The US dollar has strengthened significantly, while the Indian rupee has fallen to a lifetime low. Currency depreciation, like the rupee, can be viewed positively or negatively.
When the rupee depreciates, imported goods become more expensive, creating more opportunities for exporters.
The Reserve Bank of India (RBI) intervention is necessary to prevent excessive market fluctuations. However, the central bank’s interventions have long-term implications and benefits.
The rupee’s depreciation is a complex issue. It is not only economically important but also affects India’s reputation and position in the global market. A strengthening rupee is crucial for India to achieve a strong and stable economic future.
What is an Exchange Rate? An exchange rate is the rate at which one country’s currency can be converted into another country’s currency.
For example, if 1 US dollar is worth 84 rupees, Indians must spend 84 to buy one dollar. Different currencies around the world have varying exchange rates.
Exchange Rate Policies:
- Fixed Exchange Rate: In this system, the government or central bank keeps the exchange rate constant.
- Free Exchange Rate: In this system, the exchange rate is determined by market forces.
India operates under a free market system; however, the RBI intervenes as necessary to control excessive fluctuations.
Demand and Supply of the Rupee: Demand and supply depend on several factors. Foreign investors mainly demand the rupee, and Indians require dollars to pay for imports.
Additionally, an increase in Indian exports raises the supply of rupees, while more imports and withdrawals of foreign investments increase the demand for rupees.
There are several reasons for fluctuations in exchange rates:
- Oil Prices: India imports about 80% of its crude oil. When oil prices increase, India requires more dollars, reducing the rupee demand and causing the exchange rate to fall.
- Interest Rates: When the US Federal Reserve raises interest rates, global investors may withdraw their investments from India to invest in the US, weakening the value of the rupee.
- Trade Deficit: A situation where imports exceed exports creates a trade deficit, which puts additional pressure on the rupee.
Flexible Exchange Rate Policy: In a flexible exchange rate policy, the currency’s value fluctuates based on market demand and supply, revealing its true value and enhancing market transparency. This policy also contributes to financial stability.
RBI Intervention: The RBI’s primary goal is to reduce volatility in the rupee’s value. The level of RBI intervention has been significant since 1991.
Since late 2022, the RBI has adopted a policy of buying and selling dollars to control currency devaluation and revaluation.
However, the RBI does not disclose its policies, which creates confusion in the foreign exchange market and makes it difficult for the market to predict changes in the exchange rate.
Current Developments: The rupee has reached a lifetime low against the dollar. Despite RBI intervention, the decline continues.
The rupee’s fall has intensified following the US Federal Reserve’s increase in interest rates. Notably, the US dollar strengthened after Donald Trump’s victory while the rupee weakened. Recently, the Federal Reserve announced a 25 basis point reduction in interest rates.
The stability or decline of the rupee’s exchange rate is crucial for the economy and initiatives like “Make in India.” While RBI intervention may provide temporary stability, experts suggest adopting an independent exchange rate policy for long-term economic strategies.