This paper is a study on the depreciation of Indian currency rate which includes a brief history of the Indian exchange rate and the causes of its depreciation. Also this paper looks into how an economy would be affected by a fall in its currency exchange rate and how the Indian economy,mainly foreign trade is being affected from the fall in its currency exchange rate.

    EXCHANGE RATE

Before indulging into the causes and effects of depreciating currency exchange rate here’s an introduction about what exchange rate is Exchange rates are a key factor affecting the international market and the whole economy as it is a key element in market economy. It can be explained as the rate at which a domestic currency can be sold and bought to the foreign currency. Floating exchange rate, fixed exchange rate and managed floating exchange rate are the different forms of exchange rates, the kind of exchange rate policies used by the Indian government can be seen by studying its history.

 

HISTORY OF INDIAN EXCHANGE RATE

Indian Rupee exchange rate went through a lot of different stages and following different policies over the years and this is a brief history of it from the independence till the present period. So, after independence the government followed par value system till 1971 where the rupee’s par value was fixed with UK pound sterling and gold, then from 1971-1991 India followed a pegged system where the currency was pegged to the US dollar and later India pegged its currency to a number of currencies and this went on till 1991.In 1992 LERMS (Liberalized Exchange Rate Management System) was established and under it the government followed dual rate system and later unified the exchange rate, LERMS provided a positive stability to the Indian foreign trade and in 1993 till now India has been following a market exchange rate.

The performance of the Indian currency has been underwhelming as the value of the Indian rupee has generally depreciated except in 2003-2005 and 2007-08 when the rupee had appreciated due to the dollar’s global instability. But collectively the value of the Indian rupee has mainly depreciated compared to the other major currencies of the world. The chart below shows the exchange rates of Indian rupee and US dollar from 1991-2016.

CAUSES OF INDIAN CURRENCY DEPRECIATION

As the Indian currency is depreciating against the US dollar and other currencies it is important and crucial to understand the cause and factors responsible for the depreciation. The depreciation of the Indian currency can be attributed to a lot of causes and in a research by Deepa Divakaran.N on the causes of depreciation of Indian currency, she mainly focuses on the reasons caused by the policies made by Indian government and their effect on the demand of the Indian currency in the global market which in turn leads to depreciation of the Indian currency, In her work she mentions how public policies that have been implemented have been increasingly disappointing leading to withdrawal from investors like because the policies are “too small and too late” , an example of withdrawal of investors can be seen with this case where Global giants like Arcelor Mittal and Posco decided to withdraw their investments from projects like where Posco planned for a steel plant in Karnataka with an estimated investment of Rs. 30000 cores and Arcelor Mittal intended a steel plant in Odissa worth around Rs. 52000crores. On the other hand the federal policy creates impactful effects as investors go back to advanced countries like US, this causes an issue as increase in foreign investment can cause an increase in demand for the domestic countries currency which increases its value in the overall global market and withdrawal from these investors cause the depreciation of Indian currency.

Another cause mentioned in the study which had relation with government policy was the interest rate as increased interest rate is more likely guaranteed to bring in more foreign investment for the higher return but the interest rates have been generally low due to the slow growth there is pressure on the RBI to decrease policy rates so this in turn leads to decrease in foreign investment and demand for Indian currency. These are a few of the causes mentioned in the study and it mainly criticizes the government policies for the fall in the currency exchange rate, but there are other factors in play causing depreciation of Indian currency.

Other causes can be the increasing strengthened presence of US in the global markets as the value for dollar increases, because when a country like India pays for its imports in dollars the demand for dollar currency increase making it more valuable that the Indian rupee currency leading to depreciation of rupee against the dollar. An example for this and another cause is increased oil prices, India imports bulk of oil for satisfying the domestic demand, so paying the price of imports in dollars depreciates the value of rupee, furthermore the demand for oil keeps increasing every year and this increase means increase in the price of oil in the international market so every year with the increase in prices of oil India has to pay extra for the same quantity every year which is paid to the suppliers in dollars, depreciating the value of rupee further and further every year. Another issue with the increasing number of imports is that due to this there is trade deficit as the imports are more than that of the exports resulting in trade deficit and this means that the outflow of foreign currency is more than the inflow which means the demand for the currency is low and it results in depreciation of Indian currency.

These are the few fundamental causes of the depreciating Indian currency; now let’s look at how this fall in value affects the economy of India.

AFFECTS OF DEPRECIATING INDIAN CURRENCY ON ITS ECONOMY

The obvious impact of a low rate of a currency would be that of imports getting costlier, which leads to an imported inflation and for countries like India it is a problem as for example crude oil which is one of India’s biggest imports will cost higher which will put a pressure on the oil marketing companies who will transfer the stress on to the consumers, as in increase in oil prices inflation. It can also cause inflation in markets like automobile market as automobile companies import parts from different parts of the world for assembling. So an increase in imports will raise its production cost in turn leading to increase in prices for automobiles.

This can be looked at in another way as it can lead to unemployment also as the increasing cost will make the companies cut down their cost expenditure and this might be done by cutting off employees salary or laying them off the job, which increases unemployment percentage.  This is the case of a few industries negatively affected by the depreciating currency, there can be much more examples.

But a positive impact that a depreciating currency can have on the foreign trade is that a weak currency can boost export based industries such as IT, jewelry and precious gems and textile etc. as the weak prices will make them more competitive in the global market. So the more the rupee falls the more they earn.

So as we can see the depreciating currency has negative and positive impacts on the trade system and the economy as import based sectors suffer and export based industries gain, but a continuous depreciation will lead to high inflation this is not an ideal situation. So the government needs to adopt some policies to increase the value of the Rupee.

POLICY SUGGESTIONS

These are a few suggestions that the government can take that will help stabilize the depreciating exchange rate of the Indian currency, first the government can inculcate investor friendly policies so that there is increase in flow of foreign direct investment(FDI). Another step the government can take is establishing industries for goods to replace and substitute the imported goods, government should also take steps to boost exports as exports create demand for the currency and this can increase the value of the rupee.

 References

 Divakaran, D., & Gireeshkumar, G. (2014). Currency depreciation -causes and its impact on indian economy. 3(1), 2319–2828.

 Reserve Bank of India – Publications. (2015). Retrieved July 6, 2019, from Rbi.org.in website: https://www.rbi.org.in/scripts/PublicationsView.aspx  

 ResearchGate | Share and discover research. (2019). Retrieved from ResearchGate website: https://www.researchgate.net/ 

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