Rupee struggles to gain against the US Dollar

Hello everyone!

This week, I will be analysing the fall of the Indian Rupee against the US dollar and what measures is India taking to contain the Rupee slide.

Introduction:

The Indian Rupee (INR) hit an all-time low against the US Dollar (USD) on 28th September 2022, touching a record low of 81.94 and nearing the 82-mark against the dollar. This sent shock waves across the Indian markets and market watchers closely looking at the next step of the Reserve Bank of India (RBI) to stem the downfall of the Rupee. Earlier in the past, the RBI has stepped in and stopped the Rupee from falling any further by selling USD and buying back the INR from the forex market. However, increasing the supply of USD in the market has not proved to be enough to prevent the Rupee from falling any further. All major currencies such as the Pound, Yen and Euro have been falling compared to the dollar given the interest rate hikes by the US Federal Reserve and the strong rally of the dollar in the forex market.

Key reasons behind INR's fall:

Following the US Federal Reserve's announcement of an interest rate hike last week, the INR has since been on a downward swing against the dollar. On 21st September, the Fed delivered a rate hike for the third straight month of 75 basis points (1 basis point= 0.01%), in order to tame inflation in the US economy. Thus, the supply of dollars tightened in the market due to the Fed exercising a contractionary monetary policy. This had a great impact on the exchange rate figures in the forex market, and the dollar index gained by 3.5% hitting a 20-year high. Resultantly, many currencies including the INR nosedived against the dollar.

Global crude oil and commodity prices have been on the rise since the start of the Russia-Ukraine war which has proven to be a big challenge for the Indian economy, which imports 70% of its crude oil. This has pushed up the cost of import bills and thus the trade deficit is widening month after month putting downward pressure on the Rupee and also raising fears of imported inflation in India. Indian imports are increasing at a much higher pace than the country's exports, causing the supply of INR to increase in the forex market thus depreciating its value against the dollar. Consequently, the increasing prices of essential commodities such as coal, crude oil and other raw materials that are imported and are necessary for the Indian Economy have resulted in a weaker rupee.

Foreign portfolio investment outflows are also a major reason behind the depreciating Rupee. The tightening monetary policies in overseas economies, especially the United States, have attracted foreign investors who are now withdrawing money from India leading to investment outflows from the Indian Economy. As of July 2022, Foreign Portfolio Investors pulled out $14 billion from Indian Equity markets. This increased supply of INR in the Forex market thus depreciating the Rupee.

Steps undertaken by RBI:

The RBI has stepped up its efforts in order to arrest the depreciation in the currency. The bank has used its forex reserves to prevent the Rupee's fall and reduce its volatility in the market. RBI's forex reserves have so far been depleted by around $97 billion to $545 billion from $642 billion a year ago. If the RBI continues selling dollars in the market, the forex reserves could deplete to around $500 billion in the coming months. Therefore, sacrificing and depleting its forex reserves cannot be an option for RBI in the long run.

To protect its dollar reserves, in July RBI came up with a Rupee trade mechanism to prevent further depreciation of the Rupee reducing demand for dollars in the market. Under the terms of the mechanism, the Indian exporters will receive payment for their goods in INR and the importers will pay for the imported goods in INR. This will help bolster the Rupee by increasing its demand in the forex market along with helping RBI protect its forex reserves. The new rule will also help India trade with countries in their local currencies. Therefore, the RBI has chosen a way to stem the downslide of the Rupee by implementing a new Rupee trading system and conserving its forex reserves for future use.

Analysis:

The Rupee's downfall against the dollar will have far-ranging effects on the Indian Economy. The depreciating Rupee will have a positive impact on increasing Indian exports however the cost of higher imports, the depreciating Rupee and the imported inflation will outrun the positive impact. RBI's measures of selling the dollar in the market have proven to be helpful in the short-run as the Rupee's slide against the dollar is not as much in comparison to other currencies, which have lost a value of over 10%. However, this policy will not prove to be beneficial in the long run as India will only run out of more forex reserves which can be used in future to tackle other crises. Therefore RBI's Rupee trade mechanism should be a good start to stop the Rupee's further depreciation. The rate hikes enforced by RBI in recent months will also help moderate the depreciation of INR.

India's current repo rate (the interest rate at which RBI lends funds to banks) stands at 5.4% and the RBI is expected to deliver a 50 basis points hike on 30th September following the US Fed's 75 basis points hike last week. This move can be a breather for market watchers as it will help fight back against the strong dollar and improve foreign capital inflows in India thus, arresting the decline against the dollar.

Conclusion:

The Rupee's falling value against the dollar has been a major concern for economists as India is a nation highly dependent on crude oil and other commodity imports, which raises fears of imported inflation. The RBI might have to announce more measures to slow down the Rupee's fall against the dollar and reduce volatility in the market. Another aim should be to boost Foreign capital inflows and reduce outflows.

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References:

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