What Are The Key Reasons For Rupee Depreciation? A Deep Dive

First of all, look at the following data to understand the scenario of Rupee depreciation-

What did you deduce from the information given above? The value of the Indian rupee just fell and fell…

Looks like trading or traveling to the US is much costlier now than it was before!

But that’s not the case with some exclusive currencies. Just see how excellently they are performing against US dollars–

Then why Indian Rupee depreciation is not taking a pause? You may wonder.

Well, the value of Indian currency highly depends on the demand. Means? Go through the following sections and you will find out!

(A) Rupee Depreciation: Understanding the Concept

The value of a currency, like the Indian rupee or any other currency, depends on how much people want it i.e. “demand”. If more people want it, its value goes up (this is called appreciation). If fewer people want it, its value goes down (this is called depreciation).

When foreign investors put money into India, they need Indian rupees to do so. This makes the demand for rupees go up, and its value goes up compared to other currencies like the US dollar.

But when Indians buy things from other countries, like oil or gold, they have to pay in dollars. So they trade their rupees for dollars, increasing the demand for dollars and making the rupee weaker compared to the dollar.

Because India buys more than it sells from other countries, the rupee has been getting weaker over time. 

In the last few years, the rupee has fallen from needing ₹60 for 1 US dollar in 2014 to now around ₹82 for 1 US dollar. On average, the rupee has been getting around 36.7% weaker against the dollar each year.

While the rupee getting weaker over time is indeed a big worry because India buys more than it sells. If it gets weaker too fast and that too consistently, it can be a problem. 

It will have a disastrous impact on your finances. How? We will discuss this part in upcoming sections in detail.

(B) Key Reasons For Rupee Depreciation

Here are some of the crucial factors responsible for Indian Rupee depreciation-

(B.1) Global Economic Slowdown

Lately, the decline in the value of the Indian rupee has been influenced by outside forces. One significant factor was the rise in global inflation. You might have noticed how inflation has surged to unprecedented levels in major developed countries like the USA and UK.

How did this happen? You may wonder. 

Let me break it down for you. The global inflation was mainly triggered by the economic stimulus payments introduced for post-Covid recovery, which led to disruptions in the supply chain. 

These stimulus measures increased the amount of money in circulation while the production of goods remained limited. This created a classic scenario of “Too much money chasing too few goods,” eventually driving up prices.

Now, you may ask, how does this relate to the depreciation of the Indian rupee?

High global inflation caused economic instability worldwide. Additionally, the global economic slowdown resulted in a decrease in demand for Indian exports. As a result, the value of the rupee decreased against the US dollar.

(B.2) Foreign Investments

The slowdown in the global economy altered investors’ attitudes towards risk. As a result, many adopted a “safe haven” approach, avoiding investments in riskier developing countries such as India.

Consequently, a significant portion of investments was withdrawn from the Indian market, with investors opting for safer alternatives like US treasury bonds and gold.

Foreign investments play a crucial role in determining the demand for the Indian rupee. When foreign institutional investors withdraw their investments from our market, it leads to a decrease in the value of the rupee and an increase in the value of the US dollar.

How?

Go through the next section and you will find out!

(B.3) Overseas Investors running away from Indian markets

Due to the US Federal Reserve’s plan to raise interest rates and the ongoing conflict between Russia and Ukraine, foreign investors are pulling their money out of Indian markets. When these investors withdraw their investments from India, they receive their funds in Indian rupees. 

However, they need to convert these rupees into US dollars. This leads to an increase in demand for dollars and a decrease in demand for rupees. 

As a result, the value of the Indian currency falls in comparison to the US dollar.

(B.4) Exessive Purchasing of Crude Oil

Because India imports more crude oil than it exports, the sharp increase in global oil prices, up by over 60% since the beginning of 2022, is impacting Indian companies. 

They now have to spend more dollars to buy the same amount of oil. This surge in demand for dollars leads to a weaker Indian rupee. 

(B.5) Domestic Inflation

Inflation means prices of things go up and the money you have can buy less. This affects how much your money is worth. When inflation is high in India, the value of the rupee goes down. This makes foreign investors less interested in investing in India. 

So, the demand for the rupee goes down, and its value falls compared to the dollar.

Foreign buyers like to buy things from countries where prices are not going up too fast. This makes the currency of that country more valuable. 

Also, when there’s a lot of inflation in India, the cost of making things goes up. This makes Indian products more expensive compared to products from other countries. So, fewer people want to buy Indian goods, which makes our exports less competitive.

(B.6) Trade Balance- High Imports & Fewer Exports

The balance of trade between two countries depends on how much they import and export. When India buys more goods from the US than it sells, it creates something called a trade deficit. This happens when a country buys more things from other countries than it sells to them.

India has been in a trade deficit for a long time. This means it has to get more US dollars to pay for the things it imports. 

Because of this, the value of the Indian rupee goes down. As more people want dollars, the demand for them increases, making the rupee worth less.

But if India sells more things to the US than it buys, it creates a need for Indian rupees. This makes the rupee worth more.

(B.7) Interest Rates

The difference in interest rates between India and the US can affect how much the rupee is worth. The Reserve Bank of India (RBI) decides on interest rates, which really matters for the rupee’s value. These rates explain why the rupee might be losing value compared to the dollar. 

When the interest rate in India is higher than in the US, foreign investors like to put their money in India because they can earn more interest. This makes more people want rupees, and the value of the rupee can go up. For example, if India’s interest rate is 6-7%, while the US rate is only 2-3%, investors would rather put their money in India for better returns.

But if India’s interest rate is lower than in the US, foreign investors aren’t as interested in investing in India.

(B.8) Economic Stability

Foreign investors prefer to invest in countries where the political and economic situations are stable. Did you know that India’s GDP growth for the year 2023 was only 13.5%, lower than the expected 16%? 

This rings alarm bells for investors. They avoid investing in places with shaky economies. Less investment means fewer dollars coming in, and as a result, the rupee loses its value.

However, if investors see India’s economy as strong and growing, they will want to invest more. This increases the demand for Indian assets and makes the rupee stronger.

So, having a stable economy is important for determining how much a currency is worth.

(C) Impact of Rupee Depreciation on Your Finances

The downfall of the Indian rupee will impact your finances in the following ways-

(C.1) Rise in Inflation

When Indian companies buy things from other countries, they have to pay in dollars, like we talked about earlier. If the rupee gets weaker compared to the dollar, buying crude oil becomes pricier. The same goes for imported goods like electrical machinery, mechanical appliances, and precious metals such as gold.

So, things made from these imported materials might also become more expensive. Companies might not be able to handle this extra cost and might have to charge customers more. This could speed up inflation in India more than we thought.

(C.2) Interest Rate Hikes – Higher FD Rates and Loans

A moderate level of inflation is considered good in a healthy economy. Why? Because it doesn’t hurt consumers much and encourages businesses to grow. But if inflation suddenly shoots up, it’s not good for the economy.

In India, the RBI is responsible for keeping inflation under control. If the RBI thinks that inflation might go beyond what it can handle, it raises something called the repo rate to deal with it. If you want to know more about this, we have a blog that explains why the RBI raises interest rates to control inflation.

When the RBI increases interest rates, it becomes more expensive for banks to borrow money. So, they raise the interest rates they charge for loans and the rates they offer on deposits.

Right now, the RBI hasn’t increased interest rates because it’s trying to support growth by keeping inflation in check. But globally, other central banks are planning to raise interest rates in their countries. If inflation stays high in India, we might also see interest rates go up soon.

(C.3) Possible Dip in Your Investment Portfolio

As you have read above, when foreign investors withdraw from Indian stocks, the rupee is taking a hit. This departure of foreign investors causes a significant drop in the stock markets. 

Consequently, your investments in stocks and equity mutual funds might see a decline too.

But that’s not all – even your returns from Debt Funds could shrink. Here’s why- If rupee depreciation triggers a sharp rise in inflation, the RBI might raise interest rates. And during such times of increasing interest rates, Debt Funds tend to perform poorly.

(C.4) More Expensive Foreign Travel and Studies

One big consequence of the rupee’s drop is that expenses for foreign trips and studying abroad are set to increase. Remember how we discussed earlier that with the rupee falling, you’ll need more rupees for every dollar? 

Well, that means your costs are bound to skyrocket… So, be prepared for your travel and education expenses to go up!

(D) How to deal with Rupee Depreciation?

We know that a sudden drop in the rupee’s value is highly disappointing for Indians. But you know what? There are several ways through which you can turn this sour situation to your advantage. 

How?

You can consider investing in International Funds. This will allow you to benefit from rupee depreciation by gaining exposure to foreign currency while investing in rupees. 

If the foreign currency appreciates or the rupee weakens further, your returns could increase.

Isn’t it a brilliant idea?

Another approach is to adjust your portfolio towards companies with significant foreign exchange earnings. 

Think about sectors like IT, FMCG, and Pharma. These companies are likely to see higher revenue and profit growth because their products become more affordable overseas, helping to maintain profit margins. Thus, they’re better equipped to weather rupee depreciation.

In short, the key to managing sharp rupee depreciation lies in building a diversified portfolio and making timely adjustments to protect your finances. 

So, stay proactive in terms of making wise investments!

(E) Final Note on Rupee Depreciation

In a nutshell, knowing the reasons responsible for Indian rupee depreciation is crucial for your financial planning. Things like trade imbalances, inflation, interest rates, and the global economy all affect it. 

By staying aware and spreading out your investments, you can lessen the impact of rupee depreciation on your money. 

Also, we have thoroughly explained the topic “Why Indian Rupee Falls And Rises Against US Dollar?”

You can go through it for detailed information.

Just keep an eye out for what’s happening in the markets and adjust your plans to secure your finances from Rupee depreciation.

Thanks for reading 🙂 Don’t forget to share your thoughts in the comment section below!