Why in News?

The Indian rupee fell to an all-time low of 77.44 against the U.S. Dollar.

What is Depreciation?

• About:

  • Currency depreciation is a fall in the value of a currency in a floating exchange rate system.

  • Rupee depreciation means that the rupee has become less valuable with respect to the dollar.

    • It means that the rupee is now weaker than what it used to be earlier.

    • For example: USD 1 used to equal to Rs. 70, now USD 1 is equal to Rs. 77, implying that the rupee has depreciated relative to the dollar i.e. it takes more rupees to purchase a dollar.

• Impact of Depreciation of Indian Rupee:

  • Depreciation in rupee is a double-edged sword for the Reserve Bank of India.

    • Positive:

      • Weaker rupee should theoretically give a boost to India’s exports, but in an environment of uncertainty and weak global demand, a fall in the external value of rupee may not translate into higher exports.

• Negative:

  • It poses risk of imported inflation, and may make it difficult for the central bank to maintain interest rates at a record low for longer.

  • India meets more than two-thirds of its domestic oil requirements through imports.

  • India is also one of the top importers of edible oils. A weaker currency will further escalate imported edible oil prices and lead to a higher food inflation.

Appreciation Vs Depreciation

• In a floating exchange rate system, market forces (based on demand and supply of a currency) determine the value of a currency.

• Currency Appreciation: It is an increase in the value of one currency in relation to another currency.

  • Currencies appreciate against each other for a variety of reasons, including government policy, interest rates, trade balances and business cycles.

  • Currency appreciation discourages a country's export activity as its products and services become costlier to buy.

• Depreciation Vs Devaluation:

  • If the value of the Indian Rupee is weakened through administrative action, it is devaluation.

    • While the process is different for depreciation and devaluation, there is no difference in terms of impact.

• India used to follow the administered or fixed rate of exchange until 1993, when it moved to a market-determined process or floating exchange rate.

  • China still adheres to the former.

What are the Reasons for Current Depreciation of Indian Rupee?

• Sell-off of the Equity:

  • A sell-off in the global equity markets which was triggered by the hike in interest rates by the U.S. Federal Reserve (central bank), the war in Europe and growth concerns in China due to the Covid-19 surge, led to the rupee depreciation.

• Outflow of Dollar:

  • The outflow of dollars is a result of high crude prices and the correction in equity markets is also causing adverse flow of dollars.

• Tightening of Monetary Policy:

  • Steps taken by RBI to tighten the monetary policy to counter rising inflation has also led to depreciation.

How the Depreciation of Rupee Impact the Overall Economy?

• The current account deficit is bound to widen, depleting foreign exchange reserves and weakening the rupee.

• With higher landed prices of crude oil and other crucial imports, the economy is definitely inching towards cost-push inflation.

  • Cost-push inflation (also known as wage-push inflation) occurs when overall prices increase (inflation) due to increases in the cost of wages and raw materials.

• Companies may not be allowed to fully pass on the burden of high costs to consumers, which, in turn, affects government dividend earnings, raising questions about budgeted fiscal deficits.