On Wednesday, 13 July, one woke up to two news items. The first was that the US dollar had hit a 20-year high to a Dollar Index (DXY) of 108.56 and, that the Indian Rupee (INR) had slid to a new low of 79.60 against the dollar. For the first time in two decades, the dollar and the euro were at the same level. There was a free fall in other currencies too and major currencies depreciated against the US Dollar: the yuan by 4 per cent; the yen by 24 per cent; the euro by 17 per cent; the rupee by 7 per cent; the rand by 11.5 per cent and the pound by 15.5 per cent. Historically, there are many reasons leading to the volatility of the Indian currency. Geopolitical issues, international factors, economic reforms, rise in crude oil prices, flight of foreign capital, diminishing foreign investments, rising interest rates, along with spiraling inflation in India contribute to the depreciation of the Indian rupee.

Post-World War II, the US dollar (USD) has been the most powerful currency in the world. It has dominated the financial market and has become the de-facto currency for international trade and transactions. More than 60 per cent of global foreign reserves are in USD, making it the most commonly held reserve currency in the world. Till today, countries, including India, peg their currencies against the USD to determine their value in the global market. Prior to independence, the value of the Indian rupee was derived from the British pound with an exchange rate of 1 GBP = 13 INR. Based on the calculation that 1 GBP was equal to $2.73, 1 USD was therefore equivalent to 4.76 INR in 1947. As per the Bretton Woods Agreement of 1944, each country was required to peg the value of its currency to the dollar, which itself was convertible to gold at the rate of $35 per ounce. India being part of this agreement, followed the par value (relative) system of exchange rates.

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Independent India, however, found itself in a challenging situation to finance its increasing plethora of welfare and development activities along with its five year plans, and therefore resorted to intense foreign borrowing. Further aggravations followed with the Indo-China war in 1962, the Indo-Pakistan war in 1965, and the major drought in 1965-1966. Although the exchange value of 1 GBP = 13 INR continued till 1966, in 1967, the INR was linked to the USD on a oneto-one basis, and it was decided to devalue the INR to 17.50 per USD. The par value system continued till 1971 until the collapse of the Bretton Woods System which suspended the gold standard/ convertibility of the dollar by the USA. India too adopted a fixed rate system linking the INR to GBP but by 1975, the INR was pegged to a basket of currencies to ensure its stability and to combat the increasing imbalances and disadvantages associated with a single currency peg.

A serious balance of payments crisis ensued in 1991 caused by the collapse of the Soviet Union in the 1980s and doubling of the crude oil prices in 1990. The country’s foreign reserves had dried up and to stave off imminent bankruptcy, India had to borrow money from International Monetary Fund (IMF) against its gold reserves. The exchange rate plummeted throughout the 1980s and by late 1990, the rate was 1 USD = 17.32 INR. The economic crisis called for a devaluation of the INR, which involved initiating a process of reducing the country’s exchange rate in the international market while keeping the internal value unchanged. This was done to encourage an increase in exports and an increase in the inflow of foreign currency. In 1991, the Reserve Bank of India (RBI) lowered the exchange rate by 11 per cent, and India ended the fixed-rate currency regime moving towards a market-determined exchange rate system or the floating exchange rate system. The effect of devaluation led to an exchange rate of 1 USD to 25.92 INR in 1992. The Indian rupee kept falling thereafter.

By 2002, the rupee had fallen to Rs 48.99 against the US dollar. In 2007, the rupee appreciated and reached a high of Rs 39.27 to the dollar because of the sustained foreign direct investment (FDI) inflows into the country in terms of investment in the booming stock market, increasing remittances, and growth in exporters led by the IT and BPO firms in the country. In 2016, the USD to INR rate plummeted to 1 USD = 68.77 and the global economic crisis following the coronavirus pandemic in 2020 further contributed to the depreciation of the exchange rate to hit a record low which was 1 USD = 76.67 INR in March 2020. Hence, the fall of the Indian rupee has emerged from an economic slowdown, fear of wide budget deficits, a sharp spike in US economic growth and risk aversity of the global investors to the emerging markets. The war in Ukraine, inflation and rising crude oil prices further contributed to the current scenario.

The weighted average price of India’s crude oil imports has risen by about 22 per cent in a year. The weakening rupee will hence place immense pressure on the 80 per cent imports of crude oil and widen the trade deficit which has already grown to $70.25 billion on account of high imports in the first quarter. Although the benchmark Brent crude has fallen marginally per barrel to $100.50, any escalation would further impinge on the falling rupee. A high current account deficit, expected to reach 3 per cent of GDP in this financial year, would also render overseas borrowing more expensive. Inflation in India has upshot the benchmark of 6 per cent set by the RBI. Retail inflation was 6.01, 6.07, 6.95, 7.79, 7.04 and 7.01 per cent respectively in the first six months of 2022. RBI predictably took recourse to raising interest rates to curb inflation. The reporate, namely the rate at which it lends to commercial banks, was raised by 40 bps and 50 bps in May and June 22 respectively.

The rise in interest rates, however, would adversely affect the interests of the exporters who may not be able to take advantage of the falling rupee to push forth their competitive edge. As some advanced countries grapple with recession, the demand for India’s goods and services are also likely to see a resultant reduction in demand from International investors. The depreciation of the domestic currency would also trigger Foreign Portfolio Investor (FPI) sales from emerging markets. On June 15 this year, the US Federal Reserve raised the interest rates by 75 basis points, signalling a move to a higher interest rate regime to control inflation. The consequent attraction of higher returns on US bonds has led to the flight of international capital from emerging economies to dollar investments. The Foreign Institutional Investors (FIIs) have found the bond prices in US to be more attractive, and, triggered by the war in Ukraine that has exposed the vulnerability of the domestic markets, capital has flown back to America.

In this backdrop, the RBI’s move for export and import transactions in Indian Rupee with prior approval would indeed make the rupee increasingly tradable globally. With a likelihood of rising Non Deliverable Forward (NDF) volumes and increasing acceptance of the rupee, this move may mitigate the impact of the dollar in the long run. Another move of the RBI, in order to attract more NRI deposits, has been to remove curbs on Foreign Currency Non-Resident Account (FCNCR) deposits in the form of Interest rate curbs, and, in exempting the incremental deposits from the CRR and SLR requirements. The RBI has also used its Forex reserves to defend the currency and to instruct the Public sector banks to sell dollars. This move has led to the depletion of the country’s reserves below the $600 billion mark. To arrest further fall of the rupee, the RBI has also raised the import duty on gold. The slide, however, continues.

Although depreciation of the currency makes imported goods expensive, and foreign travel and fees for studying abroad become costly, it is an erroneous presumption that absence of a strong currency is necessarily bad. The depreciation of the rupee lowering the exchange rate has improved India’s balance of trade in the past. Such depreciation is a natural consequence in emerging economies such as India which may continue in coming years. The silver lining in this era of falling currency is also that while the rupee has depreciated by 7 per cent, other currencies such as the Euro and the Yen have depreciated even more. This of course, is not reason for any complacency but a trigger that calls for proactive actions by the Central Bank and a pragmatic monetary policy so as to prevent further trade deficits and widening inflation.