Why in news?

• The Indian rupee hit an all-time low against the U.S. dollar in the last week of June, 79 Rupees to a dollar mark  and selling as low as 79.05 against the dollar.

Rupees downfall

• The Indian rupee has been witnessing a steady decline this year, losing more than 6% against the U.S. dollar since the beginning of 2022.
• India’s forex reserves have also dropped below $600 billion, plunging by more than $50 billion since September 3, 2021.

Determining the currency value:

• The value of any currency is determined by demand for the currency as well as its supply.
• When the supply of a currency increases, its value drops.
• On the other hand, when the demand for a currency increases, its value rises.
• In the wider economy, central banks determine the supply of currencies, while the demand for currencies depends on the amount of goods and services produced in the economy.
• In the forex market, the supply of rupee is determined by the demand for imports, export and various foreign assets.

Exchange rate determination:

• A floating exchange rate is set by the forex market based on supply and demand relative to other currencies.
• A fixed or pegged exchange rate, is a rate that the government (central bank) sets and maintains as the official exchange rate.
• The price will be pegged with a major world currency like dollar, Euro etc.

Currency Value Fluctuations:

• Revaluation of a currency occurs when the value of a currency is increased relative to another currency in a fixed exchange rate regime, while its vice-versa is devaluation.
• Appreciation of a currency is an increase in the value of country’s currency with respect to one or more foreign reference currencies, in a floating exchange rate system, while its vice-versa is depreciation.

Reasons behind rupee fall:

• The U.S. Federal Reserve has been raising its benchmark interest rate causing investors to pull capital away from emerging markets such as India and increase the dollar demand.
• India’s current account deficit is expected to hit a 10-year high of 3.3% of GDP in the current financial year. It is negatively affecting the rupee.
• Consistently higher domestic price inflation in India.

Impact:

a) Positive:

• Weaker rupee should theoretically give a boost to India’s exports, but in an environment of uncertainty may not translate into higher exports.

b) Negative:

• It poses risk of imported inflation, and may make difficult for RBI to maintain reasonable interest rates.
• India’s imports value and current account deficit (CAD) will increase.
• Widening of CAD impacts the health of the economy leading to investors pulling out their investment from India. That’s another reason for falling currency and forex reserve.

Way forward :

• RBI can start supplying dollars in the open market to cool down the exchange rate.
• The government should focus on exports and rearrange the imports also.
• RBI would have to monitor the other components of demand for dollars.
• Channels for external commercial borrowing should be looked at judiciously.
• Considering a sovereign bond or any such scheme, for getting expatriates to invest in such bonds should be planned.