The current weakening of the rupee is believed to be mainly due to the exodus of foreign investors from India, which is putting pressure on the rupee. |Photo provided by: Reuters
Story so far: In the last week of December 2024, the rupee crossed the $85 mark against the US dollar and hit an all-time low of Rs 85.81. The currency depreciated by approximately 3% in 2024, continuing a long-term trend of gradual but consistent decline in value relative to the dollar.
What causes a currency to depreciate?
The price of a currency in the foreign exchange market is determined by the demand for the supply of currency. This is similar to how other products are priced in the market. If the demand for a product increases while the supply of the product remains constant, the price of the product increases to limit the available supply. On the other hand, if the demand for a product decreases even though the supply of the product remains constant, sellers will lower the price of the product to attract enough buyers.
The only difference between the commodity market and the foreign exchange market is that in the foreign exchange market, currencies are exchanged for other currencies, not goods.
When the demand for a currency (in foreign currency terms) decreases compared to the supply available in the market, a currency depreciates against a foreign currency. When the value of a currency decreases, the value of the foreign currency automatically increases on the other side. This is similar to how when the price of a good in the market rises or falls, the purchasing power of money falls or rises, respectively.
There are various factors that determine the demand and supply of currencies in the foreign exchange market.
One of the most important factors determining the supply of money in the market is the monetary policy of a country's central bank. When a central bank adopts an easy monetary policy relative to other central banks, the supply of its currency in the market increases relative to other currencies (for both goods trade and investment purposes), and its currency value will fall. On the other hand, central banks that adopt relatively tight monetary policy are likely to see their currencies appreciate in value.
On the other hand, an important factor determining the demand for a currency is the demand of foreigners for a country's goods and assets. Before foreigners can buy the goods and assets of a country, they must first buy the local currency, so high demand for goods and assets of a country leads to high demand for that country's currency, which leads to currency leads to an increase in the value of On the other hand, when demand for a country's goods and assets falls, the value of that country's currency falls.
What is behind the rupee depreciation?
The current weakening of the rupee is believed to be mainly due to the exodus of foreign investors from India, which is putting pressure on the rupee.
Investors around the world are shuffling their investments across countries as central banks readjust monetary policy to varying degrees. High inflation following the coronavirus pandemic led to monetary tightening by central banks, and this trend is now reversing as inflation is becoming more contained. This has led investors to withdraw their funds from markets such as India and invest in more developed markets.
On the other hand, the long-term depreciating trend of the rupee against the dollar can be attributed to higher inflation rates in India than in the US due to the looser monetary policy of the Reserve Bank of India compared to the US Federal Reserve. It is being India has traditionally sought high-value imports such as crude oil and gold (which increases demand for the dollar and depreciated the rupee) to sustain its economy, and its inability to increase exports (which increases demand for the rupee) This also contributes to the fact that Blame it on Rupee's lackluster performance. The RBI has been using dollar reserves to support the value of the rupee by artificially increasing the supply of dollars in the foreign exchange market and artificially increasing the demand for dollars against the rupee.
As a result, India's foreign exchange reserves fell from more than $700 billion in September to $640 billion as of the last week of December, an eight-month low.
Analysts say the rupee depreciation would have been worse without the Reserve Bank of India's intervention to support the rupee against the dollar.
The RBI's traditional stance has been to manage the exchange value of the rupee in such a way as to allow its value to depreciate gradually without causing large fluctuations that would disrupt the economy.
issued – January 4, 2025 11:05 PM IST
