Rupee Route: From Worst to Best
What & Why?
The present exchange rate of the Indian National Rupee (INR) against the United States Dollar (USD) stands at one dollar equals approximately 75 rupees. This leaves room for questions. Why is the Indian rupee so weak against the American dollar? The Indian rupee has been facing turmoil and is battling against the dollar for more than 20 years despite the prevalent rules and policies. Why are these fluctuations taking place? How did the rupee become the worst-performing currency in 2020 to the best performing currency at the beginning of 2021? To begin with, let's delve into the concepts of devaluation and revaluation.
Devaluation is the official lowering of a country's currency by the government with respect to a foreign currency. It is just the opposite of revaluation. The top 3 reasons that countries need devaluation are to boost exports, decrease trade deficits, and curtail sovereign debt. The impacts of devaluation depend on which category you belong to. Are you a common man? Then there would be a higher burden on you as now prices of fuel, imported goods, travel and fees of abroad universities will become costlier. Are you a farmer? Then, devaluation has a positive impact on you as India is the world's largest producer of wheat. So, a fall in the value of the rupee will increase your profit. Are you a foreign investor? Unfortunately, you will bear a loss as it becomes expensive to spend abroad. Are you interested in real estate? Devaluation will increase the cost of production. Are you interested in foreign direct investment (FDI)? FDI is increased as it becomes cheaper now for foreigners to invest in India.
Some other effects of devaluation include making exports cheaper and imports expensive, improvement in current a/c, increase in inflation, etc. At the time of independence, one rupee was equal to one dollar. But today 1 USD is equal to approximately 75 INR. As India freed itself from British Raj, it was devoid and stripped of its natural resources. This led to a substantial increase in Borrowings from a foreign land. Frequent wars of India with China and Pakistan were contributing factors. All these circumstances compelled the government to devalue its currency. To increase domestic production, the Indian government needed technology to tackle higher inflation, and to open the Indian economy for foreign trade, the government devalued the external value of the rupee. Some other major reasons for the same were the oil crisis of 1973, the assassination of Indira Gandhi which further reduced the confidence of investors in India, the economic crisis of 1990, import bill of petroleum, import of gold in huge quantity, Asian financial crisis of 1997 and Europe sovereign debt crisis 2011.
2020: The Year of Doom
In the unprecedented year of 2020, the rupee has remained one of the worst-performing currencies in 2020 starting from March on the onset of lockdown. In April, the Indian rupee hit a record low of 76.92 against the dollar. In the early half of 2020, there was a sell-off in the market to the great extent because of lockdown. Later, investors bought forward that crude oil prices and reduction in imports were beneficial for India. Despite these massive flows, the rupee remained devaluing. However, in 2021, the situation improved but fell again. After being the worst performer in 2020, the rupee became the best performer at the beginning of the year 2021. Some of the major reasons for the same were reduced COVID-19 cases, current a/c surplus, and the forex reserves have increased.
Past and the Future
However, the rupee weakened against the dollar again in April 2021. A major reason would be the G-sap policy of the Reserve Bank of India (RBI) and the instantaneous skyrocketing Covid cases. On April 7, RBI assured markets that it will acquire government securities worth Rs.1 lakh crore in the times to come. Further, RBI also kept the repo rate unchanged at 4% due to which the reverse repo rate was kept unchanged at 3.35%. This policy by RBI would result in an increase in money supply and a reduction in interest rate has been introduced to keep up the nation's growth in wake of COVID-19. The rupee fell sharply as the forex market was taken by surprise. RBI continues to maintain the ultra-loose monetary policy. Due to the global economic slowdown, The Indian rupee has been falling and unable to regain its value. The decision taken by the Organization of Arab Petroleum Exporting Countries (OAPEC) to reduce production and the decision taken to double the price of crude oil led India to borrow foreign currency. The US is the biggest importer of crude oil. When crude oil prices go down, the US saves more dollars by buying it. This strengthens the dollar which is another reason why the rupee is falling against the dollar.
From being one of the worst-performing currencies, the Indian rupee, with foreign inflows through FDI and FPI, is now the best performing currency across Asia. Unlike other currencies which remained steady or weaker, Indian Rupee showed a 4% rise against the dollar. However, with reduced imports projecting a better currency, we must shed light on the dollar weakening more than the rupee strengthening. When the Fed started QE in March 2020, the Indian rupee did not appreciate that much due to the central bank buying dollars. It took a long time to recover from that level. The normalization of trade flows should not be very positive for the rupee as it will affect the flow of FDI and FPI money into the country. However, if the central bank does not intervene, then the currency would appreciate. But the robustness of the rupee and its recovery trajectory depends on the dynamic determinants i.e. the current governing body, trade flows, a persistent surge of cases in Maharashtra, and an impending 3rd wave.
By Namrata Singla