Repercussions of Rupee Depreciation

Fri, 19 Feb Pre-Open

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The rupee depreciated again yesterday. But this didn't come as a surprise. The slide has been on seen since the beginning of this calendar year. It now takes more than 68 rupees to buy one dollar. At the time of writing yesterday the rupee stood at 68.49, a fresh 30-month low. This level isn't that far from the all-time lows witnessed in August 2013, when it stood at 68.80. And it could very well surpass that level judging by the pessimism all around.

Will this really happen? And if it does, what will be the repercussions? Let's take note of a few points that are closely related to the rise and fall in the rupee.

Fall in Indian Exports

Indian exports are one of the many things that have recently skidded southwards. If one has to examine, the performance on the exports front has been much worse during the second half of 2015.

If the rupee remains steady while currencies of other emerging markets depreciate, it would make Indian goods less competitive. Thus from the perspective of Indian exports, it is good news if the rupee falls further.

Low Foreign Investments

Slow pace of economic reforms, political logjam and higher risk aversion have meant that foreign institutional investors (FIIs) have continued to be net sellers this year. So far, foreign funds have sold a net US$ 1.9 billion of Indian equities and debt during this financial year. These exits by foreign investors are likely to weigh on India's foreign exchange reserves.

US Rate Hike

With the US Fed raising interest rates, funds were seen fleeing from emerging markets to the USA. India was no different. Also, the recent testimony by Janet Yellen has sparked the momentum for a further rate hike coming gradually. All of this has led to an appreciation in the US dollar and in turn depreciated the other currencies, including rupee.

Mounting External Debt

India's external debt is mounting. This is due to an increase in long term liabilities and commercial borrowings. The recent decline in rupee has made the situation even worse. This is because the amount of rupees required to pay back the debt goes up due to the currency depreciation. This debt burden makes India vulnerable to any external sector shocks.

The Pro's and Con's

The government shall make some policy changes in order to stop the fall. It needs to work on improving the country's exports growth. Also, the government should control the deficit problems and revive the investment scenario in the country. As far as the Reserve Bank of India (RBI) is concerned, it needs to play the role of minimising extreme volatility in currency rates.

On the other hand, the depreciation also has beneficial effects. The depreciation can ensure that we don't become uncompetitive against other economies even as the RBI continues its fight against lower inflation. In Raghuram Rajan's own words, "Until we bring inflation down, there will be a certain amount of depreciation of the rupee which is necessary to ensure that we don't become uncompetitive."

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