Should Ordinary Citizens Be Worried About the Rupee's Depreciation?

December 29, 2024

The Indian rupee fell to 85.80 per U.S. dollar on Dec. 27. While this decline significantly affects various groups in India, including importers, consumers, investors, financial markets, and the government, it should also be a concern for ordinary Indian citizens. Here’s why.

First, let’s understand why the rupee dropped so quickly.

One major reason for the rupee’s decline was that Dec. 27 was the settlement day for “currency futures and forwards,” according to The Economic Times. These are financial contracts that fix the exchange rate for buying or selling a currency on a future date, which helps traders manage the risk of changing prices. Because these traders needed to finalise their contracts all at once, many had to purchase dollars to do so. This widespread buying of dollars naturally increased the dollar’s value and pushed the rupee lower.

Compounding this effect was the typical end-of-month demand from businesses importing goods from abroad. Since these importers have to pay their bills in foreign currency, they also hurried to buy dollars at the same time, further weakening the rupee.

Another factor was the Reserve Bank of India (RBI)’s limited early intervention. The RBI often buys or sells dollars to prevent the rupee from moving too sharply, but on that particular morning, it held off on stepping in. By the time it did intervene, the rupee was already trading as low as 85.80 against the dollar.

Analysts say the rupee is overvalued, at about 8%, using a metric, called the Real Effective Exchange Rate (REER), according to the Times. The REER compares the rupee’s value against a group of currencies, not just the dollar. A score above 100 on this scale indicates the rupee is stronger than its ideal level. Currently at 108, the rupee is about 8% too strong, which makes Indian goods costlier abroad and imports cheaper.

This overvaluation can negatively impact exports, so a drop in the rupee’s value could make Indian exports more competitively priced internationally.

The RBI often allows the rupee to weaken so that exports remain competitive. By letting the rupee lose some value, Indian goods become more affordable for foreign buyers, which can help drive export revenues. Further, because the rupee is considered overvalued, letting it drop brings its value closer to a point that more accurately reflects global economic realities.

In comparison with other Asian currencies, the rupee’s decline has actually been somewhat milder. Even though the rupee is falling, it has been doing so at a slower rate than some of its regional counterparts.

Looking ahead, analysts predict that the rupee might weaken further, possibly dipping below 86 rupees per dollar, according to the Times. Apart from India’s own budgeting process and monetary policy decisions, multiple factors could cause this, including geopolitical events such as the inauguration of a new U.S. president, Donald Trump, and any major policy changes that might follow.

Now, should ordinary Indian citizens be concerned about the depreciation of the rupee? Absolutely.

Firstly, a weaker rupee makes imported goods more expensive. India imports various essential commodities, including oil, which affects fuel prices and, consequently, transportation costs. As transportation costs rise, so do the prices of goods and services throughout the economy, leading to inflation. This means everyday items at the grocery store could cost more.

Moreover, inflation can influence interest rates. If prices rise too quickly, the central bank might increase interest rates to control spending and inflation. Higher interest rates would make borrowing more expensive, affecting everything from home loans to business investments.

However, the overall economic environment can become uncertain during periods of currency depreciation. This uncertainty can deter foreign investment, as investors may see a volatile currency as a sign of economic instability. Reduced foreign investment can limit funding for new projects and industries, curtailing economic growth and job creation.