Why rupee is depreciating now and how it will affect you?

When the rupee moves from 45 per US dollar to 52 per US dollar, why do we call it ‘rupee depreciation’ and not ‘rupee appreciation’ given that the rupee has risen against the dollar?

This is a question for lot of people. Let us look at that with a simple example.

Let’s replace rupee with eggs. Today, one USD can buy 45 eggs. Tomorrow, 1 USD can buy 52 eggs. Doesn’t this means that eggs have become cheaper since you can buy more eggs for the same one USD? Alternatively, it means that eggs have depreciated in value.

The same is true for the rupee. When one USD can buy 45 rupees today and 52 rupees tomorrow, it means that the value of the rupee has depreciated.

The past two weeks have been disastrous for the rupee value against the dollar. The value of rupee against dollar has moved from 45 during the last week of August, 2011, to almost 52 during the last week of November.  The weakening of rupee may continue for some more time, as per the experts. This kind of increase in dollar value will have the drastic impact on the economy of the country like India, which depends too much on oil and other raw material imports.

How currency value is decided?

There are many economic factors, which decide the value of a currency. A currency will tend to become more valuable when its demand is higher than supply. It is the basic theory.

Exchange rates are expressed as a comparison of two currencies and it is always relative. Interest rates, rate of inflation and exchange rates are correlated.

What are the main reasons for depreciation of Indian rupee now?

Stock market performance

It is a known fact that Indian stock market is dominated by overseas investors. When the economy is performing well and stock market is performing better than other countries, overseas investors will become heavy investors here. To invest here, they require rupee. This will increase the demand for rupee and will result in higher value for rupee. On the other hand, when these investors are pulling money out of Indian stock market, rupee will be depreciated. Indian markets are in a bad shape for the last 1 year. The sentiments after the US downgrade and the European crisis etc. resulted in overseas investors selling in India and buying dollars.

In a bad performing market, when there is depreciation in rupee, it will bring down the overseas investors real returns. So they will start selling, which will again deepen the situation.

Despite all the problems in the US, the dollar is still the safest paper currency in the world! So, there is more demand for dollar in volatile condition like this. This will add to the rupee depreciation.

Very high prices for gold have created panic among investors and fearing a bubble there, investors started moving towards dollar. This demand in dollar is also causing depreciation of rupee.

Inflation

Another factor affecting the currency value is inflation. We are experiencing very high inflation rate in India now. This will decrease the purchasing power against other currencies. This will leads to depreciation of the currency.

Current account deficit

Current account deficit occurs when a country’s total import exceeds the total exports. This makes the country, a net debtor to the rest of the world. A high deficit indicates, we are doing more trading outside the country than it’s actual earning inside the country. This is not good for the country because, the country needs to buy more foreign currency. More demand for the foreign currency will reduce the value of that country’s currency.

India’s current account deficit is more than the expected level now and this also contributes to the depreciation of Indian rupee.

Corruption and Political paralysis

Last 1 year, we are seeing lot of corruption issues. It is not that corruption was not there earlier. It is high ticket now and more and more VIPs are entering Tihar daily. Nobody knows where it will end.

The parliament is unable to transact any meaningful business and reforms occupy a back seat in the agenda. The Anna Hazare’s campaign against corruption took the attention of the global media, which affected investor sentiments globally.

Why and how RBI control exchange rate?

RBI will interfere in this area because a steady value of rupee is essential for the orderly growth of the economy. A depreciating rupee will harm oil marketing companies, and other import oriented businesses. This may help the software companies and other exporters, who get their payment in dollars.

RBI will be watching the position and interfere to stabilize the currency value. In case of depreciation, RBI will sell foreign currency from the reserve and this will help in arresting the fall of rupee to some extent.

What way rupee depreciation will affect you?

1. Products that are directly imported, such as crude oil, fertilizers, pharmaceutical products, ores and metals, or use imported components such as Personal Computers and laptops, become more expensive following rupee depreciation
2. Depreciating rupee is bad for companies that import things and good for companies that are export oriented. Investors in import oriented companies will be affected badly in a depreciating rupee. For companies, borrowing cost will increase and this will reduce their profit margin.
3. If you are working abroad and is earning in dollars, you will get more rupees for the same dollar. So this is good for those, who are posted abroad and is earning in dollars. You have seen, there is rush from NRIs to send money to India now to take advantage.
4. If you are studying overseas, your cost will be more, because you have to pay more rupees to get the same dollar.
5. If you are planning for a foreign vacation, postpone it, otherwise it will cost you more now.

But we can expect lot of foreign tourists to India this season, because, their travel cost have come down with a depreciating rupee!