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The recent fall in the rupee is due to various factors, but we must first see how the rates are determined. Most international trade is made in US dollars, so the demand and supply of dollars is the reason for fluctuation in rupee price and the exchange rate. Two main things determine the value of the rupee: the difference in India’s imports and India’s export and foreign investment. When exports rise, then the value of the rupee rises as there is less demand for dollars and vice versa. Similarly, when imports rise, the value of the rupee falls.
Reasons for falling exchange rate
Now in the case of foreign investment, when foreign investors invest in India, there is a rise in the value of the rupee, and when they sell their assets in India, there is a fall in the value of the rupee.
The reasons for the rupee falling are the exchange rate against the higher fuel costs, rising prices of goods, rising interest rates, higher import costs, Indian export, rising inflation, importing more gold, and many other things.
The first case is our Canadian Dollar (CAD), which is troubling our country due to fewer exports (-5 %) and imports increasing by 2 %, so the net deficit is being observed. The reasons for less export are many. So to cover the deficit, we are printing rupees, which means more rupees in the market and hence the dollar exchange rate will increase. And this is a simple and logical explanation.
The main reason for the sorry condition of the Indian currency is the mammoth trade deficit (India’s trade deficit is at $190 bn) that India has. Such a large trade deficit inadvertently increases the demand for dollars among Indian buyers and consequent selling of the rupee. This creates pressure on the Indian Rupee. While this holds true even in normal conditions, traders start dumping the rupee during crises due to nervousness as they fear the flow of capital from the country (which further increases the selling of the rupee).
The reason for such a large trade deficit in India can be further attributed to two things:
Crude oil and gold import- Energy and gold-hungry India imports around 220 billion dollars of crude oil and gold annually, which comes to around 75% of our total exports. Add to that other major imports in other sectors and the amount reaches 170% of exports. But why do we need to import so much crude oil and gold?
India has not been able to make a breakthrough in finding oil and gas except for a very old discovery in Mumbai High, the KG basin discovery by Reliance and the one by Cairn in Rajasthan. Except for these, all other discoveries have been very small. So, the country is vastly unexplored in terms of natural resources. Companies want to invest, but no cheap financing is available; the risks are too high to make a commercial discovery.
The Indian government, for some reason, loves to keep the inflation consistently too high and believes in taking no steps to bring it down. Now, people forced to live in such an inflationary environment need to park their money somewhere to protect them from inflation, and here comes the gold to their rescue! On top of that, gold has always been a darling of black money. So, as corruption rises in India (hidden from nobody), the demand for gold is also soaring exponentially, fueling the gold imports (as India’s gold production is almost negligible compared to the country’s demand).
Very small manufacturing base- India has always been notorious for having a very low quality of infrastructure, erratic power supply, unstable policy environment, and high cost of borrowing. All these factors add to investors placing India at the lowest priority order for setting up a manufacturing base. So, low manufacturing means most of the demand is met up by imports in the majority of the sectors, the major ones being electronics and semiconductors, fertilisers, power plant equipment, and almost all the big-ticket items and products. Now logically, as the currency weakens, it should benefit the exports from the country, and more investors should have come forward to set up a manufacturing base in India for domestic consumption and the exports from the country. But due to structural problems, exports have stagnated, and the cost of imports is rising simultaneously as the currency devalues. So, what (currency depreciation) could have been a gain for India, has become a headache due to investors’ unfriendly environment.
Until and unless India can solve the above two problems, it is impossible to lower the trade deficit, which would, in turn, continue to take the rupee lower.
Conclusion
However, the Reserve Bank of India seems to be indifferent to the economic pressures, and it has left its policy repo rate unchanged at 7.25 per cent. The Reserve Bank of India claims that its efforts are not directed at curbing short-term inflation rates but rather at curbing long-term inflation rates. Only time will tell everyone if the Reserve Bank of India’s policies will effectively improve the economic condition of the rupee in India. As economists and experts predict, India will be enveloped in inflation in months to come due to the weakening of the Indian currency.
