Explained: What a weak rupee means to the Indian economy

global economy facing recession
The global economy is facing multiple challenges and uncertainties, from the impact of rising interest rates to the struggles of key sectors and the persistence of inflation.

Impact of weak rupee: The rupee slipped below 78 against the dollar for the first time this Monday on the prospect of aggressive rate hikes by the US Federal Reserve. The rupee has depreciated 5% against the greenback since January. Though the currency staged a recovery after hitting an all-time low of 78.20, most currency analysts expect the rupee to remain weak because of falling domestic stocks, rising crude prices, and persisting capital outflows. The dollar is likely to stay at its peak level for some time. Global markets are factoring in a 300bps hike in in the Fed Funds rate. The monetary policy gap may narrow down over some period, but an erosion of dollar’s strength is unlikely.

Most Asian currencies including Chinese Yuan and Japanese Yen are falling since April. The Japanese Yen is trading near a two-decade low against the dollar and the fall is driven by the rising US bond yields. As interest rates rise in the US, foreign portfolio investors (FPIs) sell in emerging markets. FPI outflows stood at Rs 35,000 crore in May 2022 and Rs.1.73 lakh crore since January. An FPI selloff means a flight of dollars that will lead to the weakening of the rupee. Rising crude oil prices is another reason behind the weak rupee. Brent crude is hovering above $120/bbl since January which is above its 7-year high and has risen 114% in the last one year.

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Economic impact of weak rupee

The war between Russia and Ukraine and the subsequent supply chain disruptions have pushed crude oil to this level. India is the second largest importer of crude oil after China. It imports more than 80% of its energy requirements. According to oil ministry’s Petroleum Planning and Analysis Cell, India’s crude oil import bill has already doubled in FY22 to $119 billion compared with $62.2 billion in the previous fiscal. A $10/bbl rise in crude oil prices pushes India’s current account deficit by 0.5% of the GDP.

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The rise in import bill increases India’s current account deficit. When we buy more crude, we pay in dollar. So, the high current account deficit driven by oil imports will increase the demand for the dollar and at the same time increase the supply of the rupee, pulling the domestic currency down.

Let’s examine the impact of the depreciating rupee on the Indian economy. When a domestic currency depreciates, its imports become expensive and exports will become cheaper. Exporters will get more rupee against the foreign currency. When rupee depreciates, the country will have to pay more for imported goods. This will increase our current account deficit and decrease the foreign exchange reserves. India’s forex reserves are falling continuously and currently stands at $593.28 billion.

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Rupee value and foreign trade

When the prices of imported goods increase, it also increases the domestic prices which will lead to inflation. This rise in inflation will reduce the demand and also impact the savings of people. This will negatively impact the Indian economy as savings and investments are major factors in economic growth. As inflation rises, the RBI will raise interest rates and take necessary measures to control rising prices. This will increase the overall cost of borrowing in the country. As rupee depreciates, it increases the external debt burden of the government and businesses.

The falling rupee has some benefits too. As domestic currency falls, it makes exports more price competitive in the global market. Export-oriented industries such as IT and textiles will get more rupee against each dollar. Demand for Indian goods will increase in the global market, which will eventually increase the total exports of the country. When imported goods become costlier, the demand for domestically produced cheaper goods may rise because India is a price sensitive market. So, depreciating rupee has some benefits, but overall, it is a negative impact for India, which is a major importing nation.

The Reserve Bank of India takes necessary steps to control the falling rupee and rising inflation. In March 2022, the RBI conducted a $5 billion worth dollar-rupee swap auction as part of its liquidity management. The RBI had received bids worth $13.56 billion for the auction from which it accepted 86 bids worth $5.135 billion.

Through these swap deals, RBI infused dollar and pulled out rupee from the financial system. To put it simply, the RBI took rupees worth Rs 39,000 crore from the banks in exchange of $5 billion. This swap increases the supply of dollar and decreases the supply of Indian rupee, which leads to the strengthening of the rupee against the dollar. Despite RBI’s efforts, the rupee may drop further to 80 per dollar in the coming months.

The country’s forex reserve has shrunk by 7% from the September 2021record high of $640 billion touched in . RBI may continue to use limited intervention techniques amid aggressive monetary tightening by the US and other developed nations. As concerns over declining forex reserves rise, the RBI may refrain from aggressive selling of dollars to boost the weak rupee. But it may still use the reserves to reduce volatility in the forex market.

(Rohit Modar is a student at the National Institute of Securities Markets, Mohopada.)