India's Prolonged Currency Depreciation Explained

It is not an unknown fact that Covid-19 has devastated the economies globally. India too has faced major economic lashes. Covid-19 was declared as a “pandemic” by WHO on March 11, 2020. Since then, there has been the significant economic impact on India because of reduced productivity, rising unemployment, disturbed trading activities, stagnant tourism and a huge amount of lost lives. Even after 1 year, the virus is showing no signs of leaving us, waves after waves are expected to come. Amongst, or rather because of all the chaos, Indian Rupee is Facing Depreciating Possibilities! What is meant by Currency Depreciation? A simple definition of Currency Depreciation is a fall in the value of the currency in terms of its exchange rate versus other currencies. Gradual currency depreciation is said to improve the export competitiveness and maybe trade deficit of a nation with time, however, if the same depreciation is abrupt, it leads to further losses increasing downward pressure on the currency. Also Read: Marginal rise in rupee against dollar at 71.78 Rupee Depreciation: In 2021, when things were getting slightly better for India in January, the second wave of Corona infections hit the country and there was an alarming increase in cases and death tolls. The businesses which were slowly recovering again crashed. New restrictions and curbs on people’s mobility, business hours and other lockdown guidelines further increased pressure on the already depreciating currency. Hence, as a result, the Indian rupee depreciated to 75.35 against the USD. There were many factors associated with this downfall. In its monetary policy committee meeting, RBI decided to purchase Government’s securities (G-Sec) worth Rs. 1 lakh crores. Moreover, for sustaining economic recovery after the first wave, RBI decided to infuse liquidity into the market via its bond program [ 1st G-SAP Auction aggregating Rs. 25k crores], but unfortunately, with a rebounding number of cases, this move further made rupees less powerful. Secondly, there have been FPI Outflows putting more pressure on rupees. All these moves have led to lower interest rates, which has tempted big investors to pull back capital from India. As for now, India doesn’t seem to be a very attractive market for these investors. Interest rates in India have fallen substantially over the last one-and-a-half year. Corporates may choose to borrow domestically and avoid exchange rate risk because of this. Let us understand the topic in a simple manner: In 2019-20, the Indian rupee depreciated by 1.4 per cent to Rs.70.9 per US dollar. In 2020-21, the rupee further depreciated by 4.5 per cent to Rs.74.2 per USD 2020-21. The rupee could not benefit from the overwhelming forex inflows as the Reserve Bank of India (RBI) purchased forex in the spot market worth USD 49 billion in 2019-20 and worth USD 74 billion in the first 11 months of 2020-21, which neutralized the excess dollar liquidity. Besides, the RBI kept the systemic rupee liquidity in surplus. To increase liquidity, RBI announced GSAP of around Rs. 1 trillion for the first quarter of 2020-21. This depreciated rupee value to a large extent. Even in future, RBI has planned to make more such GSAPs. So, the rupee depreciation is not expected to improve soon. Effect on Export and Import: Exports are expected to strengthen as there will be increased demand from western economies. Indian economy is not the only one that suffered from the pandemic, every economy had a setback. Likewise, western economies also suffered, and as they recover from the pandemic shock, India’s depreciating currency will lead them to demand more exports. Hence, a weakened rupee will make exports cheaper and therefore more competitive in global markets. Services exports will deliver a surplus. Computer service exports dominate here. Large IT exporting companies such as Infosys, TCS, Wipro, HCL Technologies, Tech Mahindra are witnessing healthy overseas demand. These inflows are expected to increase by 5.7 per cent to USD 94.3 billion in 2021-22. Remittances from Indians abroad are also a healthy source of dollar inflows. We expect these to rise by two per cent and recover to their pre-pandemic level of a little over USD 75 billion in 2021-22. Imports– Trading partners could place restrictions on imports from India because of the rise in infections. Imports that thrive on discretionary spending – domestic appliances, electronic goods, automobiles and gold are expected to report a sequential fall. Imports of engineering goods are also expected to slow down as corporates have curtailed their capacity expansion plans. So, the country’s imports will become more expensive. Effects on FDI and FPI: Two main sources of India’s financial inflows are foreign direct investments (FDI) and foreign portfolio investments (FPI). In 2020-21, the FDI inflows in India peaked at USD 41.1 billion and FPIs at USD 32.8 billion. But FPIs have pulled out USD 1.7 billion from the Indian capital market since the beginning of this fiscal year. In 2021-22, the FDIs are expected to fall to USD 26 billion. However, if a foreign company acquires Air India or BPCL, which are up for sale, this fall may get avoided. India may see net outflows of about USD 15 billion on account of redemptions of External Commercial Borrowing (ECBs) this year. FPI outflows of about USD 3 billion is expected. This year FPI/FII inflows are likely to remain volatile and unlikely. Conclusion: India’s currency is depreciating and is unavoidable. However, with efforts, the depreciation can be narrowed to a large extent. Though the financial inflows of India has decreased, hopefully it will be sufficient to finance its thin current account deficit of USD 17 billion, amounting to 0.5 per cent of GDP and leave a surplus. India will be able to add USD 20 billion to its forex reserves kitty. This is much smaller than such additions in the past. So, the volatility in FPI/FII flows, excess rupee liquidity, high core inflation and expected appreciation in the US dollar could guide the Indian rupee to a small depreciation.

India’s Prolonged Currency Depreciation Explained

BySayon Bhattacharya

By Sayon Bhattacharya

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