The Indian rupee this week slipped below the psychologically important level of 80 against the US dollar for the first time even as high crude oil prices amid tighter global supplies boosted demands for the American currency.
Even though the falling rupee may not benefit the entire economy, a devalued currency certainly has its merits. It aids the domestic producers in boosting their exports, thereby leading to trade surplus. Several countries prefer devaluation of their currencies, in order to boost the economic landscape. There have been some instances when countries reportedly pursued the devaluation strategy in order to gain a competitive advantage in international markets.
Even though weaker currencies are not favourable for foreign portfolio investments (FPI), they are relatively favourable for foreign direct investment (FDI) as depreciation makes host country assets less expensive.
This may be because FPI refers to investments made in financial assets of another country, while the FDI refers to investments made in businesses interests which are located in a host country. FDIs usually have a long-lasting commitment.
On the other hand, several demerits also accompany a weak currency. Since the cost of imports become higher, domestic inflation may be triggered, which in turn may reduce purchasing power in the economy. Rising costs of imports may also increase the Current Account Deficit (CAD).
India’s trade deficit widened to USD 45.18 billion in April-June 2022 period as compared to USD 5.61 billion recorded in the corresponding period of last year.
The Ministry of Finance in its latest Monthly Economic Review report underlined that India’s current account deficit, meaning a shortfall between the imports and exports, is expected to deteriorate in 2022-23 if recession concerns do not lead to a sustained and meaningful reduction in the prices of food and energy commodities.
Aiming to reduce rising current account deficit which in turn will help in appreciation of the rupee, the Central government on July 1 raised import duty on gold from 10.75 per cent to 15.0 per cent. Notably, India is a net importer of gold.
Further, loss in FPIs is also a cause for concern during a large devaluation. This triggers outflows from the host country since the foreign investors’ holdings may become less valuable.
Foreign Portfolio Investors (FPIs) have been selling equities in the Indian markets for the past nine-to-ten months due to various reasons, including tightening of monetary policy in advanced economies, and rising dollar and bond yields in the US. They have pulled out Rs 237,540 crore so far in 2022, NSDL data showed.
Further, any companies or individuals having foreign debt exposure would also see a rise in the cost of their repayment.
To reduce the dominance of the dollar, the RBI recently announced a mechanism to settle payments for international trade in rupees, especially for India’s exports.
India’s forex reserves, in the six months since January 2022, have declined by over USD 40 billion.
India’s forex reserves had dropped for five out of the past sixth straight weeks, on account of RBI’s likely intervention in the market to defend the depreciating rupee. Typically,the RBI intervenes in the market through liquidity management, including through the selling of dollars.
