needs without the economy growing at the same pace, it can lead to a disaster. More money will spike the demand for goods and services. They will become scarce. Hyper-inflation will spiral and currency notes and coins won’t be able to buy anything.