Why is the Indian Rupee Falling Against the US Dollar?

Why is the Indian Rupee Falling Against the US Dollar?

The falling value of the Indian rupee against the US dollar is a result of various economic factors affecting currency demand and supply dynamics. Below is an explanation with key headings and points.

1. What is the Exchange Rate?

• Definition: The exchange rate is the value of one currency relative to another, indicating how much of one currency is required to buy a unit of the other.
• Example: As of now, Rs 85 is required to buy $1. A decade ago, this rate was Rs 61.
• Dynamic Nature: Exchange rates fluctuate based on market demand and supply.

2. How Does the Exchange Rate Change?

• Currency as a Commodity: In the currency market, each currency is treated as a commodity.
• Demand-Supply Rule: If the demand for the US dollar is higher than the Indian rupee, the exchange rate tilts in favor of the dollar, causing the rupee to weaken.

3. Factors Determining Currency Demand

A. Trade in Goods

• Imports vs. Exports:
  • If India imports more goods from the US than it exports, demand for the US dollar rises.
  • Result: Rupee weakens relative to the dollar.

B. Trade in Services

• Tourism and Outsourcing:
  • If Indians spend more on US services like tourism, the demand for the dollar increases.
  • Result: Rupee loses value.

C. Investments

• Capital Inflows:
  • If Americans invest more in India than Indians invest in the US, the rupee strengthens.
  • Conversely, if foreign investors pull out money, the rupee weakens.

4. Key Factors Affecting Trade and Investment

A. Trade Barriers

• Example: If the US imposes high tariffs on Indian goods, American demand for Indian rupees falls, weakening the rupee.

B. Inflation

• Impact:
  • High inflation erodes currency value.
  • If India experiences higher inflation than the US, the real returns on Indian investments decrease, reducing foreign investment.
  • Result: Rupee weakens.

C. Monetary Policies

• Interest Rates:
  • Higher interest rates in the US attract global investors to the dollar, increasing its demand and weakening the rupee.

D. Geopolitical and Economic Events

• Example: Global uncertainties, like wars or oil price shocks, push investors towards safe-haven currencies like the US dollar, weakening emerging market currencies like the rupee.

5. Current Scenario and Trends

• Historical Context: The rupee’s long-term trend shows a steady weakening against the dollar.
• Recent Developments: The exchange rate breached Rs 85 per dollar due to persistent factors like foreign investment outflows and a widening trade deficit.

6. Conclusion

The weakening rupee is a reflection of trade imbalances, inflation differentials, and capital flow dynamics. While these trends are part of the natural functioning of the currency market, targeted economic policies and reforms can help stabilize the rupee over time.