The value of Rupee is depreciating against Dollar and not every other currency contrary to the popular opinion.
Why is Dollar getting Strong?
There are many reasons for the rise and rise of American currency. It starts with the American economy that has now witnessed its highest growth in recent times. America for decades has been the largest importer for several countries especially developing countries. These countries including China and India have enjoyed low import duties for their goods exported to India as opposed to high taxes these countries levy on American goods resulting in a massive trade deficit.
America’s recent policy to push American goods across the world to reduce the trade deficit and to tax goods and services from these countries have impacted exports to America and hence reduced inflows and the reason recent for US-China trade wars.
Post subprime crisis, American central bank (US Fed) actively reduced interest rates to nearly zero. This cooled markets and helped avert a recession but that also led to a lot of funds flow into emerging markets as FII funds into their stock markets.
Now as the US Fed has begun to raise interest rates ending its expansive monetary policy after the American Economy started recovering from the 2008 financial crisis, there is increasing outflow of funds from India and other markets making US Dollar more pricey. This will means that there will be higher returns on the dollar deposits as compared to other currencies.
The below table shows how Dollar performed against all other major currencies in the last 5 years
US Dollar vs Other Major Currencies
Source: Exchange Rates – X-Rates, Times of India
Indian Rupee vs US Dollar and Other Major Currencies in the last 5 years.
Indian Rupee has weakened against the US Dollar, so have almost all major currencies against US Dollars. But when we compare the data of the last 5 years then Indian Rupee has appreciated against almost all major currencies. However, despite the appreciation against other currencies, a weak rupee against the dollar will have a significant impact on India’s economy since the US Dollar is the main currency for international trade. The table below explains how INR has performed against other major currencies like the, , , and among others.
There are some fundamental reasons why USD has appreciated and may keep appreciating for some more time:
—The strength of the American Economy that has started growing at 4.2% against the predicted 4% in the second quarter of 2018. It is the highest growth since the third quarter of 2014.
—The US has tightened policies that allowed cheaper imports in the country. This means imported goods would attract more duties and the imports will fall and therefore lower outflows of USD for payment of imports.
—The US under President Trump is seeking a fair balance of trade with partnering countries asking them to lower taxes on American products that will mean there will be more American products exported that will improve inflow of USD into American Economy.
—America is the largest importing country for both manufactured goods as well as services. Trump’s America first policy aims to bring back manufacturing and many services back to America that aims to lower unemployment which is now very low and lower outflow of US Dollars
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Rupee at an all-time low. Here’s why.
1) The Lira connection
Turkey, the middle-eastern country, is going through a financial turmoil right now. Its relations with the US are infringes, leading to a very weak currency. Lira – the official Turkish currency has fallen 40 percent against the US Dollar in the first half of 2018. As is often the case, the turmoils of a financial crisis in one country do not stay confined to the national borders. The Lira crisis has made the global market anxious about its spillover effects. Developing countries tend to be more exposed to crisis like these, making the situation a tricky one for India.
2) Dependency on oil import
India is the third largest crude oil importing country in the world, coming only after US and China. India imports more than 80% of its crude oil requirements, thereby making it more vulnerable to changes in the international oil market. For example, if the crude oil prices increase, our total import cost will also increase, affecting our current account balance which in turn affects the currency market.
3) Huge current account deficit
In June 2018, India’s current account deficit rose to 42%, approximately $160 billion. Current account deficit is the difference between imports and exports of goods and service of a country. A huge dependency on crude oil imports and its increasing price, as mentioned before, affects our current account health, making the deficit larger.
How does a current account deficit impact Indian Rupee?
In simple words, an increasing current account deficit (of India) leads to an increase in the demand for Dollar. Why? Because we need more Dollars than before to finance our growing deficit, also paying for the imports. An increase in the demand for a currency leads to its appreciation. And if the US Dollar is appreciating against Indian Rupee, it means our domestic currency is depreciating.
4) US Fed (Federal Funds) rate changes
Since national economies share an intricate bond, the effects of US Fed rate hikes are felt in the Indian market as well. A hike in the fed rates (as was observed four times in 2018), strengthens the US Dollar, which in turn leads to a depreciation of the Indian currency.
5) The global market
The United States and China have been experiencing a trade war in 2018. As both are among the world’s largest economies, the trade war is set to affect the global economy. While the ball could fall on either side of the court for India, the situation has definitely created a growing unease among global investors and Indian economists.
How will the fall in Rupee affect Indian economy?
1. Cost of oil imports: Crude oil can be called a major engine for the growth and working of the Indian economy with its vast utilities. Since India imports more than 80% of its oil needs, a depreciation of Rupee will increase the cost of our humongous oil imports. This, in turn, can cause our current account deficit to worsen.
2. An increase in the import cost will directly affect the Indian corporate market for the worse.
3. Inflation: Domestic currency appreciation and inflation work in the opposite directions. So, a depreciation of the domestic currency means a potential increase in inflation.
4. To ward off an increasing inflation, the central bank of a country generally increases the interest rates. Consequently, people are able to borrow less money, and hence, they also have less to spend, keeping the inflation in check. Reserve Bank of India (RBI) might resort to increased interest rates too, further increasing the effect on corporates.
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