USD 01.00 = INR 82.06 (as of 10th March 2023)
The above value of the exchange rate is staggering enough for Indians. Because there was a time when $1 was equal to Rs.1 (in 1947 though)! Since then our rupee never saw any revaluation. Its devaluation continued and reached the dollar-rupee exchange rate stated above. However, that’s not a final point because our Rupee appreciates and depreciates on a daily basis. But why rupee is falling against dollar? You may ask. Well, there are innumerable reasons for that!
In this article, we will throw light on some of the major reasons or factors that lead to the fall and rise of the Indian rupee against the US dollar.
Reasons for appreciation and depreciation of the Indian Rupee
Two kinds of factors are responsible for the appreciation and depreciation of the Indian Rupee-
Here are some essential external factors that explain why Indian rupee is falling against dollar.
- Global Economic Slowdown
Recently, the depreciation of the Indian rupee was caused by external factors. Among them, global inflation was a key player. Recently, you might have observed how inflation reached record levels in major developed economies like the USA or UK.
You may wonder how this happened. Let me explain it in simple terms. The global inflation was mainly caused by economic stimulus payments launched for post-Covid revival that led to supply chain disruptions. The former increased the money supply while the production of goods was still low. It created a classic situation-“Too much money chasing too few goods.” Eventually, prices of goods touched peak levels.
So, how is it related to the falling (depreciation) of the Indian rupee?
High global inflation caused volatile economic conditions worldwide. Also, the global economic slowdown led to a reduction in demand for Indian exports. Due to this, the value of the rupee fell against the US dollar.
- Foreign Investments
The global economic slowdown reduced the risk-taking mindset of investors. Due to this investors developed a “safe haven mindset.” They shunned investments in risky developing nations like India. Therefore, most of them took out their money from the Indian market. And sought risk-free investments like US treasury bonds and gold.
Foreign investments in India can effectively increase or decrease the demand for the Indian rupee. When foreign institutional investors pull their money out of our market, the value of the rupee decreases and that of the US dollar increases.
The internal factors responsible for the fall and rise of the Indian rupee against the US dollar are-
- Domestic Inflation
Inflation refers to the increase in the price of goods and services and a decrease in the purchasing value of money. It heavily impacts the value of the currency. When inflation in India is high, the purchasing power of the rupee decreases. It dissuades foreign investors from making investments in the region (i.e. India). Eventually, the demand for the currency decreases. And, the value of the rupee falls against the dollar.
Foreign buyers prefer products that belong to a country with lower inflation. Thus, high demand for goods and services results in currency appreciation.
Also, high retail and wholesale inflation in our nation increases the price of manufactured goods. This leads to expensive and uncompetitive Indian exports. We will explain this in detail in the next point.
- Trade Balance – High Imports & fewer Exports
The balance of trade between two countries is determined by the difference between the value of their imports and exports. When India imports more goods from the US than it exports, it creates a trade deficit. (Note: A trade deficit occurs when a country imports more goods and services than it exports.)
India has been running a trade deficit for many years, which means that it needs to buy more US dollars to pay for its imports. This exerts downward pressure on the value of the Indian rupee. Eventually, the demand for the dollar rises, leading to a fall in the value of the Indian rupee. It leads to a trade deficit.
On the other hand, if India exports more goods to the US than it imports, it creates a demand for Indian rupees, leading to an increase in its value.
- Interest Rates
The interest rate differential between India and the US can affect the value of the rupee. The Reserve Bank of India (RBI) sets the interest rates that significantly impact the value of the Indian rupee. The interest rates determine why rupee is falling against dollar. When the interest rate in India is higher than that in the US, foreign investors are attracted to investing in India because they will get high returns. This increases the demand for the rupee and can cause its value to rise. Thus, India with an interest rate of 6-7% attracts greater capital inflow as investors get a comparatively higher return than their earnings in the US with interest rates of 2-3%.
Contrarily if the interest rate in India is lower than that in the US, foreign investors do not prefer investing in India.
- Economic Stability
Foreign investors are more likely to invest in countries with stable political and economic environments. Do you know that the GDP growth of India for the current fiscal year is only 13.5%? It is much lower than the expected value i.e. 16%. It sets a red alert for the investors. They won’t invest in a country with a volatile economic condition. And lower investments lead to a low supply of dollars. As a consequence, the value depreciates.
However, if investors perceive the Indian economy as strong and growing, it can lead to an increase in the demand for Indian assets and a rise in the value of the Indian rupee.
Thus, a stable economy plays crucial in determining the exchange value of a currency.
Market sentiment and investor perceptions can also impact the value of a currency. We have explained various factors that can influence the value of the Indian rupee against the US dollar or why rupee is falling against dollar. Thus, the Indian rupee can rise or fall depending on the balance between demand and supply for the currency in the foreign exchange market.