In July 2022, the Indian rupee fell to 80 against the dollar for the first time ever. In the first half of 2022 alone, the rupee fell more than 5% against the dollar. In this article, we look at the causes of the fall in the Indian rupee’s value and what its implications could be for the Indian economy as well as the Indian investors.
Why is the rupee depreciating?
Currency exchange rates are determined by the forces of demand and supply. The following table shows how changes in demand and supply of currencies can impact their exchange rates.
| When will the Indian rupee appreciate? | When will the Indian rupee depreciate? |
| Rise in demand for the Indian rupee | Fall in demand for the Indian rupee |
| Fall in demand for foreign currencies | Rise in demand for foreign currencies |
| Fall in the supply of the Indian rupee | Rise in the supply of the Indian rupee |
| Rise in the supply of foreign currencies | Fall in the supply of foreign currencies |
According to reports, some of the reasons for the Indian rupee’s depreciation are high import costs due to high crude oil prices, capital outflows and a strong US dollar.
How do high import costs impact the Indian rupee?
When India needs to import something, it needs to pay the seller in their currency. So, India would need to exchange rupees for other currencies. This increases the supply of the Indian currency while also increasing the demand for foreign currencies.
Thus, higher import costs would depreciate the Indian rupee.
How do capital outflows affect the Indian rupee?
When foreign investors pull out their money from Indian markets, the supply for the Indian rupee increases while the demand for foreign currencies increases. Thus, capital outflows can lead to the Indian rupee’s depreciation.
The Indian rupee’s depreciation would shrink the expected returns of foreign investors. This can lead to further capital outflows. Thus, capital outflows and depreciation of a currency can form a cycle.
Why is the Indian rupee falling against the US dollar?
The US dollar is considered to be a safe-haven currency. A safe-haven currency is typically expected to not lose value during times of market volatility. In 2022, risks of recessions in economies worldwide spooked investors, which resulted in a higher demand for US dollars.
Hikes in interest rates by the US Federal Reserve might drive capital towards US bond markets.
Thus, the Indian rupee weakened in comparison to the US dollar.
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Consequences of rupee falling
Positive impact of rupee depreciating
There can be positive effects of falling rupee on the Indian economy and Indian investors. We explain some of the positives that can come out of the rupee depreciating in the following points:
- Higher exports
When the rupee falls, Indian exports become cheaper for overseas buyers. Lower prices typically lead to higher demand. Thus, a fall in the value of the Indian rupee can boost exports. Export-oriented companies have to compete with companies from all over the world. When the value of the rupee falls, India’s export-oriented companies might find it easier to compete due to their products becoming cheaper for overseas buyers.
- Discourages imports and supports domestic industries
When the rupee falls, India’s import costs will increase. Thus, domestic industries will find it easier to compete with the prices of imported goods. In the market for some products, Indian companies are competing with multinational companies. Such Indian companies might find it easier to compete with MNCs as import costs increase.
- Chance of improving trade balance
If the domestic industries are able to take advantage of the rupee falling and produce goods that can substitute imports and export more, India’s trade balance might improve.
- Your investments in foreign markets might become more attractive
The value of your expected gains from investments in foreign markets might increase. As the value of the rupee falls, the returns you have earned in foreign currencies would have a higher rupee value.
Negative impact of rupee depreciating
Some of the negative effects of the Indian rupee falling are:
- Higher import costs
When the rupee falls, imports become costlier. If Indian companies are able to provide a cheaper alternative to imported products, India’s imports will decrease, and the trade balance might improve. But, if the Indian companies are unable to take advantage of the fall in the value of the rupee, India’s import costs would increase.
- Might drive capital out of India
When the rupee falls, the expected returns for foreign investors will shrink. Thus, foreign investors might start pulling out their money from Indian stocks and bonds.
Suppose a foreign entity has invested $1 million in Indian equities and expects to earn 15% returns in 1 year. Now, if the Indian rupee falls in comparison to the foreign entity’s currency, the value of the 15% returns will shrink.
- Can lead to a further fall in the value of the rupee
If the domestic industries are unable to take advantage of the rupee falling and foreign investors pull out of Indian assets, it might lead to a further fall in the value of the Indian rupee. This is because higher import costs and capital outflows would both increase the supply of the Indian rupee and the demand for foreign currencies.
Final Thoughts
While there may be some obvious negatives to the depreciation of the Indian rupee, like higher import costs and the possibility of capital outflows, it is also an opportunity for Indian industries to increase exports and try to substitute imported products. The rupee’s depreciation also makes investments in foreign markets more attractive.
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FAQs
When the value of the rupee decreases in comparison to other currencies, exports will be cheaper to overseas buyers, and imports will become costlier. If India is able to take advantage of this by increasing exports and substituting imports, India’s trade balance will improve.
The US dollar was strengthened due to its status as a safe-haven currency during a time when economies worldwide are facing the risk of a recession. The Indian rupee, on the other hand, has weakened due to high import costs on account of high crude oil prices and capital outflows.
A ‘weak’ or ‘devalued’ rupee might help India improve its trade balance. When the value of the Indian rupee falls, exports will be cheaper to overseas buyers, and imports will be cheaper. If India’s domestic industries are able to step up their exports and substitute imported goods, it will improve the trade balance.
