FALL OF THE INDIAN RUPEE IN 2022

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Context

The Indian rupee depreciated over 11 percent in 2022 against the dollar -- its poorest performance since 2013.
The rupee closed 2022 at 82.61 to the US dollar, down from 74.29 at end of 2021.

The concept of Rupee Depreciation

The value of Indian currency or any other currency depends on its demand.
If demand for any currency increases, its value also goes up (it is termed appreciation).
And if the demand for a currency declines, its value also goes down (depreciation).
The demand for Indian currency goes up when more and more foreign investors make investments in India.
That is because when foreign investors or companies invest in India or buy any products from India, they first convert their currency into rupees as they can invest only in rupees in Indian markets.
As a result, demand for the Indian currency increases, and its value strengthens against the US dollar and other currencies.
On the other hand, when Indian individuals and companies import something (like crude oil, gold, etc.), they have to make the payment in dollars (the de facto global currency).
So, Indians sell rupees to buy dollars because the US dollar is the currency to make payments for international trades. Consequently, demand for the dollar goes up, and the rupee weakens against the US currency.
Since India has been a net importer (we import more than we export), the rupee has gradually depreciated over time.
Given that India has been a net importer, the Indian currency’s gradual decline is never a huge concern. However, if the pace of the rupee’s fall is sudden, it is an alarming situation.

Current Scenario

The dollar is at its highest level since 2000, having appreciated 22 percent against the yen, 13 percent against the Euro and 6 percent against emerging market currenciessince the start of 2022.
While the US share in world merchandise exports has declined from 12 percent to 8 percent since 2000, the dollar’s share in world exports has held around 40 percent.
Such a sharp strengthening of the dollar in a matter of months has sizable macroeconomic implications for almost all countries, given the dominance of the dollar in international trade and finance.

Why is the dollar strengthening?

As of now, economic fundamentals are a major factor in the appreciation of the dollar:

The decision by U.S. central bankers at the Federal Reserve to begin aggressively raising interest rates to fight inflation.
A more favorable terms-of-trade—a measure of prices for a country’s exports relative to its imports—for the US.
Global investors moving assets to the perceived safety of the U.S. in the face of uncertainty created by Russia's invasion of Ukraine.
The massive terms-of-trade shock triggered by Russia’s invasion of Ukraine is a major driver behind the dollar’s strength. This is happening in Europe, in particular, because of the uncertainty created by the war in Ukraine. Russia, heavily sanctioned by the West for its aggression, controls much of the natural gas that Europe uses to power its factories and heat its homes. The surge in gas prices has brought its terms of trade to the lowest level in the history of the shared currency.

At a very fundamental level, the US economy is doing better than other economies. Despite very high rates of inflation, the American job market has done extremely well and sectors like services have remained resilient.This has increased confidence in the market, and offset concerns such as those over a slowdown in the housing sector.

The falling Rupee

The Indian rupee depreciated over 11 per cent in 2022 against the dollar -- its poorest performance since 2013 and the worst drubbing among Asian currencies.
The rupee closed 2022 at 82.61 to the US dollar, down from 74.29 at end of 2021 as the US currency headed for its biggest yearly gain since 2015.

Why Rupee is Falling?

A multitude of factors, including the ongoing Ukraine crisis, the raising of interest rates by the US Federal Reserve, investors selling Indian stocks to buy foreign ones, are believed to be the reasons behind the falling rupee.
As inflation rises across the world and domestic growth slows, investors usually look to sell their Indian assets and put the money into the US markets for better safety and returns.
The rupee is falling against the dollar primarily because of the growing trade deficit that imports are increasing at a much higher pace than exports.
The increase in imports is mainly due to a sharp increase in oil prices following the Ukraine crisis. The increase in the import bill for coal and other essential commodities particularly raw materials has bloated the import bill.

Impact Of Weakening Rupee

The weakening of the rupee against the dollar is going to impact the Indian economy and ordinary citizens. The falling of the rupee signifies the depreciation of its value against the US dollar, which broadly means the government, companies and citizens are forced to pay increasing amounts of money.
The depreciation of money is a direct indication of inflation.
As the price of the rupee falls, importing goods and raw materials becomes increasingly expensive, which then pushes up the prices in the domestic market.
India is the world's third-largest consumer of oil and imports over 80 percent of it from other countries to meet its needs. A weakening rupee puts pressure on the already high import prices of crude and raw materials, resulting in higher imported inflation.
With the increase in fuel prices, the prices of almost all the other goods and products sold in India also increase.
If the prices of crude oil continue to rise, there is a possibility that the falling of the rupee will continue. Thus, inflation in the country would continue to rise as well.
On the other hand, a stronger dollar means you need more of Indian currency to buy it than before. The personal finances of the Indians get impacted both directly and indirectly by the falling of the rupee.
As India is predominantly an import-dependent nation, the consequences of a weak rupee are more severe. Imported goods become more expensive and therefore a weakening of the rupee is one factor contributing to rising inflation at present. The prices of household goods are also expected to go up.
Industrial production costs are likely to increase in automotives, electronics, hardware and other segments where import dependency is high.
With the falling rupee, imports will become expensive while exports competitive. Regardless of what is imported, the prices of most of the commodities are linked to international prices. Prices of gold, silver, steel, copper, coal, energy and others will be affected. In nutshell, a falling rupee is bad for industrial production.

Way Ahead

The appropriate response is to allow the exchange rate to adjust, while using monetary policy to keep inflation close to its target.
The higher price of imported goodswill help bring about the necessary adjustment to the fundamental shocks as it reduces imports, which in turn helps with reducing the build-up of external debt.
In this fragile environment, it is prudent to enhance resilience. Although emerging market central banks have stockpiled dollar reserves in recent years, reflecting lessons learned from earlier crises, these buffers are limited and should be used prudently.
Countries must preserve vital foreign reserves to deal with potentially worse outflows and turmoil in the future.
Fiscal policy should be used to support the most vulnerable without jeopardizing inflation goals.