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Basics Explained: Why Does The Rupee Fall?

The rupee has fallen to record lows against the US dollar due to several stress factors dampening demand for the rupee. Sentiment has declined as India's economic growth has slowed to less than 5% from a peak of 9% while the US economy has recovered. Speculation on currency futures also puts downward pressure on the rupee. Additionally, India's large current account deficit from imports and high fiscal deficit have increased debt levels. The Reserve Bank of India has maintained high interest rates to curb inflation unlike near-zero rates in the US. Together, high inflation, slowing growth, and large deficits have reduced demand for the rupee relative to the dollar.

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Pankaj Chetry
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41 views2 pages

Basics Explained: Why Does The Rupee Fall?

The rupee has fallen to record lows against the US dollar due to several stress factors dampening demand for the rupee. Sentiment has declined as India's economic growth has slowed to less than 5% from a peak of 9% while the US economy has recovered. Speculation on currency futures also puts downward pressure on the rupee. Additionally, India's large current account deficit from imports and high fiscal deficit have increased debt levels. The Reserve Bank of India has maintained high interest rates to curb inflation unlike near-zero rates in the US. Together, high inflation, slowing growth, and large deficits have reduced demand for the rupee relative to the dollar.

Uploaded by

Pankaj Chetry
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Basics explained: Why does the Rupee fall?

The rupee has been making headlines the past few months after it dropped to its lifetime-low of 68to-a-dollar levels. Jokes were being forwarded that the rupee has retired.
The valuation of a currency is important, especially in an import-dependent country like India. It is
always fixed against another currency and follows the basic demand-supply-price dynamics. Higher
the demand, greater the value.
In such a case, to understand the rupees fall, one needs to identify stress factors that hamper
demand.
Here are some:
1) Sentiment: A big part of trading is sentiment. This is nothing but investors expectation about
the future prospects. A dampening of sentiment, thus, causes traders to sell and leads to a fall in the
valuation.
Indias economy has grown at the slowest pace in a decade.
Growth in the economy has fallen from a peak of 9% to sub-5% levels. And this slowdown is expected
to continue. In contrast, investors are happy with the recovery in the US economy. Hence, the
preference for dollars over the rupee.
2) Speculation: Traders try to guess the rupees value over a certain period of time on the basis of
various factors. This is called speculation. This is done so by betting using currency futures a
derivative instrument. Speculation affects the underlying value of the rupee.
3) Current account deficit: Current account deficit (CAD) is when a countrys payments to other
nations exceed the amount it receives. This is predominantly led by a huge import bill. Since the
payments are in foreign currency, it means sale of rupees. Higher selling leads to a fall in value. In
the last five years, Indias current account deficit has risen more than 10-fold.
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4) Fiscal deficit: Fiscal deficit is when the government spends more than it earns. This means high
debt. Fiscal deficit and CAD are together called twin deficits, which the government is frantically
trying to curb. While developing countries are expected to have a higher deficits, too much debt
increases risks.

5) Monetary policy: The Reserve Bank of India (RBI) regularly monitors Indias monetary policy
by deciding lending rates and regulating the banking sector. This indirectly affects corporates, the
economic growth, and thus, the valuation of the rupee.

The RBIs first priority is to tackle high inflation. For this purpose, we have had a high interest rate

regime for the past few years. In contrast, the US has had near-zero rates since the 2008 crisis to fuel
demand and growth.

The RBI also regularly intervenes in the foreign exchange market to curb fluctuations. It sells dollars
from its forex reserves. This is a temporary measure to halt the slide of the rupee by creating artificial
demand.

6) Inflation: India has battled high inflation for many years. Retail inflation, measured by the CPI,
has hovered in double digits. This hampers everything from individual budgets to industry and
economy. For this reason, investors prefer to buy the currency of a country with lower inflation. In
the US, inflation is barely 2%. Another reason for the dollar-rush.

7) Economic growth: The economy is measured by the Gross Domestic Product (GDP). A growth
in GDP signifies expansion. Higher the growth, greater the value of an economy, and consequently
more demand for its currency. Indias GDP growth forecast has been downgraded by analysts
worldwide from over 6%-levels to 5%-levels.

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