DEPRECIATION OF INDIAN RUPEE

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.

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