DEPRECIATION OF INDIAN RUPEE
Why in News
- The Indian currency declined 2.2% in the Sep-Dec 2021 quarter. This depreciation of currency is due to global funds worth $4 billion having been pulled out of the country’s stock market.
- This downfall of currency makes the Indian rupee as Asia’s worst-performing currency.
About Depreciation:
- Currency depreciation is a fall in the value of a currency in a floating exchange rate system.
- Rupee depreciation means that the rupee has become less valuable with respect to the dollar.
- It means that the rupee is now weaker than what it used to be earlier.
For example:
- USD 1 used to equal to Rs. 70, now USD 1 is equal to Rs. 76, implying that the rupee has depreciated relative to the dollar i.e. it takes more rupees to purchase a dollar.
- Impact of Depreciation of Indian Rupee: Depreciation in rupee is a double-edged sword for the Reserve Bank of India.
Positive:
- While a weaker currency may support exports amid a nascent economic recovery from the pandemic.
Negative:
- It poses risk of imported inflation, and may make it difficult for the central bank to maintain interest rates at a record low for longer.
Appreciation vs Depreciation of Currency
- In a floating exchange rate system, market forces (based on demand and supply of a currency) determine the value of a currency.
Currency Appreciation:
- It is an increase in the value of one currency in relation to another currency.
- Currencies appreciate against each other for a variety of reasons, including government policy, interest rates, trade balances and business cycles.
- Currency appreciation discourages a country’s export activity as its products and services become costlier to buy.
Currency Depreciation:
- It is a fall in the value of a currency in a floating exchange rate system.
- Economic fundamentals, political instability, or risk aversion can cause currency depreciation.
- Currency depreciation encourages a country’s export activity as its products and services become cheaper to buy.
Devaluation v/s Depreciation
- In general, devaluation and depreciation are often used interchangeably.
- They both have the same effect – a fall in the value of the currency which makes imports more expensive, and exports more competitive.
- However, there is a difference in the way they are applied.
- A devaluation occurs when a country’s central bank makes a conscious decision to lower its exchange rate in a fixed or semi-fixed exchange rate.
- A depreciation is when there is a fall in the value of a currency in a floating exchange rate.
Reasons for Current Depreciation of Indian Rupee:
Record-High Trade Deficit:
- India’s trade deficit widened to an all-time high of about $23 billion in November amid higher imports.
- This growing trade deficit is driven by a rebound in oil prices.
Policy divergence Between RBI and Federal Reserve:
- The strengthening of USD in line with expectations of better growth in the US economy and favorable interest offered by the Federal Reserve (US’ Central bank).
- The RBI has been continuously buying dollars to build its reserves and prepare itself for any volatility.