A country’s currency is a determinant of its financial stability and prosperity. In order to have a strong currency, a country needs to be self sustainable, with stable Government policies and a strong economy. A weak currency is a sign of poor economic policies, lack of reliability, and bad governance.
India is facing a huge decline in Rupee against US dollar, which has put a smile on the faces of exporters as they will get more Rupees per US Dollar, but is a sign of worry for the Indian economy as India is a net importer and is currently facing a trade deficit of $78 billion.
At the time of writing this post, the Indian Rupee is already trading at 70.40 to the Dollar, the lowest level it has ever been.
So what is the reason behind such a drastic fall in the India Rupee? There is not just one but four major reasons why Indian Rupee is losing its value. Let us examine each of them one by one.
1. Rising Crude Oil:
Crude oil is the biggest import for India. In the year 2016-17, India imported Crude oil of $54.8 billion. India’s 80% of Crude Oil demand is met by imports. If we look at the recent trends in the crude price, we can see there has been a significant rise in crude oil’s price.
India’s GDP is growing at 7% per annum. Rapid economic expansion is leading to higher demand for crude oil, and rising crude oil prices is adding significant pressure to our import bills.
If the crude oil prices keep rising, its going to worse India’s import bills, leading to widening of trade deficit.
2. Rising Gold Imports:
India is the 2nd largest consumer of gold in the world. It is the second biggest import for India after crude oil.
India saw a huge jump in gold import in the month of July, with 44.2 % jump in year on year basis. With festive season round the corner, there will be a huge surge in demand of Gold, leading to further imports, and since most of the India’s gold is imported, it will put more pressure on Indian Rupee against the US Dollar, leading to further decline.
3. Rising Trade Deficit:
Trade deficit is the amount by which a country’s imports exceeds the exports. In other words, if a country imports more goods than it exports, the difference between the import and export is called deficit.
High Trade deficit implies that country’s import bills are higher than export bills and it has to buy more foreign currency to pay for its trade obligations.
Because of this, there is higher demand for foreign currency(in this case USD), leading to decline in value of domestic currency(in this case INR).
India’s trade deficit widened to USD 18.02 billion in July 2018 from USD 11.45 billion in the same month a year earlier. It was the largest trade gap since May 2013, as imports jumped 28.81 percent to USD 43.79 billion, boosted by higher purchases of petroleum, crude (57.41 percent), gold (40.94 percent).
As the trade deficit widens, more US Dollars will be purchased by India, leading to further rise in US Dollar against the Indian Rupee.
4. Decline in FDI (Foreign Direct Investments):
Unlike FIIs, which are considered “hot money” as they can pull out their funds any time, FDIs or Foreign Direct Investments are long term investments made by foreign entities.
FDI involves buying assets such as land, building etc (in partnership with an Indian company), manufacturing and selling products in India.
FDI requires buying of Indian Rupees in exchange of US Dollars, leading to stronger Rupee against the US Dollar.
In the past few months, there has been a significant decline in FDI inflows. As per the data released by DIPP(Department of Industrial Policy and Promotion) in July, despite Government’s efforts, there has been a mere 3% growth in FDI in the year 2017-18.
A further decline in FDI inflows could put pressure on country’s balance of payments, leading to further decline in value of Indian Rupees.
A weak Rupee creates a natural barrier for imports as it becomes more expensive, but it also makes exports more attractive as now each Dollar of export fetches more Rupees.
Since higher import (especially energy) means higher inflation, stock market investors should be ready for some volatility in markets, as higher inflation will lead to increase in interest rates, making fixed income instruments a preferred investment.
This will lead to some profit booking in the already overvalued market, causing some market correction in the near future. Investors looking to make fresh entry in the market should be cautious as declining Rupee may cause market sell off.