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Rupee depreciation 2021
Read more on - Polity | Economy | Schemes | S&T | Environment
- The story: In April, the Indian Rupee depreciated to a nine-month low of 75.4 against the USD, it is one of the biggest losers among the emerging market currencies. Over the last three weeks since 22nd March 2021, Rupee has lost 4.2% against the USD. Interestingly, prior to this the INR had remained very strong, due to constant capital inflows into India. Not anymore.
- Points to note: There are many reasons for this decline. A small list -
- Sharp second wave of Covid-19 - The rising Covid-19 cases have emerged as a key concern, as many states considered more stringent lockdown measures, so market participants got concerned over delay in the recovery of the economy, which was hit hard in 2020-21 by the pandemic.
- US Dollar's strengthening - The strengthening of USD in line with expectations of better growth in the US economy, put pressure on the Rupee.
- RBI's money printing - RBI’s announcement of Government Securities Acquisition Programme (G-SAP) programme to infuse liquidity has also put additional pressure on the Rupee. In the three months to June 2021, the RBI plans to buy government securities worth ?1 trillion. The RBI will have to print money to buy these securities. This is a kind of quantitative easing policy the global central banks have been following. Here,the RBI will support the government’s elevated borrowing programme through infusion of liquidity.
- Decreasing FPI investments - The decreasing support of the Foreign Portfolio Investors (FPIs), who pumped huge inflows into Indian equity markets between October 2020 and February 2021, pushed the INR down. (Why? More dollars flow into the market, relatively less rupees, so rupee appreciates) While the FPIs invested a net of Rs. 1.94 lakh crore between October 2020 and February 2021 (in the Indian markets), in the month of April 2021 they have pulled out a net of Rs 2,263 crore (till date).
- Impact of repreciating Rupee: Those who lose include (a) People Importing from outside, (b) People seeking foreign education, (c) People travelling abroad, (d) People investing abroad, and (e) People seeking medical treatment abroad etc. Those who gain include (a) People exporting from India, especially IT exporters, (b) People receiving remittances from Non Resident Indian (NRI), and (c) Foreign tourists as travel to India gets cheaper.
- Currency depreciation: It refers to a fall in the value of a currency in a floating exchange rate system. In a floating exchange rate system, market forces (based on demand and supply of a currency) determine the value of a currency. Rupee depreciation means that rupee has become less valuable with respect to dollar. It means that the rupee is now weaker than what it used to be earlier. So earlier if USD 1 used to equal to Rs. 70, and now if USD 1 is equal to Rs. 76, it implies the rupee has depreciated relative to the dollar i.e. it takes more rupees to purchase a dollar.
- Factors that influence value: Some standard factors are inflation in the economy, the prevailing interest rates, trade deficit of the country, macroeconomic policies being followed, state of equity markets, etc. Currency depreciation increases a country’s export activity as its products and services become cheaper to buy. The RBI intervenes in the currency market to support the rupee as a weak domestic unit can increase a country’s import bill.
- RBI's intervention: There are a variety of methods by which RBI intervenes:
- It can intervene directly in the currency market by buying and selling dollars.
- If the RBI wishes to increase the rupee value, then it can sell dollars and when it needs to bring down rupee value, it can buy dollars.
- The central bank can also influence the value of rupee by the way of monetary policy. It can adjust the repo rate (the rate at which RBI lends to banks) and the liquidity ratio (the portion of money banks are required to invest in government bonds) to control rupee.
- Historically: In the long-term, it was observed that the rupee loses 4-5% against the dollar every year on an average. This is because the inflation in the US is much lower than that in India, and hence, the dollar-rupee exchange rate needs to adjust. But this doesn’t happen every year. Short term factors dominate.
- 2021 situation - While the RBI has openly said it'd do whatever it takes to keep government's borrowing costs low, in the US, the return on American government bonds has been going up since early February 2021. If this continues, money will leave India and go to the US. Why? Because here the rates are reducing (RBI policy) and there they are rising. So in the increased demand scenario for US dollar, the foreign exchange market will drive down the value of the rupee. The RBI's desire to make enough INR borrowings available to GoI is also why the RBI is not intervening in the forex markets to buy rupees and sell dollars (from its reserves).
- Unwinding of Carry Trades - With the rupee depreciating, the carry trades are unwinding. A carry trade involves borrowing money in a currency in which interest rates are very low (as is the case with much of the rich world currently) and investing it in a currency where interest rates are on the higher side (like the rupee). Traders lose money if depreciation of the currency in which money is invested, happens. As the currency in which money has been invested loses value, the total amount of money that an investor makes in the currency he has borrowed goes down. To avoid this possibility, investors unwind the carry trade. Today, this would mean selling rupees and buying dollars, leading to a further depreciation of the rupee.
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