The Indian rupee has been depreciating against the US dollar since 1966, and Here we shall look at some of the reasons why the Indian Rupee (INR) has been depreciating against the US Dollar (USD). The INR is now close to the 70/USD level.
Was Re. 1 worth Us Dollar 1 in 1947?
It’s a myth that INR 1 was worth USD 1 when India gained her independence on August 15, 1947. Before the USD became the standard global currency, we measured the INR against the British Pound. The INR was devalued in 1966 and pegged to the USD. In 1966, USD 1 was equal to INR 4.76, and after the devaluation, USD 1 was equivalent to INR 7.50.
Devaluation happened because India was facing her first big financial crisis. The crisis depleted her foreign currency reserves, and the INR became unacceptable overseas. India was unable to pay for imports and the only option left was to borrow money abroad.
In 1947, India was not engaged in trade and had no external borrowings, so it was not possible for INR 1 to be equal to USD 1. Besides, India had weak growth of 0.8% at that time, so it was not possible for the INR to have the same value as the USD.
Let’s take a closer look at the factors that have contributed to the depreciation of Indian Rupee against the US dollar:
Crude oil prices
The price of crude oil has always had a significant impact on the value of the INR against the USD. When the price of crude oil rises, the INR depreciates. In the same way, when crude prices decline, the INR appreciates because India imports around 80% of her crude oil and pays for those imports in USD.Learn how to mange your money & create wealth, Download your FREE eBook now
Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) can affect the value of the Indian Rupee. High FDI flows have given stability to the Indian Rupee. When foreign investors withdraw their money from India, there is significant demand for the US dollar. The value of the Indian Rupee falls, and this leads to even more selling.
A currency war occurs when countries try to boost exports by devaluing their currencies. Currency wars tend to harm all the nations that engage in them. However, when one country devalues its currency to make its exports cheaper, other countries are forced to retaliate.
The Dollar Index
The Dollar Index (DXY) is an index of the US dollar’s strength against a basket of hard currencies. It also measures the weakness of other currencies against the US dollar. The Indian Rupee moves in line with the other currencies against the US dollar. If the Dollar Index strengthens, the Indian Rupee weakens, and vice versa.
The Fed’s monetary stance
The monetary stance of the Federal Reserve (Fed) of the US decides the future direction of interest rates. The Fed’s stance affects the course of action of global investors. If they can earn higher returns by investing in safe US bonds, there is no need for them to invest in risky emerging markets. When the Fed raises interest rates, the US dollar strengthens, and the Indian Rupee weakens.
Current account and balance of payments
The current account of a country reflects its balance of trade and earnings on overseas investments. It reflects all the transactions, including imports, exports, and debt. A current account deficit occurs if a country spends more of its currency on imports than it earns from exports. Higher imports of crude oil, gold, products, raw materials, etc. can make the INR depreciate against the USD.
The central government’s debt is also known as the national debt, public debt, or government debt. A country with high government debt is less likely to attract foreign capital, resulting in inflation. Overseas investors will sell their bonds in the open market if government debt is expected to rise, causing a decline in the value of the currency.
Changes in the rate of inflation can make the exchange rate go up or down. The currency of a country with a lower inflation rate is likely to appreciate. When inflation is low, the prices of goods and services go up at a slower pace. The currency of a country with consistently low inflation tends to appreciate.
Inflation, interest rates, and forex rates are all interconnected. A change in the interest rate affects the value of the currency and the exchange rate. If the interest rate goes up, the currency appreciates. A higher interest rate gives greater returns to lenders, attracting more foreign capital and raising the exchange rate.
Political stability and economic performance also impact the strength of the currency. A country with a lower risk of political turmoil will attract more foreign investors. Growing foreign capital flows make the value of the currency appreciate. If a country has sound trade and financial policies, there is more certainty about its currency.
A country that is going through a recession is likely to have a falling interest rate, reducing its chances of attracting foreign capital. Its currency will weaken as compared to countries with stronger economic performance. Foreign investors tend to move their money to countries with better economic performance.
If investors expect the currency of a country to appreciate, they buy more of it to make quick profits. The expectations of speculators can make the currency appreciate. The higher demand for the currency makes its value go up. Negative expectations can also cause a fall in its value.
Terms of trade
The “terms of trade” is the ratio of export prices to import prices. It is related to the balance of payments and current account. If export prices increase at a higher rate than import prices, the terms of trade of the country improve. Better terms of trade increase the revenue, causing more demand for the country’s currency and appreciation in its value.
The Indian Rupee can depreciate against the US dollar due to a combination of local and global factors, and this trend may continue as India is a developing nation. The exchange rate can have a profound impact on the economy. The RBI targets a particular exchange rate, and it may choose to actively intervene in the market by buying or selling US dollars.