Rupee Vs Dollar: When Rupee falls against the US Dollar, it brings bad news for the economy, thus directly affecting the cost of living. The immediate impact of the fall in the currency value is that rise in inflation. Like other markets, the money market too works on the basis of demand and supply; thereby, if the demand for the dollar gets high, the rupee depreciates and that is the basic working methodology of the floating exchange rate.
The value of Rupee dropped to an all-time low recently, prompting the Reserve Bank of India (RBI) to stem the currency’s sliding value. Mahesh Shukla, Founder & CEO, PayMe India said that widening trade and current account deficits, heavy foreign fund outflows and a strengthening US dollar, resulted due to geopolitical spills and a series of other factors led to the fall of the country’s currency to its all-time low.
"Since the geopolitical tensions erupted as a result of the war crisis, the rupee has been under pressure, with most major economies, particularly in the West imposing sanctions. As a result, the price of key goods increased over the world, raising fears of inflation. Due to supply limits, India has seen a significant increase in import costs” Shukla said.
The dollar index, which impacts the performance of major currencies, has hit its 20-year high this year, going up by nearly 9 per cent. Thereby, not just the rupee but other currencies have also tumbled due to the dollar up cycle.
Inflation rises, impact on spending
The major impact of the falling rupee is that inflation increases. This is because production cost becomes costlier. India imports 80 per cent of crude oil to meet its demand, (80 per cent on imports), edible oil and other items.
The depreciating Rupee direct impacts an individual's spending capacity. Mahesh Shukla said that when prices of commodities or household expenses go up (retail inflation), this impacts customers.
Impact on industry
India is heavily dependent on fertilizer imports and fertilizer subsidy is set to hit a record high. Also, gems and jewellery, petroleum products, organic chemicals and automobiles and machinery items – which are the country’s key export items with significant import content – would see a rise in the margin. Mahesh Shukla said the major impact would be on the export sector where the import intensity is high.
The Information Technology and labour-intensive export sectors like textile, with low import dependency, might be less affected, he said.
Shukla said that the movement in Rupee has a very high correlation with stock prices. When Rupee falls, it also impacts foreign investors' portfolio. Their buying and selling directly influence the domestic stock market. When Rupee depreciates, they start pulling out of equity markets, triggering a big fall which could result in a decline in the valuation of companies' stocks and other equity-related investments like mutual fund.
Foreign investors keep a close track of Rupee movement because their holdings get affected significantly when the currency value fluctuates, Shukla explained.
When markets witness a sell-off, the value of Rupee too depreciates on account of the fear that FIIs could offload their holdings. The situation is the reverse when markets rally.
Foreign travel, education
As Rupee falls, foreign travel and education get expensive. This is because a person will have to give more Rupees for the exchange of every Dollar. This means students going abroad for study or anyone planning a foreign tour will now have to spend more.
Loans become expensive
The RBI recently altered the repo rate to act quickly before inflation derails the economy. The central bank is likely to further increase the key rate in its upcoming policy review meeting. This will result in banks and financial institutions raising the lending rates, which means that people will have to pay more EMIs on their loans.
What's causing inflation
The shortage in the global supplies has pushed the demand on the higher side, resulting in soaring pricing and taking inflation rates to over a two decades high. This directly impacts the economy and food inflation as well which accounts for almost half of the consumer price index (CPI).
Also, the Indian foreign exchange reserve witnessed a steady fall in weeks, reaching below the $600 billion mark after almost a year, due to the higher cost of imports and lower export gain. India’s foreign currency assets – the biggest component of forex reserves – also fell significantly.
Why stable rupee is required
Gaurav Kapoor, director and co-founder, Fincorpit Consulting, said that India's macro economic stability makes it an attractive destination for foreign investments and to maintain the current substantial level of foreign inflows, the country requires a stable rupee.
"In the present globalised environment, majority of costs like raw material, shipping charges, warehousing and other related services are denominated in foreign currency or at import parity price. If the currency is weak, spending will increase leading to price rise," he said.
"Hence, a stable range-bound currency is required both for stability and certainty for quoting prices and accepting orders in today’s competitive global environment," Kapoor added.
It is the central bank of a country that takes steps to balance the currency’s demand or supply. In the past years, RBI has taken several measures to stabilize the value of Rupee like clamping restrictions on the import of gold, tightening the position limits on currency futures, rationalizing forex outflows by residents and encouraging capital inflows.
"A balance between GDP growth and low inflation attract foreign investments and ultimately it makes the currency stronger. Another important factor is trade deficit. The bigger the deficit, the weaker a currency will become against USD," he said.