Why Indian Rupee is Falling: Reason, Impact, and Analysis

The Indian Rupee's value has recently reached its lowest point, with $1 now costing ₹94. This phenomenon, known as currency depreciation, signifies a fall in the rupee's value, requiring more rupees to purchase foreign currency. 

Concerns exist about a potential further decline, possibly to $1 = ₹100, exacerbated by rising crises in West Asia.

Defining Currency Depreciation

Currency depreciation refers to a fall in the value of a currency. This means that one needs to spend more local currency to acquire one unit of foreign currency. 

For instance, if $1 was initially ₹1, then ₹50, and is now ₹94, it illustrates the rupee's falling value as more rupees are required to buy the same dollar.

Why Compare with the US Dollar?

The dollar serves as the global benchmark because most international commodities, international trade, and valuations are conducted in dollars. 

Consequently, currency appreciation or depreciation is typically measured relative to the US dollar.

The Fundamental Principle: Demand and Supply

The fluctuation in currency value, whether falling or rising in the international market, is fundamentally governed by demand and supply. 

Just as excessive availability (supply) in a relationship can decrease one's perceived value, an over-supply of a currency or a lack of demand for it leads to a decrease in its value. Conversely, high demand for a currency leads to an increase in its value.

Applying Demand and Supply to Currencies

The demand for the dollar is high globally because international trade (covering oil, vehicles, weapons, gold, fertilizers) is largely conducted in dollars, thereby increasing its value. 

Conversely, the supply of rupees is high when India, being a net importer (especially for critical goods like oil, defense, gold), constantly supplies rupees in exchange for dollars to pay for imports. This high supply of rupees and high demand for dollars consequently depreciates the rupee's value.

Key Reasons for Rupee Depreciation

Several factors contribute to the depreciation of the Indian Rupee:

• High Crude Oil Imports: India imports approximately 88% of its crude oil needs, necessitating a large supply of rupees for dollars.

• Defense Equipment Imports: Significant procurement of defense equipment from abroad, paid in dollars, increases rupee supply and dollar demand.

• Other Major Imports: This includes gold, fertilizers, and a wide array of non-essential, luxury, and electronic items. The high volume of imports consistently involves supplying rupees and demanding dollars.

• Current Account Deficit / Trade Deficit: A trade deficit arises when a country's imports are significantly higher than its exports. This imbalance leads to a higher supply of the domestic currency (rupee) in the market to pay for imports, causing currency depreciation.

• Global Uncertainty and Wars (Capital Outflow): During global uncertainties, foreign investors (e.g., Foreign Institutional Investors (FII), Foreign Portfolio Investors (FPI)) tend to sell their Indian assets and demand their dollars back, leading to rapid capital outflow and rupee depreciation.

• Vicious Cycle with Oil Prices and Depreciation: Global conflicts often increase oil prices. Higher oil prices mean India supplies more rupees to import oil, leading to further currency depreciation. This depreciated currency then makes oil even more expensive, creating a detrimental feedback loop.

• US Central Bank Interest Rate Increases (Capital Flight): When the US Central Bank (Federal Reserve) raises its interest rates (Fed Rates), US investments become more attractive. Foreign investors may move capital from India back to the US (capital flight), causing rupee depreciation.

The most significant reason for India's currency depreciation is the imbalance between imports and exports, with imports being substantially higher.

Implications and Effects of Rupee Depreciation

Rupee depreciation has several critical implications:

• Increased Import Costs: A depreciated rupee makes importing goods more expensive. For instance, if crude oil costs $1, and the rupee falls from ₹50 to ₹94 per dollar, India pays significantly more rupees for the same oil.

• Inflation: The higher cost of imports, particularly crude oil, directly impacts transportation costs. This rise in transport expenses contributes to inflation across various goods and services domestically.

• Vicious Economic Cycle: Depreciation can initiate a negative economic cycle: Inflation rises due to expensive imports, leading to an increased import bill. This higher import bill, in turn, causes further currency depreciation. The depreciated currency then further inflates the import bill, perpetuating a cycle of economic challenges.

Is Depreciation Always Detrimental? Theoretical Benefits and India's Challenge

While often viewed negatively, currency depreciation can offer theoretical benefits, especially for nations with robust export capabilities.

Theoretical Benefits of Depreciation

1. Increased Exports: A depreciated currency makes a country's exports cheaper for foreign buyers. For example, if $1 previously bought goods worth ₹50, but after depreciation, $1 buys goods worth ₹100, Indian products become more globally competitive, potentially boosting exports. China is known for strategically devaluing its currency to enhance export competitiveness.

2. Increased Foreign Investment: A depreciated currency means foreign investors can buy more assets or invest more capital in the country with the same amount of foreign currency. For instance, with $1, an investor could previously invest ₹50; after depreciation to $1 = ₹100, the same $1 can now invest ₹100, which is attractive under stable conditions.

Why India Doesn't Fully Benefit

Despite the rupee's depreciation, India has not significantly leveraged these theoretical benefits to boost exports or attract stable long-term investment, particularly during global uncertainties. The primary reason is India's lack of a robust manufacturing base. 

Without sufficient "Made in India" products for export, the advantages of a cheaper currency for exports cannot be fully realized. While some relative improvements in import reduction and export growth might occur, in absolute terms, imports remain vastly higher than exports.

Solutions to Currency Depreciation

Addressing currency depreciation requires a multi-pronged approach focused on reducing imports and boosting exports:

1. Reduce Imports:

• Substitute Crude Oil: Invest in alternatives like ethanol blending and electric vehicles (EVs) to lessen reliance on imported crude oil.

• Domestic Production: Increase domestic manufacturing of items currently imported, such as defense equipment and fertilizers.

• Reduce Non-Essential Imports: Discourage the import of items like gold and electronic goods through policy measures or public awareness campaigns.

2. Increase Exports: Focus on developing a strong manufacturing sector to produce goods (e.g., pharmaceuticals, steel) for export, thereby increasing the inflow of foreign currency.

3. Promote Rupee-based Trade: While theoretically possible, the current challenge is the limited international acceptance of the rupee. For widespread rupee-based trade, India's export volume would need to significantly increase, making the rupee a more desirable currency for other nations.