INDIAN RUPEE

Context

Key point

• The Indian rupee has been witnessing a steady decline this year, losing more than 6 per cent against the U.S. dollar since the beginning of 2022.
• Many analysts expect the rupee to weaken further in the coming months and move past the 80 rupees to a dollar mark.
• The International Monetary Fund (IMF) expects the rupee to weaken past the 94 rupees to a dollar mark by FY29.
• India's forex reserves have also dropped below $600 billion, Plunging by more than $50 billion.
• Since September 3, 2021 forex reserves have stood at an all-time high of $642 billion.
• Drop-in India's forex reserves are believed to be primarily due to steps taken by the Reserve bank of India to support the rupee.
• The drop in forex reserves is due to a fall in the dollar value of assets held as reserves by the RBI.
• If a portion of the reserves are in euros and depreciates against the dollar, it would cause a drop in the value of forex reserves.

RBI 

• The Indian Central Bank has usually tried to slow down or smoothen, rather than reverse or prevent.
• The fall in the exchange value of the rupee against the U.S. dollar.
• The RBI's policy aims to allow the rupee to find its natural value in the market but without undue volatility or causing unnecessary panic among investors.
• State-run banks are usually instructed by the RBI to sell dollars to offer some support to the rupee.
• The selling dollars in the open market in exchange for rupees, the RBI can improve demand for the rupee and cushion its fall.

• The value of any currency is determined by the demand for the currency as well as its supply.
• When the supply of a currency increases, its value drops. On the other hand, when the demand for a currency increases, its value rises.
• In the wider economy, central banks determine the supply of currencies, while the demand for currencies depends on the number of goods and services produced in the economy.
• In the forex market, the supply of rupees is determined by the demand for imports and various foreign assets.
• If there is a high demand to import oil, it can lead to an increase in the supply of rupees in the forex market and cause the rupee's value to drop.
• The demand for rupees in the forex market depends on foreign demand for Indian exports and other domestic assets.
• There is great enthusiasm among foreign investors to invest in India.
• This can lead to an increase in the supply of dollars in the forex market which in turn causes the rupee's value to rise against the dollar.

• Since March this year, the U.S. Federal Reserve has been raising its benchmark interest rate causing investors to seek higher returns to pull capital away from emerging markets. Such as India and back into the U.S.
• It has put pressure on emerging market currencies which have depreciated significantly against the U.S. dollar so far this year.
• Even developed market currencies such as the euro and the yen have depreciated against the dollar and its index is up more than 9 per cent so far this year.
• The RBI's surprise decision to raise rates in May could have simply been to defend the rupee by preventing any rapid outflow of capital from India.
• The rupee fell 15 per cent against the dollar in about three months after investors were spooked by the US Federal Reserve's decision to trim down its bond purchase programme.
• It had helped keep long-term interest rates low in 2013.
• India's current account deficit measures the gap between the value of imports and exports of goods and services is expected to hit a 10-year high of 3.3 per cent of the GDP in the current financial year.
• India's import demand amid rising global oil prices is likely to negatively affect the rupee unless foreign investors pour sufficient capital into the country to fund the deficit.
• Foreign investors are unlikely to plough capital into India investment yields are rising in the U.S. 
• Yields on the U.S. 10-year Treasuries have risen from around 0.5 per cent in mid-2020 to over 3 per cent now.
• The rupee has consistently lost value against the U.S. dollar for several decades now.
• A major reason for this has been consistently higher than domestic price inflation in India.
• Higher inflation in India suggests that the RBI has been creating rupees at a faster rate than the U.S. Federal Reserve has been creating dollars.
• The capital and trade flow gain a lot of attention in discussions on the rupee's value, and the difference in the rates at which the U.S. Federal Reserve and the RBI regulate the supply of their currencies may play a much larger role in determining the value of the rupee in the long run.

• Over the long run, the rupee is likely to continue to depreciate against the dollar given the significant differences in long-run inflation between India and the U.S.
• At the moment, the U.S. Federal Reserve is raising rates to tackle historically high inflation in the country, other countries and emerging markets.
• In particular, will be forced to raise its interest rates to avoid disruptive capital outflows and to protect its currencies.
• It should be noted that inflation in the U.S. hit a 41-year high of 8.6 per cent.
• The RBI too has been trying to rein in domestic consumer price inflation hit a 95-month high of 7.8 per cent in April, by raising rates and tightening liquidity.
• As interest rates rise across the globe, the threat of a global recession also rises as economies readjust to tighter monetary conditions.