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Declining Rupee: What's Really Happening?
India needs to brace up cause the US Fed chairperson clearly stated that they will not stop tightening until the inflation target of 2 percent is achieved.
Photo Credit : http://ste.india.com/;zee news
There is an old saying, ‘When America sneezes, the rest of the world catches a cold'. In the present day and age, this is evident from the impact it has had on the currency and commodities market. As most of us would be aware, the Indian Rupee has weakened to 81 per Dollar. In a nutshell, this is happening because The USA Federal Reserve has taken aggressive steps to increase 75 basis points. This has led to the biggest single-day decline in seven months. It is interesting to note how this situation boils down in practical terms.
How does all this work?
For the non-economics students amongst us, understanding how the rupee fluctuates is far from a cakewalk. Let us try to understand it in simple terms. It is a well-known fact now that inflation is a global phenomenon now. In fact, many countries are soon to hit a recession (which is a fall is GDP across two successive quarters). One key ways to control inflation is to suck out the liquidity from the market. To do this, the interest rate applied to loans has been increased. If this is done, people will have to pay back the bank substantially more than what they already are for their loans. This is basically what the American Federal Reserve is doing.
If America increases the interest rate, US investors pull assets away from the emerging markets, due to low returns expected in the near future. On a good day, the investors borrow money from the US at a cheap interest rate and park it in the Indian stock markets. If the interest rates go up, as it is happening now, capital flows more toward the American economy. They take out the money and park it in the US stock market. In a nutshell, money is going out of India. This will lead to a Dollar shortage. And anything which is in scarce supply will have a higher value. This phenomenon has pushed up the dollar value.
This happens in India too, but the US Fed hike has been far more aggressive. The cumulative increase in interest rate is 300 basis points since June, which is three percent. This has had a cascading impact on the Indian Rupee. It is making it difficult for Indian businessmen to avail of loans at reasonable interest rates. India needs to brace up cause the US Fed chairperson clearly stated that they will not stop tightening until the inflation target of 2 percent is achieved. In the US the inflation rate is at a 40-year high of 8.3 percent.
In addition to availing loans, India is also a major importer of crude oil, with 80 percent of its supplies coming from outside. We consume close to 5.05 million barrels a day, and an increase in Dollar value means an increase in import cost of import, as we will be bringing in less oil with the same amount of money. This will make the already high fuel prices further soar. Additionally, day-to-day devices, like cell phones, laptops, TV sets, and the like will cost substantially more, given that we import a large chunk of its components from outside.
What is India doing?
The RBI strategy of selling dollars has only led to a decrease in Forex Reserve from 640 Billion to 500 Billion USD. This comes at a time when the dollar index is constantly increasing. However, India has far from given up. For example, we are working towards the de-dollarisation of our international trade. The Rupee-Riyal trade with Saudi Arabia, the non-dollar trade with Bangladesh are positive developments in this issue. Also, on the bright side, this is a golden opportunity for exporters who can now sell at a higher price.