Why is the rupee falling against the dollar?

Why is the rupee falling against the dollar?

The Bretton Woods Accord established the United States Dollar as the official leader of the global reserve currency, backed by the most significant gold reserves on earth. After the Second World War, this happened. Despite its strength, the U.S. dollar remains a global currency of choice. In its current form, the dollar note was first produced in 1914. Even now, approximately 60% of the reserves held by central banks worldwide, including India, are in U.S. dollars.

 

Currency Force and Demand

A currency’s value rises when demand for it rises and falls in value when demand for it falls. Worldwide, central banks are in charge of the power of money. On the other side, the demand for the currency mentioned above is determined by the demand for the country’s goods and services.

Requests for foreign exchange adhere to the same rules. When there is a higher demand for foreign currency, currencies depreciate more.

 

What Causes the Indian Rupee to Depreciate Against the Dollar?

India’s INR has steadily lost value against the dollar in the post-Covid world of 2022. Understanding that the Indian Rupee has been depreciating versus the dollar for many years is crucial. Rising inflation that is having an impact on the Indian economy is one of the leading causes of this. The Indian Rupee now exchanges for around 79 INR to 1 USD. The Indian Rupee has dropped to an all-time low value versus the U.S. dollar in the previous few weeks, falling to 79 INR. This rapid fall has several causes, some of which are domestic.

The withdrawal of FIIs from an uncertain global market is one of the leading causes of this drop. The geopolitical uncertainties brought on by the Russia-Ukraine conflict are added to this.

Investors have, as a result, moved away from emerging countries like India and toward the security of the USD. Recent statistics show a 2.11 lac crore outflow of foreign portfolio investors.

The sharp increase in crude oil prices is one of the leading causes. The increased cost of cooking oil, which is also a result of the Russia-Ukraine conflict, adds to this strain. This high price will continue to pressure the Indian Rupee because most of India’s crude and edible oil needs are imported.

The performance of the Indian Rupee has been compromised. Global trade conditions that are deteriorating, geopolitical unrest, the departure of FIIs (foreign institutional investors), and the RBI’s position on foreign exchange are the icing on the cake. The situation is not, however, as bad as it appears. The Indian rupee has fared better than some peers against the dollar on the international stage. This shows that the end of the tunnel is rapidly near.

 

What Prospects Does the Indian Rupee Have?

The war’s immediate impacts will be felt in the next quarter, which might keep the Indian Rupee under pressure. The Indian Rupee may stabilize between INR 77 and INR 79 versus the U.S. Dollar shortly. However, there are numerous grounds to anticipate the INR increasing in the future on the international markets. The RBI has a sizable FOREX reserve, which is the first and primary consideration.

Even though India’s current account deficit is well over 90 billion USD, this reserve would help stop the rupee’s decline versus the dollar. While the COVID-19 epidemic temporarily put the globe on hold, it also caused businesses to take a second look at their overseas production facilities, most of which were situated in China.

Most manufacturing corporations have started looking to other emerging countries like India and Indonesia to set up their operations due to the Chinese government’s generally unfavourable policies. This will probably entice FIIs back into the nation and expand their investment holdings.

 

Why did the rupee today fall to a record low of 78 versus the U.S. dollar?

On Monday, the Indian rupee touched a new record low against the U.S. dollar, falling to 78.20. Since January 2022, the rupee has fallen 5%, with the leading causes being a higher U.S. dollar index, rising oil prices, and dollar outflows from Indian stock and bond markets. Foreign institutional investors have taken out more money in the first five months of 2022 than they invested during 12 years, from 2009 to 2021, totalling over Rs 2,15,000 crore.

The equity markets also reflect this attitude. Since January, the 30-share BSE Sensex and the Nifty have lost more than 10% of their value. Rising interest rates throughout the world are one of the causes of the selloff. Foreign institutional investors (FIIs) start withdrawing capital from unstable economies like India when interest rates rise, and the rupee’s devaluation is increasing their fears. It is thought that rising U.S. dollar values are bad for emerging markets.

IFA Global stated in a report on Sunday that “weak local markets, increasing crude oil prices, a strong dollar, and ongoing foreign capital outflows are projected to keep the domestic currency under pressure in the week ahead.”

 

Why has the rupee fallen?

Although the rupee exceeded 78 today, it is still in line with other currencies compared to the U.S. dollar. The U.S. and other safe havens are seeing an influx of capital. The ongoing conflict in Ukraine, the resulting supply interruptions, and the oil price have reduced growth prospects and raised the cost of financing. As a result, FIIs withdrew their funds, depreciating the rupee, according to Astha Mago, Associate Director at Client Associates.

The value of the INR has decreased by about Rs. 20 during the last ten years, and based on the present situation; it may continue to decline. Although other currencies outside India have also been impacted by the current currency environment, Central European and Asian currencies have also seen changes. However, the key participants in this transaction are India’s higher inflation prediction and the U.S.’s proactive stance on managing its economy.

Higher interest rates and a limited supply of the USD are results of American monetary policies. This difference has a detrimental impact on the import of crude oil and the outflows of foreign funds. This has already affected the stock market, as seen by the significant declines in the Nifty and Sensex today, and it will continue to impact the Indian economy in terms of gasoline costs negatively. At this moment, India needs swift, strong fiscal policies to absorb this hit, according to Sonam Chandwani, managing partner of K.S. Legal and Associates.

 

The rising dollar index

As the U.S. dollar outperforms other currencies, its index keeps rising. The U.S. dollar index, established in 1973, calculates how much the U.S. dollar is worth compared to the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona. The index’s value provides a reliable representation of the dollar’s worth on international markets. If the USDX increases, the U.S. dollar becomes more valuable or robust relative to other currencies.

All underlying assets linked to the dollar increase in value when the dollar’s value does. These include U.S. government bonds, Treasury bonds, currency bonds, and stocks of American corporations. The value of the Indian rupee falls when the Dollar index rises, strengthening the dollar. A weaker rupee raises the price of imports and reduces India Inc.’s profitability by increasing the cost of manufacturing. Finances become more difficult for the commoner due to rising prices for products and services due to inflation.

The U.S. Dollar Index (DXY) is about to challenge the 105 levels after rising again. As a result, currencies from emerging economies (E.M.) are losing value relative to the dollar. High oil prices are causing increased pressure on these currencies. High oil prices cause “imported inflation,” which affects FII inflows and business profitability. The cost of Indian crude oil is at a 10-year high. These cumulative worldwide trends are causing the INR to decline, according to Vijay Bhambwani, Head of Research Behavioral Technical analysis at Equitymaster.

 

What causes a rupee to lose value?

“The rupee has been stronger if it can purchase more dollars for one, and vice versa. The current rupee sink results from investors dumping their rupee-based assets and replacing them with ones based on dollars. The rupee hit an all-time low today as more investors sold off their dollar-based assets for rupee-based ones. Given that India buys more than it exports, this might increase inflationary pressure, according to Anushka Arora, Principal & Founder, ABA Law Office.

 

Interest rates and the rupee

The U.S. Federal Reserve is predicted to raise its policy rates by about 75 basis points in reaction to the record retail inflation in the U.S. The return on dollar assets rises compared to emerging economies like India when the U.S. Fed raises interest rates. “When the rupee declines in value, FII’s investment value decreases, which affects the overall amount invested. FIIs sell their investment to offset the loss to avert additional loss, “Managing Partner at PSL Advocates & Solicitors, Sameer Jain, remarked.

The rupee depreciates when money leaves India, and the rupee-dollar exchange rate is affected.

A significant amount of pressure is put on the already high import prices of oil and raw materials due to this devaluation, which also increases the cost of manufacturing and import inflation in addition to retail inflation.

“Since payments for imports are done in U.S. dollars, the rupee’s decline versus the greenback significantly influences the increase in import prices. On the other hand, exports benefit if payment is made in USD. As imports become more expensive, the local cost of living rises, and inflation increases “extra Jain.

In its report, India Ratings and Research stated that the global central banks had raised their policy rates in addition to ending their ultra-loose monetary policy even before the RBI’s policy decision on May 4, 2022, as a result of growing inflation in advanced nations.

After a hiatus of more than three years, the U.S. Fed increased its policy rate for the first time by 25 basis points (bps) in March 2022 and then again by 50 bps in May 2022. “As predicted, the U.S. Fed’s monetary tightening has led to a decline in portfolio investment. Foreign portfolio investors withdrew 21.2 billion USD from India as of May 16. This has suddenly put pressure on the Indian currency and foreign reserve, in addition to a greater import bill,” it continued.

According to Ind-Ra, the Indian rupee would weaken by 4.9% and average at 78.19 against the U.S. dollar in FY23.

Crude oil

Since the geopolitical crisis has worsened due to Russia’s invasion of Ukraine in late February, the rupee has been under increased pressure. Eighty-five per cent of India’s energy needs are satisfied by crude oil imports. When crude prices rise, it puts pressure on the rupee since India’s import costs rise. Brent crude’s price, which was about $110 per barrel on May 21, has now grown to $122 per barrel.

In its most recent policy review, the RBI used a $105 international oil price rate last week to assess inflation. When giving the monetary policy statement last week, RBI Governor Shaktikanta Das stated that inflation is now forecast to be 6.7% in 2022–23, with Q1 inflation being 7.5%, Q2 inflation being 7.4%, Q3 inflation being 6.25%, and Q4 inflation being 5.8%, with risks being equally balanced.

If oil prices are growing, imports must also be rising steadily. The U.S. dollar appreciates against the rupee due to increased demand, and the Indian rupee continues to lose value. As a result, the Indian currency’s purchasing power on the global market declined.

 

FPI pullout

The amount of foreign capital left the Indian equities markets in June was close to Rs 14,000 crore. FPI equity investments decreased by Rs 1.81 lakh crore in 2022.

“This is because the market prices, which have been solidifying over the last seven months, already take into account a significant portion of the transition, such as the economic slowdown, hawkish monetary policy, supply restrictions, and rising inflation. Additionally, substantial inflation is necessary for central banks to continue their aggressive policies over the long run, “said Vinod Nair, Geojit Financial Services’ Head of Research.

Foreign investment in the stock market is one of the variables affecting the rupee’s strength.

The rupee depreciates if foreign investors turn into net sellers. The rupee fell by 6% in June 2013 due to FIIs withdrawing about $7.5 billion from Indian markets out of concern that the U.S. Federal Reserve will reduce quantitative easing.

“A weakening rupee impacts the FIIs since it lowers their net earnings in the bond and equity markets. When an overseas investor invests Rs 60,000 on a rupee bond with an annual yield of 8%. The U.S. dollar value was 60 rupees at the time of funding. As a result, he invested $1,000 and received interest of $80 (at an annual rate of 8%). The value of his investment will drop to $857 if the dollar is at Rs 70 at the time of redemption, indicating that the rupee has appreciated.

His interest profits will drop to $68 as a result. At the end of the year, his investment will be worth $925, a loss of 7.5% in total. Foreign investors could participate in fund distress sales due to the drop in their interests’ value. The rupee’s value might fall even more if these investors panic and withdraw their money from the market. Because of the hot money, many foreign investments would be removed from the market, argues Kotak Securities.

 

Conclusion

The signals are that, despite the somewhat gloomy immediate future, there is every reason to expect a magnificent recovery of the Indian Rupee versus the U.S. Dollar as the Indian economy grows and the local financial markets push closer to a bull run. The rupee has been continuously declining, and there are no indications that it will begin to appreciate appreciably any time soon. On Wednesday, the Indian rupee closed roughly at 79.30 against the U.S. dollar, not far from its historically low closing of 79.37.

The rupee is sinking, so why?

The value of the Indian rupee about the U.S. dollar is determined by supply and demand. The value of the dollar rises when the order is more robust. The Russian-Ukrainian conflict’s impact on supply chains, the Covid pandemic’s aggravation of global economic problems, inflation, high costs for crude oil, etc., have contributed to the Indian rupee’s slide since the beginning of this year.

The value of a nation’s native currency will decrease about the dollar if it imports more than it exports, as is the case with India.

 

According to analysts, the decrease in the rupee in recent months has been caused by rising crude oil prices, a strong foreign currency, and outflows of foreign money.

 

Because foreign institutional investors (FIIs) have sold shares worth more than $30 billion this year, foreign funds have been expelled from domestic markets. This is far more than the $11.8 billion selloff observed during the 2008 global financial crisis.

The dollar-rupee exchange rate is impacted as money leaves India, which causes the rupee to devalue.

The import prices of petroleum and raw commodities, which are already high, are significantly impacted by this devaluation. Along with increasing retail inflation, this raises import inflation and manufacturing costs.

The U.S. Federal Reserve recently increased interest rates, and when compared to other emerging countries like India, the return on dollar assets increased. Additionally, there are rumours that the U.S. Fed may raise rates more aggressively, which would be detrimental to the rupee. In conclusion, the backdrop of high inflation, the Covid issue, monetary tightening by critical central banks, and economic disruptions caused by the Russia-Ukraine war have slowed global growth, resulting in the rupee’s enormous decline versus the dollar.

 

What can be done to stop the rupee’s troubling downward trend, then?

Last week, the government announced several actions that are likely to limit international commerce and stop the devaluation of the rupee, including increases in gold import taxes and higher taxes on diesel, gasoline, and ATF. Additionally, the import duty on gold was raised from 7.5% to 12.5%.

It is anticipated that the Reserve Bank of India will support the rupee by selling dollars in the spot, future, and other derivatives markets. Additionally, as part of a procedure anticipated to entice foreign investors into debt assets, it will likely boost policy rates even further.

But will that be sufficient?

“India will need to respond much more forcefully in the meantime, with more exports and decreased imports, assuming that the new global energy order entails prolonged hardships in the oil market. Otherwise, it is unlikely that RBI currency reserves would again fall to 15% of GDP in the upcoming years (a formula for external instability, as witnessed during the 2013 “taper tantrum”).

In light of this, it is best to allow the INR to diminish over time so that CAD can be gained gradually over time. As a result, according to a research note from Emkay Global Financial Services, “We think the RBI may finally permit the currency rate to adjust to new circumstances, although orderly, allowing it to operate as a natural macro stabilizer to policy reaction functions.

Therefore, analysts concur that India must take deliberate steps toward reducing imports and rising exports, even if there may not be a simple solution. To reduce imports and support the rupee, the government may also actively encourage the usage of domestic products in the future.

 

FAQs

• What causes the value of the rupee to decline?

Some factors contributing to the rupee’s decline versus the dollar include increased import prices, rising crude oil prices, and the Russia-Ukraine war.

• What occurs if the value of the rupee drops versus the dollar?

The cost of raw resources will rise if the rupee depreciates against the dollar, which would be passed on to customers and raise the price of goods.