Falling Indian Rupee- Reasons and Repercussions

The Indian rupee has hit an all-time low recently against the dollar. It currently is below 84.50. In November, it has fallen the most in a one-month timeframe. But why is the Indian rupee falling, and how will it impact the Indian economy? Let us look at the details in this article.

Why is the Indian rupee falling?

Here are the top three reasons for the falling rupee:

Reason 1: Continuous outflow of foreign funds

When Foreign Institutional Investors (FIIs) invest in Indian stocks and bonds, they bring foreign currency into the country, increasing the demand for the Indian rupee. This increased demand strengthens the rupee. Conversely, when FIIs withdraw their investments from India, they sell their Indian assets and convert the rupees they receive into foreign currency, typically US dollars. This increased demand for dollars weakens the rupee. And in the last two months, we have seen FIIs pulling out of the Indian market. In October, the net outflow was Rs 1.14 lakh crore, while in November, the net outflow was Rs 45,974 crore. It is one of the main reasons for the falling rupee.

Reason 2: US Election Result

Trump recently won the US presidential election. The win is likely to lead to higher US Treasury yields and a stronger dollar due to market expectations of fiscal expansion, rising interest rates, and increased safe-haven demand. These factors would pressure Asian currencies, including the Indian rupee, by triggering capital outflows (reason 1), increasing import costs, and widening trade deficits.

Reason 3: Ongoing Geopolitical Tension

Ongoing geopolitical tensions, particularly the Russia-Ukraine conflict and increasing US-China rivalry, have created a volatile global economic environment. This uncertainty has led to a risk-off sentiment among international investors, prompting them to seek safety in US dollar-denominated assets.

Impact of a Falling Rupee on India

A falling rupee can have positive and negative impacts on the Indian economy. Let us look at the details:

Positive Impacts

• Export Boost: A weaker rupee can make Indian exports more competitive in the global market. This can lead to increased demand for Indian goods and services, boosting export earnings. The Indian IT industry is one of the biggest beneficiaries of the falling rupee.
• Remittance Benefits: For Indians living abroad, a weaker rupee means that their remittances can go further in India. It can benefit the economy, especially in regions heavily reliant on remittances.

Negative Impacts

• Inflationary Pressure: A falling rupee can lead to higher import costs, particularly for essential commodities like crude oil. This can fuel inflation, eroding purchasing power and affecting consumer sentiment.
• Increased Debt Burden: Indian companies with foreign debt will face higher costs to service their loans as the rupee depreciates. This can strain corporate balance sheets and hinder investment.
• Foreign Investor Sentiment: A weakening rupee can erode investor confidence, leading to capital flight and a decline in foreign direct investment (FDI) inflows.
• Economic Growth: A combination of higher inflation and reduced investment can slow down economic growth.

How can RBI stop the falling rupee?

The Reserve Bank of India (RBI) plays a crucial role in stabilizing the Indian rupee. Here are a few of the steps/actions RBI can take:

Selling Dollars: The RBI can directly intervene in the foreign exchange market by selling US dollars from its foreign exchange reserves. This increases the supply of dollars, reducing its demand and thus weakening the dollar relative to the rupee. India's forex reserve had an all-time high a few months back, and now RBI is selling dollars from the reserves to ensure the rupee does not nosedive against dollars.

Buying Rupees: By buying rupees, the RBI can increase the demand for the Indian currency, strengthening it.

Interest Rate Adjustments: The RBI can adjust interest rates to influence the demand for the rupee. Higher interest rates can attract foreign investors, increasing the demand for the rupee.

Liquidity Management: By controlling the liquidity in the market, the RBI can impact the exchange rate. Tightening liquidity can reduce inflationary pressures and strengthen the rupee.

Conclusion: Rupee Outlook

Historically, the Indian rupee depreciates against the USD at a long-term annual rate of 3.2% (last 20 years' data). In the last year, the depreciation is low at 1.7%. Experts believe that the rupee will fall significantly in the next few years. As per the SBI research report, the rupee may depreciate 8-10% against the US dollar during the Trump 2.0 regime. Investors should closely monitor the direction, as it not only impacts the equity market but the overall Indian economy.